Embedded Value Research Articles

Unregulated Corporate Financial Disclosure and Analysts’ Forecast Properties: The Case of Embedded Value Reporting by Life Insurers

This paper investigates the association between life insurers’ voluntary disclosure of embedded value (EV), an unregulated market-driven fair value measure, and analyst forecast accuracy and dispersion. EV is an estimate of the present value of future net cash flows from in-force life insurance business. Advocates of this disclosure believe that EV is a better measure of economic performance than traditional GAAP measures. Others argue that corporate management has discretion in estimating and reporting EV. Further, analysts may have access to information that allows the development of possibly more accurate estimation metrics in the absence of EV disclosure. It is then an empirical issue to determine whether EV disclosure has any incremental effect on analysts’ forecast properties. Using a multi-country setting, we find that EV disclosure is positively associated with analysts’ earnings forecast accuracy and negatively related to forecast dispersion. This result is consistent with the alternative hypothesis that disclosure of EV provides a richer information set that enriches analysts’ forecasts beyond their own in-house developed surrogates. As guidance for insurance accounting and disclosure evolves, our findings support the value of continuing to provide EV information to the public.

Unregulated corporate financial statements and analysts' target price accuracy: evidence from embedded value reporting by life insurers

Multiple studies support the value relevance of embedded value (EV) disclosures by life insurance companies. To the best of our knowledge, this is the first paper to examine the impact of EV voluntary disclosure on analysts' target price forecast accuracy. Our findings support the proposition that EV is a valuable supplemental information in and should be of special interest to financial reporting policy makers, financial analysts, managers, and academics. Our analysis suggests that life insurers that currently do not disclose EV should consider disclosing the measure, and financial analysts in the US should encourage US life insurers to disclose EV to support their valuation of life insurers' stocks. We contribute to the extant literature on embedded value, and voluntary disclosures, by providing evidence that suggests that EV disclosure helps improve the accuracy of analyst forecasts.

Embedded value reporting quality and credit risk: evidence from life insurance companies

This study investigates the effects of releasing embedded value (EV) reports and EV report disclosure quality on life insurance companies’ credit risks, using issuer credit rating and bond yield spread data from 2001 to 2010. Results show that releasing an EV report and EV report disclosure quality are both significantly and negatively associated with life insurance companies’ credit risks. In addition, the CFO Forum (2004a, 2004b, European Embedded Value) significantly strengthens the negative effect of releasing an EV report on firm credit risk while the subprime crisis has the opposite effect in Europe. Finally, the results are robust to endogeneity issues and different model specifications of fixed effects.

Evolution of financial reporting of life insurers

PurposeThis paper aims to examine the capital market effects and predominance of unregulated embedded value (EV) financial reporting in the life insurance industry in foreign domestic markets, and US markets for foreign firms that cross-list in the USA.Design/methodology/approachRecent empirical archival data are analyzed and evaluated to determine the incremental and relative value relevance of an unregulated valuation metric that is disclosed by life insurers.FindingsThe findings support the proposition that EV is valuable supplemental information in foreign domestic markets, and in US markets for foreign life insurers that cross-list in the USA. Given that International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) are engaged in projects to improve accounting standard for insurance companies, and have faced criticism with the existing drafts on this issue, the two institutions ought to consider the valuation relevance of EV disclosures. Moreover, this analysis strongly suggests that financial analysts in the USA should consider EV in valuing life insurers’ stocks.Practical implicationsThe findings discussed in this paper are of special interest to financial reporting policy makers, financial analysts, firm compensation committees and managers, and academics.Originality/valueThis paper contributes to the extant literature by providing recent evidence that suggests that EV, an unregulated fair value market-driven metric, is more value-relevant than traditional earnings metrics such as earnings and book value. It is the only study that we are cognizant of that critically examines the recent empirical literature on this evolving issue.

The Implementation of Embedded Value (EV) Reporting in Israel: Myth and Reality

Abstract In recent years, we have witnessed increasing acceptance of embedded value (EV) reporting as the most robust measure of shareholder value for life and health insurance businesses. Therefore, the Commissioner of Insurance in Israel decided to request insurance companies to disclose the EV of their life, pension and health insurance business annually, beginning with the annual statements for FY 2007. Even though the insurance and financial community expected the publication of the EV data and emphasized its importance, the reaction of the capital market seemed to ignore the EV data. All things being equal, if an insurer is writing profitable new business, its market capitalization should exceed its EV. However, the market capitalization of all listed insurance companies in Israel is far below their reported EV, and the gap is growing. The purpose of this article is twofold: (a) to suggest several explanations for this apparent EV “puzzle,” both competing and complementary; (b) to argue that although the question of whether the EV report and market-consistent EV methodology really indicate the fair value of the insurance company remains controversial, the EV report contains data that give better insights into the forces driving operating performance and the impact of management actions. “The EV analysis should also be considered when evaluating management performance and remuneration schemes.”

