Embedded Value Calculation for. a Life Insurance Company

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1 Embedded Value alculaion for a Life Insurance ompany Frédéric Tremblay Frédéric Tremblay, FSA, FIA, is an Acuarial onsulan, Indusrial Alliance, orporae Acuarial Serices, 8 Grande Allée Oues,.P. 97, Succ. Terminus, Québec GK 7M3, anada,

2 . INTRODUTION DEFINITION OF EMBEDDED VALUE FORMULAS AFTER-TAX PROFITS ON IN-FORE RELEASE OF MARGINS ASSETS OST OF LOKED-IN APITAL EMBEDDED VALUE ALULATION Profis o shareholders mehod os of capial mehod Profis o shareholders mehod equals cos of capial mehod ASSUMPTIONS EONOMI ASSUMPTIONS NON-EONOMI ASSUMPTIONS REFLETING THE RISK IN THE EMBEDDED VALUE ALULATION EMBEDDED VALUE REONILIATION FROM ONE PERIOD TO ANOTHER NORMAL INREASE IN EMBEDDED VALUE VALUE ADDED BY NEW SALES DIVIDEND PAID UNEXPETED HANGE IN EMBEDDED VALUE EMBEDDED VALUE VS STOK PRIE OTHER USE OF THE EMBEDDED VALUE AND ITS METHODOLOGY OMPENSATION TIED TO EMBEDDED VALUE ATUARIAL APPRAISAL GOODWILL ONLUSION BIBLIOGRAPHY... 2

3 ABSTRAT During he pas few years, we hae seen a new ool gaining imporance in he appreciaion of life insurance companies. Afer haing been used by European counries, he embedded alue calculaion has now made is appearance in Norh America. In his paper, we will ake a look a he embedded alue for a anadian company. Een if his paper has been wrien in a anadian conex, he principles behind he embedded alue calculaion also hold for any company in any counry. Firs, we will look a how he profis emerge from a life insurance company. Nex, we will look a he formulas behind he embedded alue and discuss how he assumpions can be deermined. Then we will analyze he moemen of he embedded alue from one year o anoher and idenify elemens haing an impac on he embedded alue. Finally, we will look more closely a he use of he embedded alue.. INTRODUTION The financial resuls of life insurance companies are ery complex o analyze. They are prepared according o accouning and acuarial principles arying from one counry o anoher. The financial communiy ofen uses he price-o-earnings raio as a ool o analyze and compare companies. The profis generaed by he company in one year are no guaranee of he fuure. I is impossible o deermine he alue of a company using hese simple 3

4 resuls. Eeryhing around a life insurance company is ied o solency and he naure of he producs sold is long erm, which makes his ype of business unique. Oer he years, life insurance companies hae buil ools o help hem analyze and undersand heir financial resuls. Mos of hese ools do no hold a long-erm ision of he profiabiliy for he company, relying solely on he shor-erm financial resuls. One ool has he abiliy o synhesize he informaion on long-erm profiabiliy in one simple alue; his ool is called he embedded alue. The embedded alue is he calculaion of he alue of a block of business ha considers all he requiremens an insurance company can hae. This is he calculaion of he presen alue of surplus disribuable o shareholders based on bes esimae assumpions. 2. DEFINITION OF EMBEDDED VALUE The embedded alue is he aluaion of a company s curren in-force alue wihou aking ino accoun is capaciy o generae new business. By definiion, i is hen a minimum alue for he company according o he assumpions used in is calculaion. The embedded alue can be adjused by adding he esimaed alue of fuure new sales o obain he appraisal alue of he company (acuarial appraisal is discussed in secion 7.2). The embedded alue is defined as he alue of in-force business plus he alue of he free capial. The alue of in-force business is he presen alue 4

