ET in the classroom: Embedded Value & Listing

Embedded Value (EV) is not a metric that is in vogue in Indian stock markets, thanks to the non-existence of insurance companies in stock exchanges. The recent deals in the life insurance industry valued insurers at several times the embedded value. The valuation of Star Union Dai-ichi was close to four times the embedded value while Reliance Life was at three times. All eyes are now on the valuation of the HDFC Life and Max Life merger.

1.Why embedded value?

It is used to measure life insurance business, as life insurance policies are long-term contracts, where policyholders pay premiums to be covered against any risk in the future. For insurers, future income is the premium paid by policyholders.

Companies have to pay claims to policyholders in the future at specified times. The value may change with the assumptions used in the calculations. There are various methods of reaching the embedded value, like the European Embedded Value method, the market consistent embedded value or cost of capital method by taking different parameters.

2. What is EV?

Embedded value is an estimate of insurance companies’ net assets and income expected from the policy in force. It is the present value of future profits and the net asset value — the difference between the total assets and liabilities of an insurer. It is measured by adding the value of the existing business, which is the future profit, to the market value of net assets. It is an actuarial term used to value insurance companies.

3.Why is the value of an insurance company more than the embedded value?

As embedded value does not take into account the future sales and brand value while arriving at the valuation, there is a multiple paid on the EV. Multiple is paid on the brand, distribution strength and growth opportunities, among other factors.

4. What is the required EV for insurance companies to list in India?

Life insurance companies are required to have an EV of twice the share capital to be able to list on stock market. While removing the profitability requirement, the regulator mandated that companies must have EV twice the share capital to list its shares on the bourses.