What it means
The calculation has two main parts. The first is the adjusted net asset value, meaning the insurer's own capital at market values, and the second is the present value of profits expected from policies already in force, discounted back to today.
It matters because life insurance is a long business. Premiums arrive over thirty years while the costs of writing a policy land immediately, so reported profit in a growth year can look poor even when the underlying economics are excellent.
Analysts use embedded value to compare insurers and to judge acquisitions. A buyer typically pays a multiple of embedded value, and the premium above it represents what the buyer thinks the company's ability to write new business is worth.
Because the calculation projects cash flows decades ahead, the assumptions carry enormous weight. Lapse rates, mortality, expenses and the discount rate all feed in, and a small change to any of them can move the total by a wide margin.
Variants exist to make the numbers more comparable. European embedded value introduced common reporting principles, and market consistent embedded value goes further by valuing guarantees and options using market prices rather than internal judgement.
Insurers normally publish a movement analysis alongside the headline figure. It splits the change into new business written, expected returns, experience against assumption and the effect of changing assumptions, which is what tells a reader whether growth came from trading or from the modelling.
In practice
Real-world examples.
Example
A mid-sized life insurer reports modest statutory profit while writing record volumes of new policies. Its embedded value rises by 14% over the same year, which tells shareholders the weak profit line reflects upfront costs rather than a weak business.
Example
An acquirer bids for a closed book of annuities with no new sales at all. Because there is no future new business to value, negotiations centre almost entirely on the embedded value figure and the assumptions behind it.
Example
An insurer cuts its discount rate assumption from 8% to 7% and embedded value jumps sharply. Analysts adjust the figure back to a common basis before comparing it with peers, since the increase came from an assumption rather than from trading. The published sensitivity table makes that adjustment straightforward, which is part of why regulators encourage insurers to provide one.
Think of it
“Embedded value captures the profit locked in existing insurance policies-the value of future earnings.
Formula
Calculation
Embedded value = Adjusted net asset value + Present value of in-force business - Cost of holding required capital. Take a life insurer with adjusted net assets of $600,000,000 and expected future profits from policies already sold worth $900,000,000 in present value terms. Holding the regulatory capital that supports those policies has an opportunity cost with a present value of $120,000,000. Embedded value is 600,000,000 + 900,000,000 - 120,000,000 = $1,380,000,000, and if the shares trade at a total of $1,725,000,000 the market is paying 1.25 times embedded value.Case study
Seen in the real world.
Selworth Life is a fictional insurer used purely as an illustrative example. Its statutory profit had been flat for four years and one large shareholder was pressing publicly for the chief executive to go.
Management published an embedded value analysis alongside the annual report. Adjusted net assets stood at $410,000,000 and the in-force book was worth $780,000,000 in present value terms, less $95,000,000 for the cost of required capital, giving embedded value of $1,095,000,000 against $860,000,000 three years earlier. The flat profit line was an artefact of writing a great deal of new business whose costs hit immediately.
The board also published its lapse, mortality and discount rate assumptions and a sensitivity table showing the effect of moving each one. That transparency mattered more than the headline number, because it let investors judge whether the growth was real or simply the product of optimistic modelling.
Watch out
Common mistakes.
- Treating embedded value as the full worth of the company, when it deliberately excludes any value from business not yet written.
- Comparing two insurers' embedded values without checking whether the discount rates and lapse assumptions are on a similar basis.
- Reading a rise in embedded value as trading success, when it may simply reflect a change of assumption or a move in market rates.
Questions
People also ask.
Why not just use the reported profit figure?
Because insurance accounting recognises costs upfront and income over decades, which distorts the picture for any insurer that is growing.
What is appraisal value?
It is embedded value plus an estimate of the value of future new business, which is what an acquirer is usually really buying.
Do general insurers use it?
Rarely, since their policies typically last a year, so there is little locked-in future profit to value.
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