5 of he amouns generaed by he in-force ha will be disribuable o he shareholders in he fuure. Disribuable amouns are discouned using he reurn expeced by shareholders on heir inesmen. The free capial is he capial in excess of wha is currenly required o mee he goernmen s regulaory capial requiremens under he assumpions of he embedded alue. This amoun could be immediaely disribuable o he shareholders. Een hough he alue of fuure new business is no included in he embedded alue, he alue of one year of new business is ofen disclosed as a separae iem ha will be used exernally, so he olailiy of his alue is clearly an imporan issue. According o he Inerim Draf Paper on he onsideraions in he Deerminaion of Embedded Value for Public Disclosure in anada, published in Sepember 2 by he ommiee on he Role of he Appoined/Valuaion Acuary of he anadian Insiue of Acuaries, new business for embedded alue reporing purposes should be defined in a manner consisen wih he company s curren financial reporing pracices. Any change o his definiion should be disclosed, oherwise here could be unexplained ariaion in he alue. We need a precise definiion of new business o disinguish i from in-force business. This definiion is mos imporan for group insurance, indiidual annuiies wih ax-free ransfers, renewable deposis conracs and reinsurance, because we need o clearly disinguish beween a new issue and a renewal of conrac. 3. FORMULAS 5

6 3. AFTER-TAX PROFITS ON IN-FORE The afer-ax profi on in-force business is defined as: Premiums(P ) InesmenIncome(II) Benefis(B) Expenses(E ) - ΔSR TaxOnIncom e(t) AferTaxPr ofis where Δ SR is he increase in sauory acuarial resere. The benefis include deah benefis, wihdrawal benefis, suriorship benefis, ec. The expenses include compensaions paid o agens, premium axes, inesmen income axes, ec. The ax on income is equal o: where TaxOnIncom e ( P II B E ΔTR) Tx Δ TR is he increase in ax resere and Tx is he ax rae. Because of legislaie requiremens, he ax resere is someimes differen han he sauory resere. This creaes a iming difference beween he period profis are earned and he ime he ax is paid on hose profis. So in one year a company can hae high profis wih low ax o pay while in anoher year he company can hae low profis bu a high ax o pay. To preen his, companies hold a deferred ax proision 2. This proision is used o accoun for he iming difference beween he sauory profis and he ax profis and i recognizes he gain or he loss of haing o pay for he ax earlier or laer in ime compared o he ime sauory profis are earned. 2 The calculaion of his proision is described in he educaional noe Fuure Income and Alernaie Taxes published in December 22 by he ommiee on Life Insurance Financial Reporing 6

7 By definiion, his proision axes he company on profis as hey are earned and recognizes immediaely he gain or he loss due o he iming difference. For policies issued afer 995, income in anada is axed on a sauory basis. This means he ax resere is equal o he sauory resere for hose policies. For he sake of simpliciy, in his paper we will assume he ax resere is always equal o he sauory resere. This is a conseraie assumpion if he ax resere calculaed for policies issued before 996 is higher han he sauory resere. This is because axing hose producs on he sauory profis has he effec of no including he gain from being able o pay he ax laer han he profis are earned. Howeer, his assumpion would no be correc if he ax resere is lower han he sauory resere because he subsequen recoery of axes paid sooner han profi was earned would no be refleced. 3.2 RELEASE OF MARGINS Pre-ax profis released from he reseres are essenially he proisions for aderse deiaion (PfADs). PfADs are profis held back in he reseres in addiion o he amoun necessary o coer he fuure liabiliies because of conseraism included in he calculaion of reseres (which is required by acuarial principles o make sure ha he acuarial reseres are sufficien should experience deiae unfaorably from expeced). Those PfADs flow hrough he income saemen when experience shows ha such proisions are no longer necessary. Wihou margins in reseres, he presen alue of profis would be null, profis would be released a policy issuance hrough a negaie resere, and here would be no more profis o be released in he 7

