Valuing Insurance: EV and VNB.
Why standard profit metrics fail for life insurers and how to use correct valuation frameworks instead.
Your neighbor starts a business. He spends a fortune today to find customers, paying agents and setting up systems. But those customers will pay him small fees every year for the next thirty years. If you look at his bank balance today, he seems bankrupt. But is he?
Life insurance companies look unprofitable on day one. They spend heavy commissions and administration costs to acquire a customer. This cash goes out immediately. However, the premium from that policy will flow in every year for decades. Standard profit metrics like the P/E ratio only look at this year's net profit, completely missing the stream of future cash.
To solve this, we look at Embedded Value, or EV. Think of EV as the total value accumulated inside the insurer. It is the sum of the company's current net worth and the present value of all future profits expected from existing customers. It tells you what the company is worth if it stops selling new policies today.
To measure growth, we use the Value of New Business, or VNB. This is the expected profit from new policies sold during a single year. When we divide VNB by the total new sales volume, called Annualized Premium Equivalent or APE, we get the VNB Margin. This margin shows the pricing power and profitability of the insurer's product mix.
Finally, we must track the persistency ratio. It measures the percentage of customers who continue paying their premiums year after year. If customers stop paying early, the projected future profits vanish, and the insurer's Embedded Value shrinks. A high-quality insurer keeps this ratio high.
The gold rate vs making charges
When you buy gold jewellery, the price is not just the gold rate. It has two parts: the value of the raw gold itself, and the making charges for the design. In insurance, Embedded Value is like the raw gold in the locker; it is the solid wealth already accumulated. The Value of New Business is like the making charges on new designs sold this year. It represents the fresh profit coming from new customers today.
Why this matters
When you invest in life insurance companies, you are buying a long-term compounder. If you rely only on standard P/E ratios, you might think these stocks are expensive or unprofitable. By looking at Embedded Value and VNB growth, you can identify which insurers are quietly building massive wealth under the hood for your portfolio.
Where people go wrong
- Valuing life insurers using standard P/E ratiosP/E ratios fail because insurance costs are paid upfront while profits flow in slowly over decades.
- Ignoring the persistency ratioIf customers stop paying their premiums early, the expected future profits disappear and the Embedded Value drops.
- Assuming high VNB growth guarantees successFast sales growth can destroy value if VNB margins are low or negative due to poor pricing.
Embedded Value measures the wealth already accumulated from past and present policyholders.
VNB Margin shows the profitability and pricing power of the insurer's product mix.
Always check the persistency ratio to ensure customers keep paying their annual premiums.
We cling to familiar tools like P/E ratios because calculating Embedded Value requires effort. But lazy shortcuts will cost you dearly when analyzing insurers.