EVM: The application of value appraisal of insurance companies

Value appraisal of insurance companies is crucial to all stakeholders. In current insurance market which becomes mature gradually, the valuation system of an insurance company has a great impact on the company’s performance and future development. This article provides an overview on the background and history of the value appraisal systems of insurance companies, as well as an analysis of the evolution and application of Swiss Re’s Economic Value Management (EVM) as a valuation management tool. It shows that the objective of value assessment and management should not be limited to just satisfying regulatory and disclosure requirements, but more importantly, a value appraisal system should be developed to guide business development.

From accounting indicators to value indicators in assessing life insurance companies

As we all know, understanding the performance of the life insurance industry is very important to policyholders, investors, company management and regulatory authorities. As such, what are the indicators commonly used in assessing the performance of life insurance companies?

  • Book value per share: Book value is the difference between assets and liabilities calculated based on the adopted accounting principles.
  • Price to book (P/B) ratio: The P/B ratio reflects the proportion between market value and book value and their trends.
  • Return on equity (ROE): ROE reflects the relationship between net profit and shareholders’ equity; on company level, ROE has a positive correlation with the P/B ratio.

These commonly used accounting indicators are usually derived based on provisions regarding the balance sheet and income statement as stipulated in the statutory accounting principles (SAP), or generally accepted accounting principles (GAAP):

  • SAP: The focus is on measuring solvency to ensure contract obligations are fulfilled. Taking the US as an example, assumptions regarding statutory reserves are relatively conservative, and acquisition cost cannot be deferred. Therefore, under SAP, profit in the current year cannot truly reflect the business performance of the insurance company in that year.
  • GAAP: The focus is on reflecting the potential of revenue creation. GAAP is more suitable in assessing the financial performance of life insurance companies than SAP. Using US GAAP as an example, sales commission is capitalised using the method of deferred acquisition costs (DAC) at the time of policy issuance and is gradually converted as expenses during the term of the policy, thereby partially resolving the issue of losses incurred by new business. Furthermore, liabilities are determined based on best estimate assumptions instead of conservative assumptions. The shortcoming of this method is that discrepancies in the standards used in measuring assets and liabilities may result in significant volatility in shareholders’ equity under GAAP.

The following controversies have always existed when the above-mentioned accounting indicators are used in measuring the performance of life insurance companies, and not until the traditional embedded value (TEV) principles were developed, were such issues resolved.

Compared to accounting indicators, value indicators can better reflect the long-term economic value created by the insurance company, and can be applied in the company’s internal business decisions, pricing, business monitoring and performance measurement, including management compensation. The sensitivity analysis on investment income, risk discount rate, expenses and incidence rate in the embedded value (EV) report is very useful to investors. Analysis on changes in EV at different points in time, such as the variance of underwriting and variance of investment experience, can serve as a reference to management and investors on business activities during a certain period of time.

Over time, the defects of TEV, such as using a fixed risk discount rate, and not taking into account the value of embedded options and guarantees in life insurance policies, were exposed. As a result, concepts such as European embedded value (EEV) and market consistent embedded value (MCEV) were formed. More companies started using EEV or MCEV for external reporting, especially in Europe. However, some external investors and analysts had doubts about MCEV due to data instability.

For the life insurance industry, using consistent, transparent, reliable, and simple indicators to reflect the company’s value creation and earning trends is ideal. However, in reality, there is no perfect, comprehensive measuring tool to reflect the complicated long-term characteristics of the life insurance business that can be understood by all stakeholders. The best solution for life insurance companies is to continue promoting the concept of EV as a supplementary financial reporting tool while monitoring other financial indicators and developing a better assessment system for the industry. The EVM concept introduced in this article is such an example.

EVM as an example of the application of value appraisal

EVM is the integrated economic valuation indicator and steering framework used by Swiss Re Group for business planning, pricing, reserve planning and guiding business direction. EVM was developed based on the valuation principle of market consistency, and is used to measure the value created by different business activities in order to support business decisions behind the value creation, including internal management of each business line as well as integrated management across different business lines.

  • Why adopt EVM?