8 fuure. Negaie reseres can arise because anadian sauory reseres are calculaed using he gross premium. The gross premium is sufficien o coer fuure benefis as well as issue expenses herefore creaing a negaie resere in early policy years. The presen alue of profis in he embedded alue calculaion is no simply he presen alue of margins calculaed wih he resere mehodology, because i would assume ha he presen alue is done using he aluaion ineres rae. In fac, shareholders require a higher rae of reurn han he aluaion rae, so he presen alue of profis should be lower han he presen alue of margins calculaed using he aluaion rae. 3.3 ASSETS The following graphic shows he oal asses held by a life insurance company: Free apial Locked-in apial Proision for aderse deiaion Bes Esimae Liabiliies As we saw in secion 3.2, he bes esimae liabiliies and he proisions for aderse deiaion compose he resere. The locked-in capial is he capial 8

9 ha he company mus hold according o he regulaory auhoriies. I is a percenage of he Minimum oninuing apial and Surplus Requiremens (MSR) or is proincial equialen. ompanies mus hold more han percen of he MSR because he calculaion does no explicily address some risks. The Office of he Superinenden of Financial Insiuions (OSFI) expecs each insiuion o keep a capial leel a no less han he superisory arge of 5 percen MSR 3. The free capial is he capial of he company in excess of he locked-in capial a he aluaion dae. The embedded alue will be composed of he same alues as he oal company asses. Howeer, he free capial will be included a is marke alue in he embedded alue. The locked-in capial will be less han is marke alue because we hae o reduce i by he fuure expeced cos of keeping i, as we will see in he nex secion. As explained in secion 3.2, he alue of he margins will be lower han he alue of he asses backing i because he presen alue of he release of margin will be done using a higher rae han he aluaion rae. The bes esimae liabiliies are gien no alue in he embedded alue because hey will be used o coer fuure liabiliies or coningencies; hey are no a profi. 3.4 OST OF LOKED-IN APITAL The quesion is how can keeping capial cos somehing? The capial comes from he shareholders and hey expec a higher reurn on heir money han he risk-free rae of reurn aailable on he marke because here is a risk of 3 See MSR guideline, p

10 inesing in he company. The company iness his capial in low-rae asses, such as risk-free asses, and he company has o pay income ax on he reurn i ges from his inesmen. The shareholders will require a reurn equal o he risk-free rae plus a risk premium, so he company needs addiional profis o coer he risk premium plus he income ax. The aferax profis needed in addiion o he afer-ax inesmen income on he asses backing he capial o coer shareholders expecaions are he cos of he capial. The rae of reurn required by shareholders is he hurdle rae (see secion 4 on he discussion of he assumpions o learn more abou he hurdle rae). 3.5 EMBEDDED VALUE ALULATION 3.5. Profis o shareholders mehod The more direc way o calculae he embedded alue is hrough he profis o shareholders mehod. This mehod calculaes he profis aailable o he shareholders each year and hen akes he presen alue of hose profis. The profis aailable o shareholders are defined as: AferTax Pr ofis AferTaxInIncomeOnapial IncreaseInapial Pr ofistoshareholders

11 In he las formula, he AferTaxInIncomeOnapial is he inesmen income earned by inesing he capial. The increase in capial is he amoun of capial ha has o be held in addiion o wha was held in he preious period. I is he change in locked-in capial. As he business ages, capial is released and compleely disribued back o shareholders. The presen alue of he profis o shareholders will be calculaed a he hurdle rae (see secion 4 on he discussion of he assumpions o learn more abou he hurdle rae). The iniial amoun of capial a he beginning of he projecion will be equal o he locked-in capial. The free capial is he capial in excess of he locked-in capial a he aluaion dae and i will be added o he presen alue of profis o shareholders o ge he oal embedded alue. This amoun of capial is immediaely disribuable o he shareholders os of capial mehod Anoher way o calculae he embedded alue is called he cos of capial mehod. In his mehod, he embedded alue is sripped ino hree pars: he oal capial (free capial plus locked-in capial) plus he presen alue of fuure afer ax profis less he presen alue of he cos of capial. The presen alue of fuure profis is simply he presen alue a he hurdle rae of he afer ax profis, and he free capial is he capial in excess of he locked-in capial a he aluaion dae.