Investigating the voluntary European embedded value (EEV) disclosure practices in the European life insurance industry

This study examines the informational content and relevance to external stakeholders of voluntary embedded value (EV) disclosures by publicly listed European life insurers and bancassurances post the voluntary adoption of the European embedded value principles (EEVPs) in 2005. It is found that despite the increase in the number of European life insurers and bancassurances that have adopted EEVPs since 2005, diversifications in practice for EV calculation and disclosure between companies and countries have not been eliminated. It also reveals that EV earnings have no incremental information content beyond the statutory accounting information, although some EV disclosures, namely the present value in-force (PVIF), have information content over and above statutory earnings and book value of equity.

The valuation effects of embedded value disclosure by life insurers

Many life insurance companies outside the US disclose embedded value (EV), an actuarial estimate of the present value of the future net cash flows arising from the company’s in-force life insurance business. Industry surveys have shown that EV is used by analysts for valuation purposes. However, there is little empirical research of EV disclosures. This study fills that void by testing the valuation relevance, information content and reduction in information asymmetry associated with the reporting of EV. We provide evidence supporting the premise that the market prefers EV to traditional accounting metrics in assessing security prices. This study advances our understanding of the valuation effects of corporate voluntary disclosures, and should be of interest to financial reporting standard setters such as the IASB and the FASB who are currently working on harmonizing financial reporting in the insurance industry.

The value relevance of voluntary European embedded value disclosures: evidence from UK life insurance companies

This study examines the value relevance of the voluntary embedded value (EV) disclosures by publicly listed British life insurers pre and post the mandatory adoption of International Financial Reporting Standards (IFRS) in 2005. It provides evidence for the first time that the voluntary European embedded value (EEV) and market consistent embedded value (MCEV) disclosures are value relevant and have incremental information content over and above the statutory accounting information. It also shows that the changes in the methods by which EV numbers are calculated do not have any impact on the value relevance of EV disclosures.

The Value Relevance of Embedded Value Disclosures: Evidence from European Life Insurance Companies

Following IAS/IFRS, the current accounting regime for European life insurance companies is oriented towards delaying the recognition and distribution of profit, and is still largely rooted in requirements for statutory solvency reporting. But, since the late 1980s, some insurers and banks with life operations have voluntarily measured and reported within supplementary financial disclosure the value of in-force business, a forward-looking measure that captures the expected net value of the underlying contracts signed by the insurer as a component of equity (Embedded Value), and have calculated profits as the change in equity between two consecutive periods. In the recent years the concept of Embedded Value (EV) has been developed by the practitioners, first as European Embedded Value (EEV), and more recently as Market Consistent Embedded Value (MCEV). Right now EV disclosures are widely adopted by major European 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 and more specifically for the debate over the right design of accounting principles for life insurance contracts. This paper tests empirically the value relevance of the alternative “realistic reporting regime” of voluntary EV disclosures adopted by leading European insurers. We identified 28 European life insurers that in the period 2005-2010 provided voluntary EV disclosures. Data on EV’s have been handly collected, while for balance sheet information Compustat dataset has been used. Preliminary results are consistent with the value relevance of EV’s disclosures.

Value Relevance of Embedded Value and IFRS 4 Insurance Contracts

In light of the recent exodus of foreign insurers from Taiwan and the local insurers’ outcries against the International Financial Reporting Standard (IFRS) 4 Insurance Contracts, we examine the value relevance of financial statements for life insurance firms, with particular interests to the embedded value (EV) disclosure. We find that the EV of equity has an incremental information role for book value of equity, which indicates that the accounting mismatching problem in the insurance industry creates a demand for fair value accounting. The fair value of liabilities under IFRS 4 Phase 2 has been disputed globally by accountants, actuaries, academia and regulators. The EV model is a concept approaching the fair value model. The research findings provide important empirical evidences supporting the fair value concept of IFRS 4.

