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Draft for discussion at ICAEW IISC meeting, 20th June 2005 - page 44 / 51

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  • 6.

    The industry

    • a)

      CFO Forum 2004 European Embedded Value Principles and Basis for

Conclusions The European Embedded Value Principles (EEV) was published in May 2004 and sets out a voluntary set of principles for reporting supplementary embedded values to be adopted for the 2005 financial year onward by European insurance companies. There have been criticism of the traditional embedded value (see below) and consequently the CFO Forum attempted to address these by ensuring their guidance is credible, robust and can be applied consistently. It requires the inclusion of a cost for financial options and guarantees; and prescribes a minimum level of disclosure including sensitivity analysis. However the document avoids radical change from the traditional EV methodology used by insurers and, in particular, the methodology retains the concept of risk premiums on assets and the use of a risk discount rate. The reason for this is that the CFO Forum believes that this approach ‘best reflects insurance company management’s views of value’.

The document is fairly short and follows a principles-based, rather than a rules-based approach. There are 12 key Principles (Principles 1 to 6 cover issues primarily of definition, whilst 7 to 12 set out requirements for, and limitations on practice) and 65 related areas of Guidance. However, within their ‘Basis for Conclusions’ there are also 127 additional comments to support and clarify the EEV Framework. The key areas that the EEV addresses relate to the setting of the discount rate, the explicit recognition of financial guarantees and options, and the definition of ‘required capital’, as well as the standardisation of disclosure.

The overall objective of these principles is to improve the consistency and transparency of European insurance reporting.

The 12 Principles are:

  • 1.

    Embedded Value (EV) is a measure of the consolidated value of shareholders’ interest in the covered business.

  • 2.

    The business covered by the EV methodology (EVM) should be clearly identified and disclosed.

  • 3.

    EV is the present value of shareholders’ interest in the earnings distributable from assets allocated to the covered business after sufficient allowance for the aggregate risks in the covered business.

  • 4.

    The free surplus is the market value of any capital and surplus allocated to, but not required to support, the in-force covered business at the valuation date.

  • 5.

    Required capital should include any amount of assets attributed to the covered business over and above that required to back liabilities for covered business whose distribution to shareholders is restricted. The EV should allow for the cost of holding the required capital.

  • 6.

    The value of future cash flows from in-force covered business is the present value of future shareholder cash flows projected to emerge from the assets backing the liabilities of the in-force covered business (‘PVIF’). This value is reduced by the value of financial options and guarantees as defined in Principle 7.

  • 7.

    Allowance must be made in the EV for the potential impact on future shareholder cash flows of all financial options and guarantees within the in-force covered business. This allowance must include the time value of financial options and guarantees based on stochastic

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