12 As we saw in secion 3.4, he cos of capial is he cos of haing o pay he shareholders a higher reurn on capial hen he reurn he company can earn on he asses backing he capial. In he embedded alue calculaion, he capial ha he company has o pay is he locked-in capial (see secion 3.3 on asses). According o he definiion we gie i aboe, he cos of capial in a gien year can be ranslaed ino he following formula: HurdleRae apial AferTaxInIncomeOnapial osofapial where apial is he locked-in capial a he beginning of year and osofapial is he cos of he capial a he end of year Profis o shareholders mehod equals cos of capial mehod The mehods presened aboe are equialen. This secion presens he reconciliaion of he wo mehods. According o he profis o shareholders mehod, he embedded alue is equal o he following: 2

13 EmbeddedValue Freeapial PV (Pr ofistoshareholders) Freeapial PV ( AferTax Pr ofis AferTaxInIncomeOnapial IncreaseInapial) Freeapial PV ( AferTax Pr ofis) PV ( AferTaxInIncomeOnapial) PV ( IncreaseInapial) where PV( ) represens he presen alue of he iems in parenheses a he hurdle rae. According o he cos of capial mehod, he embedded alue is equal o: EmbeddedValue Freeapial LockedInapial PV ( AferTax Pr ofis) PV ( osofapial) Freeapial LockedInapial PV ( AferTax Pr ofis) PV ( HurdleRae apial AferTaxInIncomeOnapial) Freeapial LockedInapial PV ( AferTax Pr ofis) PV ( HurdleRae apial ) PV ( AferTaxInIncomeOnapial) The wo formulas aboe hae pars in common ha we can remoe o ge he following equaliy o be proed: or PV ( IncreaseInapial) PV ( HurdleRae apial ) LockedInapial PV ( HurdleRae apial ) PV ( IncreaseInapial) LockedInapial To simplify he presenaion, he following noaion will be used in he proof below: 3

14 4 IncreaseInapial apial LockedInapial apial h HurdleRae h Δ Δ The following equaliy is also known: h Proof: ) ( ] [...] [...] [...] ) ( ) ( ) [( ) ( ) ( PV h h h h h h h h h h PV Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ Δ 4. ASSUMPTIONS

15 The assumpions deerminaion is ery criical in he embedded alue calculaion. The embedded alue is ery sensiie o he assumpions underlying he calculaion. Therefore, for he sake of consisency in fuure embedded alue recalculaion, i is imporan ha he mehodology used o se he assumpions produces realisic assumpions and ha i be objecie. The objeciiy crieria is ery imporan because we wan he embedded alue o reflec changes in he enironmen, no changes due o human judgmen. The assumpions used in he embedded alue calculaion can be mainly spli ino wo caegories: he economic and he non-economic assumpions. 4. EONOMI ASSUMPTIONS The economic assumpions refer o all he assumpions relaed o he economic marke. Those are mainly fuure reinesmen raes on fixed income asses, fuure reurns on ariable income asses (such as socks and real esae), currency exchange raes, defaul raes, inflaion raes and inesmen expenses. 4 Because hose assumpions hae a high leel of correlaion, i is ery imporan o ensure consisency in heir seing. Ineres raes are used o projec asses and liabiliies as well as o discoun fuure profis in he embedded alue (he hurdle rae). The ineres raes for asses and liabiliies mus be consisen for each fuure projecion year. The hurdle rae is a fixed 4 See Inerim Draf Paper on he onsideraions in he Deerminaion of Embedded Value for Public Disclosure in anada 5