The Informational Content Of Voluntary Embedded Value (EV) Financial Disclosures By Canadian Life Insurance Companies During The Recent Period Of Market Turmoil

The informational content and relevance to external stakeholders of voluntary financial disclosures by commercial banks is now becoming more widely recognized. For instance, banks voluntary disclosures of liquidity, interest rate and market risk metrics have been found to be closely associated with market value of equity and credit ratings. So far, there has been very scarce published research on investigating the informational content and relevance to external stakeholders of voluntary financial disclosures by life insurance companies during the recent period of market turmoil. In order to improve upon this situation, this paper updates previous findings and reports on the informational content of voluntary embedded value (EV) financial disclosures by Canadian life insurance companies during the 2000-2010 time period. As opposed to traditional statutory balance sheet and earnings reporting, EV voluntary disclosure attempts to estimate the present value of future earnings generated by a life insurers current book of various insurance businesses. The preliminary results presented in this study indicate that recent EV voluntary financial disclosures failed to communicate intrinsic informational content and to provide value relevance to external stakeholders in the sense that they were not found to be closely associated with life insurers market value of equity and credit ratings during the recent 2007-2010 period of market turmoil.

Consequences and Institutional Determinants of Unregulated Corporate Financial Statements: Evidence from Embedded Value Reporting

ABSTRACTI analyze Embedded Value (EV) reporting by firms with life insurance operations to assess the impact of unregulated financial reporting on transparency and to examine the institutional characteristics that promote unregulated reporting. Under EV accounting, the present value of future cash flows from in‐force contracts is included in shareholders’ equity, and profit is calculated as the change in equity between two periods. In contrast to Generally Accepted Accounting Principles (GAAP), this approach produces higher shareholder's equity and recognizes income at contract inception. I find firms that adopt EV reporting exhibit a decline in information asymmetry, with the decline increasing as EV reporting evolves to address methodological deficiencies and to permit more comparability across firms. The decrease in information asymmetry is contingent on providing an audit certification, and larger for firms that commit to providing EV reports. Moreover, I document that EV reporting is more widespread in countries with more hostile takeovers, managers that do not avoid volatile income measures, regulators that are less likely to intervene in the product market, and analysts that believe EV disclosure increases the value of their information intermediation function.

Discussion of Consequences and Institutional Determinants of Unregulated Corporate Financial Statements: Evidence from Embedded Value Reporting

Serafeim [2011] examines the determinants and economic consequences of embedded value (EV) reporting, a voluntary disclosure arrangement in the life insurance industry. He finds substantial reductions in bid-ask spreads for EV reporting firms, and links the occurrence of this disclosure practice to the nature of competition in the insurance business. In my discussion, I focus on two aspects of his hypothesis development: (1) does EV reporting give rise to a credible commitment to transparency? (2) What are the country-level determinants of EV reporting? First, on a conceptual level, I highlight the distinction between an ex ante commitment to transparency and ex post voluntary disclosure. To illustrate my point, I examine the change in information asymmetry around various voluntary disclosure choices with varying degrees of commitment. I find a reduction in bidask spreads following U.S. cross-listings and the voluntary adoption of IFRS, but not after a switch to a Big Five auditor. These results let me gauge the magnitude of the effects for EV reporting. Second, I discuss the notion of complementarities among the elements of a country’s institutional environment. I then empirically show that institutional forces likely act both ways, i.e., from a single industry to the rest of the economy and vice versa, and that EV reporting is not independent from other voluntary commitment devices in a country. In sum, my findings underscore the importance of (and difficulties in) cleanly identifying the determinants and effects of voluntary disclosure choices. JEL classification: G14, G15, G30, K22, M41, M42

The Informational Content Of Voluntary Embedded Value (EV) Financial Disclosures By Canadian Life Insurance Companies

The informational content and relevance to external stakeholders of voluntary financial disclosures by commercial banks is now becoming more widely recognized. For instance, banks voluntary disclosures of liquidity, interest rate and market risk metrics have been bound to be closely associated with market value of equity and credit ratings. So far, there has been very scarce published research on investigating the informational content and relevance to external stakeholders of voluntary financial disclosures by life insurance companies. In order to improve upon this situation, this paper studies and reports the informational content of voluntary embedded value (EV) financial disclosures by Canadian life insurance companies. As opposed to traditional statutory balance sheet and earnings reporting, EV voluntary disclosure attempts to estimate the present value of future earnings generated by a life insurers current book of various insurance businesses. The preliminary results presented in this study indicate that EV voluntary financial disclosures communicate intrinsic informational content and provide value relevance to external stakeholders in the sense that they were found to be closely associated with life insurers market value of equity.

