THE EMBEDDED VALUE CONCEPT AND ITS APPLICATION IN SOUTH AFRICA

The purpose of this research report is to review the embedded value concept and toexamine its practical use in South Africa. Important recent developments relating tothe embedded value concept are discussed and compared with the existing embeddedvalue concept. These developments include fair value accounting, market-consistentembedded value and the European Embedded Value Principle.In the second part of the report, the disclosure of the embedded value information offour major South African life assurance companies is examined. It was found that themarket capitalisations of these companies were smaller than their embedded valuesfor most of the period under the investigation. Reasons for this phenomenon areconsidered and tested against the data available.It was found that the risk discount rates used by some life assurance companies incalculating their embedded values may be too low. It appears that a ‘herding’tendency exists among South African life assurance companies when selecting riskdiscount rates for the embedded value calculation.It is suggested that a more market consistent approach for the embedded valuecalculation and a better disclosure for the embedded value reporting should beconsidered by life assurance companies in South Africa. This should improveinvestors’ understanding and confidence in the embedded value disclosed, which inturn should help narrow or eliminate the discount of the market capitalisation to theembedded value observed in the market.