16 rae consisen wih he acual enironmen a he embedded alue calculaion dae. The hurdle rae mus no ary for he projecion period because i has o reflec he curren rae cure, no he expeced rae cure(s) in he fuure. This rae should reflec he long-erm, risk free rae plus an esimae of he risk premium demanded by inesors. The hurdle rae may ary according o he counry in which he business operaes o allow for differences in he risk free rae and he risk premium (as an example, he risk premium may be increased o reflec currency exchange raes). The fuure reurn on ariable income asses should be consisen wih he expeced raes on fixed income asses and wih he hurdle rae. Therefore, i may be appropriae o assume ha he fuure reurn on socks is no higher han he hurdle rae. Seing he fuure reurn on socks equal o he hurdle rae has he adanage of aoiding o creae unusual embedded alue moemen in he fuure. If he hurdle rae changes we auomaically change our reurn expecaion on socks. For morgages, a mehod o reflec he relaionship wih fixed income reurns can be o se a risk premium oer fixed income asses and o assume i is consan oer ime. Regarding he inflaion rae, a mehod can also be deeloped o hae i consisen wih he fixed income raes. 4.2 NON-EONOMI ASSUMPTIONS The main consideraions in seing he oher acuarial assumpions are ha hey mus be bes esimae assumpions comparable o aluaion assumpions wihou margins. Therefore, he assumpions should be consisen, or he 6

17 same, as he assumpions presened in he Appoined Acuary s repor. In he een of any regulaory resricion in he bes esimae assumpion se by he appoined acuary, he assumpion used in he embedded alue calculaion should be he rue bes esimae, wihou any resricion. 5 An example of his is he moraliy improemen ha should be included in he embedded alue projecion bu canno be refleced in he aluaion of liabiliies. The assumpions relaing o required capial calculaions or axaion (inesmen income ax, premium ax, corporae ax) should only reflec fuure changes ha are announced or confirmed by he ax auhoriies a he calculaion dae. An assumpion is also required o deermine he appropriae leel of lockedin capial. As we saw in he secion 3.3 aboe, OSFI expecs each insiuion o keep a capial leel a no less han he superisory arge of 5 percen MSR. Therefore, he locked-in capial should be se o produce a solency raio a leas equal o 5 percen. urrenly, he companies ha publish heir embedded alue in anada are seing heir locked-in capial o hae a raio of 5 percen. For he sake of consisency and o allow comparisons beween companies, a arge raio of 5 percen should be used. 4.3 REFLETING THE RISK IN THE EMBEDDED VALUE ALULATION 5 See Inerim Draf Paper on he onsideraions in he Deerminaion of Embedded Value for Public Disclosure in anada 7

18 The embedded alue is only a bes esimae. In he fuure, here may be differences beween he assumpions used in he calculaion and he realiy. This is only one ision of he fuure. There are a lo of ways o reflec he risk in he embedded alue (he risk ha he real embedded alue differs from he calculaed one). The bes way o help people assess he risk in he embedded alue is o presen he sensiiiy of he number o differen changes in he assumpions. As an example, one could change he risk premium. A high sensiiiy of he embedded alue o he risk premium indicaes ha mos of he profis are far ino he fuure. Anoher es ha could be done is o change he ineres rae cure. In addiion o he es of differen assumpions, he alue of some assumpions could be separaely presened. As an example, one could disclose he alue of moraliy improemen in he projecions. The alue of a higher risk block of business could also be presened separaely. Segregaed funds wih a guaranee is a good example of a risky business wih a alue changing according o he sock marke. Because his business can be ery olaile, he embedded alue associaed wih i could be isolaed from he res of he business and presened separaely. 5. EMBEDDED VALUE REONILIATION FROM ONE PERIOD TO ANOTHER The mos imporan hing wih he embedded alue is no he alue iself, bu he change in his alue oer ime. As we saw in secion 4, he embedded alue reflecs one ision of he fuure, so wo acuaries can hae differen 8

19 expecaions for he fuure. Een if he embedded alue is differen for wo acuaries, he impac of he enironmen on he alue should be similar for he wo of hem. As an example, if he goernmen reduces he ax rae, he embedded alue will increase. So, for wo acuaries he embedded alue should increase and he proporion of he increase o he embedded alue should be similar for boh. The embedded alue moemen from one period o anoher is defined in he general formula below. EmbeddedValue( ) NormalIncreaseInEmbeddedValue ValueAddedByNewSales DiidendsPaid UnexpecedhangeInEmbeddedValue EmbeddedValue( ) 5. NORMAL INREASE IN EMBEDDED VALUE The normal increase in embedded alue is as follows: ( EmbeddedValue( ) Freeapial) h Freeapial i NormalIncreaseInEmbeddedValue where h is he hurdle rae and i is he afer ax inesmen income on capial. The free capial canno earn he hurdle rae because he free capial is 9

