Embedded value

July 15, 2022
Posted by: OptimizeIAS Team
Category: DPN Topics

Embedded value

Subject: Economy

Why in the news?

Shares of Life Insurance Corporation of India (LIC) gained about a per cent on the BSE after the insurance giant on Thursday reported the Indian Embedded Value (IEV) rise.

Concept:

The Embedded Value (EV):

Embedded value is the sum of the net asset value and present value of future profits of a life insurance company.
This measure considers future profits from existing business only, and ignores the possibility of introduction of new policies and hence profits from those are not taken into account.
In other words, it measures the consolidated value of shareholders’ interest in the life insurance business. It represents the present value of shareholders’ interests in the earnings distributable from the assets allocated to the business after sufficient allowance for the aggregate risks in the business.

Cause of EV Jump:

The amendment to Section 24 of the LIC Act, brought prior to commencing the IPO, segregated the previously single ‘Life Fund’ into participatory and non-participatory funds.

A participatory policy– a policyholder can get a share of the profits of the company. This is received as a bonus. Examples of such products offered by LIC include JeevanLabh and Bachat Plus.
Non-participatory policy– No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as Saral Pension and Nivesh Plus.

Changes:

As all insurance companies do, LIC also reinvests premium sums that policyholders pay. The profits or surplus that comes about as a result was held in one single fund– the Life Fund.
But the amendment has necessitated the segregation of the Life Fund into participatory and non-participatory funds, depending on the nature of the policies they support.
Sharing of surplus out of such funds:
- Non-participating funds-surplus from the non-participating business would be transferred to shareholders i.e. 100% profit to shareholders.
- Surplus from participatory business, however, would be shared between policyholders and shareholders in a ratio 90:10.

Impact on IEV:

Earlier, only 10% of the value of the entire equity assets and reserves under non-participatory policies was captured in the embedded value. Post-bifurcation,100% of the value is captured in the embedded value.
The change, which has enabled 100% of the surplus in non-participatory funds to flow to the shareholder, has led to a massive jump in the Indian Embedded Value (IEV).
IEV-a measure of future cash flows in life insurance companies and it establishes the market valuation of LIC and determines how much money the government raises in the flotation.