Embedded Value is an estimate of the worth of an insurance company, without regard for any value added by future improvements to, or increases in, the business. It is a valuation method used primarily outside of the United States and is primarily employed by the insurance industry. The measurement of Embedded Value lays the groundwork upon which a company can price their products and determine their profitability. Essentially, Embedded Value is the sum of the adjusted net asset value and the present value of future profits of a firm.
Embedded value can be calculated via the following equations1:
- Shareholders’ Free Surplus
- Required Capital
- Cost of Capital
- Value of Inforce Business
- Business Value = (4) - (3)
- Embedded Value = (1) + (2) + (5)
Embedded Value excludes aspects of value aside from the balance of its assets and liabilities. Thus, the perceived assets of a firm such as "strong management, good location, or a happy workforce,"2 are not taken into account in the valuation process.
1 Risk Management Metrics Subgroup. Embedded Value Definition. http://rmtf.soa.org/embedded_value.pdf. Society of Actuaries. 03/03/2005.
2 Embedded Value. www.investopedia.com. 5/22/2005.