20 assumed o be reurned o he shareholder a he beginning of he projecion because i is in excess of he locked-in capial (see secion 3.5 aboe, according o he embedded alue definiion, all of he excess capial is auomaically reurned o he shareholder a he aluaion dae). Therefore, any capial kep in excess of he locked-in capial is lowering he embedded alue reurn below he hurdle rae, because his excess capial is no inesed in business earning he hurdle rae, i is inesed in asses earning a lower afer ax rae. ompanies need he profis on heir in-force business o pay he shareholders for he capial. If a company holds more capial han needed, hen he inforce business may no be able o generae enough profis o pay he shareholders. This is he risk of haing oo much free capial. 5.2 VALUE ADDED BY NEW SALES The alue added by new sales represens he presen alue of he fuure afer-ax profis on new sales less he presen alue of he fuure cos of capial. The presen alue of he fuure afer-ax profis mus include he srain (or he gain) a issue, bu no he iniial capial ransfer from free capial o locked-in capial. When here are new sales, a porion of he free capial is reallocaed o back he required capial of hose sales. This elemen does no impac he oal embedded alue since i is only a reallocaion of he oal capial. If he free capial is no sufficien, hen new capial mus be injeced o coer he new sales. This would hae an impac on he embedded 2

21 alue and i should be disclosed as an unexpeced change in embedded alue. The alue added by new sales can be posiie, negaie or null. A negaie alue can arise if he new sales gie a lower reurn on inesmen han he hurdle rae. If he new sales reurn on inesmen is equal o he hurdle rae, hen no addiional alue will be creaed. 5.3 DIVIDEND PAID The diidend paid represens he real diidend acually paid o he shareholders during he period. Because his diidend is paid from free capial, i direcly reduces he alue of he free capial and herefore reduces he embedded alue. 5.4 UNEXPETED HANGE IN EMBEDDED VALUE This las reconciliaion componen represens anyhing else affecing he embedded alue. The following elemens are he mos frequen: Difference beween expeced assumpion and acual experience for he period (ineres rae, moraliy, lapse, ec.); hange in embedded alue assumpions; apial injecion; Buy back of shares by he company; hange in required capial formula; 2

22 hange in ax rae; Acquisiions 6. EMBEDDED VALUE VERSUS STOK PRIE By definiion, he embedded alue is he presen alue of all fuure amouns ha will be disribuable o shareholders. Because i includes eeryhing belonging o shareholders, i can be iewed as he price of he company, so i could easily be compared o he sock price. The only difference beween he wo is ha embedded alue excludes he alue of fuure business and may use a differen discoun rae. Any change in he enironmen surrounding he company will hae an impac on is price. Measuring he alue of hose changes is a hard ask; his is where he embedded alue mehodology becomes a useful ool. Alhough no giing he exac change in he sock price, he impac of he change on he embedded alue can gie some insighs as how he marke can reac o he change. I is imporan a his poin o undersand ha he calculaion canno gie he exac impac, because here is an infinie number of facors ha canno be included in he model, such as shareholders behaior or oher companies reacions o he change. Howeer, he calculaion can gie some guidance, or i can more precisely assess he alue of and he impacs of he change. As an example, he regulaor can change he required capial formula. How could we ge a sense of his change? Using he embedded alue mehodology, a projecion of he required capial wih he old formula and he new one can be done. The presen alue of he fuure impac, as well 22

