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EV and PVIF

M

MissBeta

Member
I'm getting mixed up with Q23.4 in the chapter on analysis of change in embedded value. Why does the EV increase by the profit amount only (£400) and the PVIF increases by the profit amount and the fall in the free surplus (£700).

I thought the PVIF was only concerned with the profit and the EV was the profit plus the free assets - so I thought the answer would be that the EV increases by £100 (Profit less the Reserves and AS) and PVIF increases by £400?
 
Hi MissBeta

I think your understanding is basically fine and it's just a question of interpreting what a "profit criterion of £400" means. Perhaps some numbers help...

Imagine that before it sells this policy the company has free assets of £2,000 and PVIF of £0. (Not very realistic, but easier to see what's happening!). So, the total value of the company is £2,000.

When it sells a policy that is worth £400 to the company, the value of the company will increase to £2,400.

We know that when the policy is sold the free assets will become £2,000 - 200 - 100 = £1,700. For the total value of the company to be £2,400, the PVIF must therefore be £700.

In summary, I think a "profit criterion of £400" is effectively the same as an "EV of £400" rather than a "PVIF of £400" (ie it includes the cashflows at t=0).

Hope this helps
Lynn
 
Queries on this question seem to come up repeatedly - can adjustments not be made to the answer in the notes to explain this a bit better?

Thanks
 
We're about to start our next review of the Notes, so I'll flag this up. Thank you.
 
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