Figuring out the future and the now

There are many reasons to doubt the perfect applicability of the 6% cost of capital rate used in South Africa for the solvency Risk Margin calculation.

Not least of which is the decrease to the rate in Europe and in the UK.

However, if we borrow ideas from Embedded Value (TEV/EEV or MCEV) and look at the components of…

A) a required premium or return for risk (2% to 6% or even higher depending who you ask); and
B) a frictional cost for taxes and shareholder investment expenses

…it becomes hard to justify a rate much lower than 6% in South Africa.

One reason for the difference from the conclusion in Europe? The absolute level of our interest rates and the additional tax drag on that. (Incidentally, this is the same reason it’s hard to make a real return outside of retirement savings vehicles and Tax Free accounts, and also why it’s more tax efficient to invest in hard currencies.)

Keep an eye on ‘Frictional Costs’—a term that’s likely to become more relevant as EV reporting evolves and MCEV ideas come alive again. This could easily be 2.5% to 3.5%.

Here’s an illustration to ponder. Your results may vary based on assumptions.

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