Embedded value

Abstract: F inancial planning is a goalsbased profession. Financial planners help clients determine how to accomplish their goals through advice and guidance on a variety of topics, such as saving, investing, and risk management. While investing well is generally an important part of the process of accomplishing a goal, achieving a goal often requires advice beyond building appropriate portfolios (beta) and selecting investments that are expected to outperform their peers on a risk-adjusted basis (alpha). The body of research dedicated to quantifying the potential benefits of financial planning beyond alpha and beta is growing. For example, Blanchett and Kaplan (2013), using the concept of “gamma,” found that a retiree can expect to generate 22.6 percent more in certainty-equivalent income in retirement through implementing five fundamental financial planning decisions or techniques. This paper builds on the gamma concept by determining an optimal goals-based strategy. While past research has focused primarily on determining optimal portfolios to fund different types of goals, this paper focuses on the choice of which financial goals to fund, as well as how to save for those goals over time. Certain goals, such as retirement, are decomposed where the household is assumed to have varying levels of preference with respect to replacing different amounts of income. For example, replacing 50 percent of pre-retirement income may be critical to fund nondiscretionary expenses, with the remaining levels of replacement (up to 100 percent of pre-retirement income) becoming increasingly less important. In this study, a utility model based on prospect theory was used to determine the optimal funding strategy for a household, based on the unique prefeences and financial situation of that household. Results suggest that using a goals-based framework to determine which goals to fund and how to fund them can lead to an increase in utilityadjusted wealth of 15.09 percent for a hypothetical household versus a naïve strategy focused only on funding retirement. This is equivalent to generating an annual alpha of 1.65 percent for the lifetime of the base scenario household. These potential gains suggest a significant amount of value using a goals-based financial planning approach that extends beyond traditional asset management decisions. The Value of Goals-Based Financial Planning

Abstract: Embedded value has been widely adopted by European and Canadian life insurance companies for supplementary performance reporting and increasingly by US insurers for management purposes. It has important implications for the international debate over the appropriate use of fair values in financial reporting. But EV has still not been accepted by standard setters (e.g. IASB) for inclusion in the main financial statements. The concept of Market Consistent Embedded Value has been developed primarily by actuaries utilizing modern financial economics. This paper analyzes how both top-down and bottom-up methodologies for estimating MCEV may lead to unrealistic allowance for risk and explores the dangers of double counting of elements in the MCEV 'economic balance sheet', of a misunderstanding of the synergistic nature of overall firm value, and of a naive belief in market efficiency. It outlines potential empirical research with wider implications for 'fair value' accounting and reporting.

Abstract: The valuation of insurance contracts using a market value approach, also known as the fair value approach has recently attracted a lot of interest. Seconding this trend, we would like to illustrate in this paper how we can determine the market value of a with-profits insurance policy. The method we use is based on finding a set of financial instruments that can identically replicate the cash flows of the insurance policy. Using this approach we show that the market value of a with-profits insurance policy can be determined objectively.