23 as he projecion of he impac iself, will indicae if he change in he formula is posiie or negaie o he company. Wihou he embedded alue mehodology, he company can hink he change is a profiable one because curren solency raio could increase. Bu in fac he effec could reerse in he near fuure, leading o a negaie impac for he company. By assessing he impac of he change, he company could reac promply and aoid fuure problems. Anoher use of he embedded alue can be o es he impac of curren managemen decisions and o know how i will affec he company s alue. 7. OTHER USES OF EMBEDDED VALUE AND ITS METHODOLOGY Embedded alue iself and he calculaion mehodology surrounding i can be used for asks oher han rying o predic he sock price. Some of he oher uses are discussed below. 7. OMPENSATION TIED TO EMBEDDED VALUE As seen in secion 6, he sock price ariaion is closely correlaed o embedded alue moemen. According o his principle, i could be ineresing o base managemen compensaion on he embedded alue moemen. This is common pracice in counries such as in Europe, bu no in anada. A good way of doing his can be o base compensaion on he impac of decisions for which managemen has conrol. Wih his ype of compensaion, managemen will hae o ake care of he long-erm impac of is decisions and i will hae he ools o do so. Howeer, we mus be ery 23

24 careful when using embedded alue because of is sensiiiy o he assumpions underlying is calculaion. To base compensaion on he embedded alue may induce manipulaion of he assumpions underlying i. 7.2 ATUARIAL APPRAISAL The embedded alue mehodology can also be used o deermine he purchase price of a company or a block of business. This price is also known as he acuarial appraisal. The acuarial appraisal represens he alue of he in-force business and he alue of fuure business ha he company purchased will proide. The alue of he fuure new sales is ofen expressed as a muliple of he alue added by one year of sales. As seen in secion 5b, if he new sales reurn on inesmen is equal o he hurdle rae, hen no addiional alue will be creaed by fuure new sales. Noe ha his is more likely o happen in appraisal alue calculaion han in embedded alue calculaion because he hurdle rae used for an acuarial appraisal is ofen higher han he hurdle rae used for he embedded alue calculaion. 7.3 GOODWILL New accouning rules for business combinaions and for inangible asses and goodwill were announced by he anadian Insiue of harered Accounans (IA) in 2. Since July 2, all business combinaions mus be accouned for using he purchase mehod. Under his mehod, 24

25 goodwill is he difference beween he oal purchase price and he fair alue of ne asses. The new accouning rules do no assume ha goodwill declines in alue oer ime. For fiscal years beginning on or afer January, 22, goodwill is no amorized. Insead, i is esed for impairmen on an annual basis for applicable reporing unis. The es is a comparison beween he fair alue of he reporing uni and is book alue o deermine if here is an impairmen. If here is one, hen he fair alue of he ne asses of he reporing uni mus be compared o he fair alue of he reporing uni o arrie a he fair alue of he goodwill. The embedded alue mehodology, hrough he acuarial appraisal mehod, can be used o deermine he fair alue of he reporing uni in purchase ransacions inoling insurance liabiliies. 8. ONLUSION I is imporan o keep in mind ha he embedded alue mus be used carefully, always haing in mind he assumpions underlying he calculaion. Wih is adanages and disadanages, he embedded alue is a porion of a whole and i mus be aken his way. This is anoher ool for he inesmen communiy, which in addiion o price o book alue, rae of reurn on equiy, earning by source and price o earnings raio, adds alue o a company. In addiion o proiding an esimaed alue, he embedded alue mehodology is a powerful learning ool. Because is mehodology akes ino 25

26 accounnearly eery aspec of a life insurance company, calculaing i implies haing a closer look a all hose hings in one single projec. 26

27 REFERENES ommiee on Life Insurance Financial Reporing, Fuure Income and alernaie axes, December 22. ommiee on he Role of he Appoined/Valuaion Acuary of he anadian Insiue of Acuaries, Inerim Draf Paper on he onsideraions in he Deerminaion of Embedded Value for Public Disclosure in anada, Sepember 2. Office of he Superinenden of Financial Insiuions anada, Minimum oninuing apial and Surplus Requiremens (MSR) for Life Insurance ompanies, Ocober

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