With several life insurers reporting financial results, including horribly broken measures of new business profitability such as VNB margin or VNB / PVFNBP, it feels like time to roll out New Business Margin on Revenue again and describe why it is a much better measure.
It is a good time, but I don’t currently have the time. I’m going to try to prepare a basic spreadsheet example to make it clearer. I’ve also decided on a provisional treatment of pure financial instruments that I hope will give useful results.
Watch this space.
The Value of New Business written by an insurers is a good measure of the value created through sales activity over a certain period. It’s not the easiest number to interpret in terms of profitability though.
New Business Margin, which is the Value of New Business (VNB) as a percentage of the Present Value of New Business Premiums (PVNBP) is a common measure of profitability of that news business.
But it’s a flawed measure, especially when it comes to comparing product lines and insurers or even to understand the change in profitability from one period to the next. It uses and unequal yardstick to measure business.
New Business Margin on Revenue (NBMR) provides a significantly improved measure of profitability that can be used to compare margins across products, across insurers and across time. Further, it leads easily to a component analysis of the margin, adding additional insights to shareholders, brokers and regulators.
If you haven’t read my introductory post on New Business Margin on Revenue, it would be worthwhile doing so now – this post is going to illustrate the sort of results it provides in a practical, numerical example.
Example 1 considers how NBMR clarifies distortions from a change in mix of business.
Example 2 shows how more complex dynamics can be understood through a component analysis of NBMR. The spreadsheet showing the underlying calcs is attached at the end of this post. Continue reading Gaining new insight into insurer profitability through New Business Margin on Revenue
Embedded Values (EVs) are widely used to measure value for life insurers. In the context of long-term contracts such as individual life, it reflects the value embedded in prudent regulatory provisions (or “actuarial reserves”).
For short-term business (group risk, health insurance, health administration, general insurance etc.) it is something different since these lines don’t have long-term prudent provisions. In these cases it reflects the present value of future profits expected to be earned out of the existing business.
The inclusion of these short term types of business within EV is widespread. It seemingly increases consistency between different types of contracts since we are considering the long-term expected profitability in all cases. More on this apparent consistency in a moment.
What do we include in the EV and VIF?
EV is not a complete economic measure of the value of an insurer, since it ignores future profits arising from future new business. This is by design. An Appraisal Value incorporates the Value of Future New Business (VFNB) as well, although there is always subjectivity over how many years of future new business should be included. (More on this in a separate post.)
Existing Business vs Future Business
The idea of “existing business” and “future new business” is clear in the individual life context. It’s existing business if you have a contract, and future new business if not. Premium increases and slight benefit modifications can usually be accommodated within the existing contract and so should ideally be included in the Value of In Force (VIF) based on the expected probabilities of these changes. Continue reading New thoughts on renewal rates for Embedded Values
A new measure of life insurance new business profitability is required.
What is New Business Margin?
Many life insurers currently calculate a measure of the profitability of new business sold over a period called “new business margin”. As defined by the CFO Forum’s MCEV Principles and confirmed in South Africa’s PGN107 covering embedded values, this is the Value of New Business (VNB) divided by the Present Value of New Business Premiums (PFNBP) calculated on a consistent basis.
This is a useful measure since it shows, on average, how much of each premium goes to shareholders as profit, after deducting operating costs, benefits paid to policyholders and a cost of the capital required to support the business.
It’s far more useful than a common previous metric of VNB / API where API is Annual Premium Income or APE Annual Premium Equivalent, since the numerator reflects a multi-year stream of profits and the denominator just a single year. It’s a more difficult number to interpret intuitively.
Of course, New Business Margin is also fatally flawed. Continue reading New Business Margin on Revenue