Why is the market-consistent embedded value important?
The market-consistent embedded value (MCEV) is used in order to value future income streams from life insurance policies and to determine the value of life insurance in force for their shareholders. The valuation of life insurance business is complex because the policies often run for very long terms and contain a wide range of financial options and guarantees. With the MCEV these policies can be valued more accurately than with more traditional methods. It is therefore calculated by almost all large life insurance companies.
Its calculation follows a number of firmly established principles and is based on the latest financial market data and securities prices. The process of determining MCEV involves modelling all cash flows from life insurance in-force business and simulating them for several thousand different future capital market scenarios. Thus, these calculations are fairly complex and time-consuming. MCEV is used to value companies, to manage and coordinate business processes and to form the basis for various regulatory capital requirements.
What are the main components of MCEV?
MCEV corresponds to the equity available (SNA, B2), plus the current value of future profits from in-force life business (VIF, A2 / A3). The main components of MCEV are:
equity available (capital required for solvency reasons plus free capital)
value of future profits in the case that all investments yield the return of a risk-free investment
cost of options and guarantees for insurance policies incurred as a result of volatility in capital markets
Opportunity costs such as taxes and investment costs, e.g. for capital required for solvency reasons
cost of risk capital for risks not otherwise taken into account, e.g. insurance risks such as death and disability.