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What is Embedded Value? Why it is an Important Parameter for Insurance Companies?

What is Embedded Value? Why it is an Important Parameter for Insurance Companies?

Published on 20 September 2022 .Views 49 .Comments 0
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Embedded Value is an important terminology or a parameter that is very important for the insurance industry. So, let’s simplify this term and understand it better in this article as we move ahead.

What is Embedded Value:

  • Embedded Value estimates the consolidated value of shareholders’ interest in an insurance company.
  • Embedded Value is also termed Market Consistent Embedded Value (MCEV).
  • For Insurance businesses, Embedded Value is considered rather than Enterprise Value as Enterprise Value does not showcase true factors.
  • Embedded Value is a summation of the present value of the future profits and Net Asset Value which is calculated by deducting liabilities from the assets.
  • Generally, the Net Asset Value is the shareholder’s claims or the fund provided by them.

Usage of Embedded Value:

1) Internal Use:

  • From an internal usage perspective, the Embedded Value justifies the share price, what’s the relation between the company’s embedded values and Key Managerial Personnel (KMPs) salary, helps in capital allocation decisions, and for other purposes.

2) External Uses:

  • Externally, the Embedded Value helps in the case of merger and consolidation of the companies or any case of external reporting.

3) External Uses from Investors Viewpoint:

  • Here, investors can assess the overall financial health of the insurance company via this factor.

What to look at in Valuation for Insurance Companies:
  • Like Enterprise Value, the Price to Earnings (P/E) ratio is also not a good parameter to analyze the valuation of insurance companies as all the business factors are not accounted for in the P/E of the company.
  • Hence, for estimating fair valuations of the insurance company, investors can calculate P/EV which can be calculated by dividing the market cap by the embedded value of the company. Here, Market Cap can be calculated as the outstanding no. of shares of the company multiplied by the current market price.
  • From the above example, LIC posts a lucrative figure among all the key insurance players.

What Should Investors Do?

Embedded Value is an important parameter specifically used for insurance companies as other valuation factors like P/E ratio, Enterprise Value, etc. does not stand true for such companies hence investor analyzing any insurance companies should carefully consider this parameter before making any investment decision.

Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.

Originally Published On:https://blog.investyadnya.in/what-is-embedded-value-why-it-is-an-important-parameter-for-insurance-companies/
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