▶ It reflects insurance companies’ economic value more accurately

  1. Increasing external demands on economic assessment frameworks (investors, analysts).
  2. Regulatory and accounting framework gradually shifting towards economic valuation principles such as SII, SST and IFRS.
  3. Under the macroeconomic environment of increasingly complex insurance products and markets, a more accurate and comparable valuation method is required to measure economic value.
  4. Other economic valuation methods may not be appropriate for insurance companies (overly simplistic), or are not based on actual economic principles

▶ It is an integrated performance valuation measure that can be applied to different business lines (including L&H and P&C insurance)
▶ Increasing competition in the insurance market has led to greater competition for internal capital, thus the allocation of internal capital should be considered.

  • Applying EVM

▶ Implement effective capital allocation through EVM to achieve the group’s financial objectives

▶ Connection between risk-taking and value creation

That is, throughout a performance cycle, an integrated framework is used to evaluate the outcome of controlled risk-taking and capital allocation decisions. While taking into account risk appetite constrains, EVM can also provide a comparison of economic benefits across different business and product lines, thereby providing guidance for capital allocation.

▶ Splits performance of underwriting and investment activities

EVM results are meant to respond to the following three basic questions:

  • Whether the underwriting business can create economic value on a stand-alone basis
  • Whether the investment activities can create economic value after risk adjustments
  • Whether we assess different underwriting and investment opportunities on a like for like basis

Relationship between EVM and other valuation frameworks

  • US GAAP: Swiss Re’s EVM incorporates financial measurements under non-accounting principles. Compared to US GAAP, the EVM indicator is more volatile. Key differences between the two also include whether the cost of capital is accounted for and the timing of recognising profit.
  • SST: EVM and SST are consistent to a large extent, including calculating liabilities using best estimate assumptions, risk-free discount rate and market consistent valuation of investment. The main difference is that EVM is primarily used to measure the value created for shareholders while SST is mainly used to measure the capital available to protect  the policyholders in case of risk occurrence.
  • MCEV: The concepts of EVM and MCEV are very similar, and EVM can be converted into MCEV. Both concepts follow the principle of market consistent in evaluation of assets and liabilities. Asset value is calculated based on the tradable amount at the valuation date while insurance liabilities are valued by structuring replicating portfolios. The main difference between the two is the method used in calculating discounted cash flows and the cost of capital. EVM is an internal used valuation method by Swiss Re, and the concept of EVM appeared earlier than MCEV.

Conclusion and recommendations

In summary, EVM is a mature management tool for value appraisal and management developed by Swiss Re based on its business needs and objectives, and is continuously applied in strategy planning, capital allocation, business decisions and performance management.

Looking back at the development of practice of value appraisal in Chinese insurance industry in the last decade, although Traditional Embedded Value (TEV) has always been used, the actual computation has been evolving in line with changes in accounting systems and solvency requirements; adapting to changes in accounting systems and regulations has become the norm. In 2009, with the implementation of Chinese accounting standards (China GAAP), the life insurance companies have gradually adapted the practice of calculating the income tax based on China GAAP, in the cash flows calculation for TEV. In 2016, with implementation of the Chinese Risk-Oriented Solvency System (C-ROSS), the guideline of EV under C-ROSS is an initiative without any international precedent.

Today, as the insurance industry in China continues to mature and the technical strength of insurance companies improves, the objectives of value appraisal and management for mature insurance groups/companies should not be just limited to meeting regulatory requirements and listing requirements. More importantly, the valuation systems should be further enhanced, and internal teams should be encouraged to conduct industry-leading research focused on creating a value appraisal method that is suitable for the company’s actual business, and applying it to the performance assessment. The current research on EV under C-ROSS, led by the China Association of Actuaries, is expected to be implemented in the second half of 2016. This offers an excellent opportunity for insurance companies in China to enhance the depth of their value management systems: for example, by defining how to link risks and value closely, and how to optimise capital allocation through value management. Conducting internal R&D and leveraging external resources, such as consulting firms and reinsurance companies, are effective solutions of advancing this effort. By referring to the international experience, the financial impact of reinsurance on insurance companies could be taken into consideration: embedded value results may be improved through reinsurance arrangements, which is similar to solvency relief and profit smoothing through reinsurance. These are all classic examples of the impact of reinsurance on the financial indicators of insurance companies.


  1. Swiss Re Sigma: Insurance Research, 1/2012 Understanding profitability in life insurance
  2. Economic Value Management 2015
  3. Annual Report by Swiss ReApplication of Economic Capital, for SOA Annual Meeting, 16 October 2012, by Kathryn Hyland from Swiss Re
  4. Introduction to the EVM methodology, July 2013, from Swiss Re
  5. Leadership Development Program Value creation at Swiss Re

Published July 2016