Discussion of Consequences and Institutional Determinants of Unregulated Corporate Financial Statements: Evidence from Embedded Value Reporting

Serafeim [2011] examines the determinants and economic consequences of embedded value (EV) reporting, a voluntary disclosure arrangement in the life insurance industry. He finds substantial reductions in bid-ask spreads for EV reporting firms, and links the occurrence of this disclosure practice to the nature of competition in the insurance business. In my discussion, I focus on two aspects of his hypothesis development: (1) does EV reporting give rise to a credible commitment to transparency? (2) What are the country-level determinants of EV reporting? First, on a conceptual level, I highlight the distinction between an ex ante commitment to transparency and ex post voluntary disclosure. To illustrate my point, I examine the change in information asymmetry around various voluntary disclosure choices with varying degrees of commitment. I find a reduction in bid-ask spreads following U.S. cross-listings and the voluntary adoption of IFRS, but not after a switch to a Big Five auditor. These results let me gauge the magnitude of the effects for EV reporting. Second, I discuss the notion of complementarities among the elements of a country’s institutional environment. I then empirically show that institutional forces likely act both ways, i.e., from a single industry to the rest of the economy and vice versa, and that EV reporting is not independent from other voluntary commitment devices in a country. In sum, my findings underscore the importance of (and difficulties in) cleanly identifying the determinants and effects of voluntary disclosure choices.

Life Insurance Securitization: An Issuer’s Perspective

Securitization is one of many tools available to a (re)insurer for risk or capital management purposes. The use of the capital markets to absorb insurance and related financial market risks, through securitization, increases the available capital to support these risks taken by (re)insurers and leads to greater capacity and a more efficient market. Packaging life insurance risks into insurance-linked securities (ILS) enables sponsors to access additional capital in the fixed-income market, whose players value the ability to diversify risks and assets, and the opportunity to invest in instruments with a range of durations at attractive spreads. Life ILS typically fall into three broad categories: first, catastrophe cover to manage peak risks, i.e., pandemic protection; second, embedded value (EV) securitizations to help firms manage their capital more efficiently; and, third, financing transactions, such as redundant reserve financing, i.e., “XXX” or “AXXX” securitizations where little or no insurance risk is transferred. <b>TOPICS:</b>Technical analysis, fixed income and structured finance

The value relevance of ‘realistic reporting’: evidence from UK life insurers

Even under the International Financial Reporting Standard 4 (IFRS 4), the current accounting regime for UK life insurance companies is oriented towards delaying the recognition and distribution of profit, and still remains largely rooted in traditional requirements for statutory solvency reporting. This paper tests empirically the value relevance of the alternative ‘realistic reporting regime’ of voluntary embedded value (EV) disclosures that has been generally adopted by leading UK and Continental European insurers. In recent years, EVs have also been used internally (but not disclosed) by many US life insurers. The results found here are consistent with value relevance and some implications for standard-setters are explored.

The Value Relevance of 'Realistic Reporting': Evidence from UK Life Insurers

Following IFRS 4, the current accounting regime for UK life insurance companies is oriented towards delaying the recognition and distribution of profit, and is still largely rooted in requirements for statutory solvency reporting. This paper tests empirically the value relevance of the alternative 'realistic reporting regime' of voluntary embedded value (EV) disclosures that has been generally adopted by leading UK and Continental European insurers. In recent years EVs have also been used internally, but not disclosed, by many US life insurers. The results found here are consistent with value relevance and some implications for standard setters are explored.

Managerial Use of Discounted Cash-Flow or Accounting Performance Measures: Evidence from the U.K. Life Insurance Industry

Owing to the increasing prevalence of value-based methodologies and the competitive and political pressures faced by the industry to improve its performance, the U.K. life insurance industry provides an interesting environment in which to examine whether senior management uses accounting vs. projected cash-flow-based financial performance measures for both managerial performance evaluation and strategic budgetary planning and control purposes. A survey is employed to examine what economic and organizational factors could condition managerial propensity to use three alternative measures: traditional accounting-based measures, Economic Value Added (EVA) and multiperiod, actuarial cash flow based measures such as embedded value (EV). Survey evidence suggests that life insurance CEOs are more likely to use EV for strategic management planning and control purposes, and that this preference is strongly conditioned by the firm's ownership structure. These results support the managerial incentive hypothesis, after controlling for the effects of other organizational structural and behavioural variables that potentially influence the choice of financial performance measure.