EV vs EEV vs MCEV

[Joi]

Hi,

I am confused with the differences of these 3, and would like to check if my understanding correct:

EV is the most traditional embedded value methods, lack of consistency and did not always allow appropriately for risks or for the value of options and guarantees.

Both EEV and MCEV improve consistency & transparency, allowance for risk for value of options & guarantees, but

1. EEV allow for the time value of options and guarantees (compared to EV), and others remain the same as EV? Eg investment returns us BE assumptions, discount rates used required rate of return

2. MCEV is the evolution of EEV or it is a "choice" such that company can choose to use EEV or MCEV? and which one usually used in industry?

3. my understanding for the formula is:
EV = Net Assets + PVIF {where net asset is Free surplus + Required capital minus cost of holding capital but does not explicitly separate)
EEV = Free surplus + Required capital minus cost of holding capital + PVIF
what about MCEV?

4. In exam, when question say EV is actually refering to EV or EEV?

 

[Lindsay Smitherman]

'EV' is just short-hand for 'embedded value'.

EV can be calculated on a traditional basis, or (if the company is based in Europe) it might comply with the European Embedded Value (EEV) principles or with the Market-Consistent Embedded Value (MCEV) principles.

EEV could either be calculated on a traditional or market-consistent basis. So the projection basis could either use best estimate assumptions (including investment returns) & a 'risk discount rate', or risk-free investment returns & risk-free discount rates.

As you indicate, EEV needed to allow for the time value of options & guarantees (whereas, prior to that, traditional EV calculations didn't necessarily do so) and net assets are split down into free surplus and required capital, with a deduction being made for the cost of holding required capital.

The MCEV Principles were issued in 2008 (as stated in the Core Reading), intending to replace the EEV approach, but only stayed as draft. They basically were the same as for EEV but now required a market-consistent projection basis to be used. They never became mandatory - largely because at around that time, Solvency II was being developed and (as explained in the course notes) the value of continuing to report any EV became questionable when the Solvency II balance sheet would provide (broadly) equivalent information.