Refer to Theory in Practice 2.1 relating to the embedded value of Manulife Financials' common shares. Required 1. Serafeim (2011) reported lower information asymmetry for insurance companies that report embedded value, compared with companies that do not report this information. However, this lower information asymmetry held only for firms that employed an outside consultant to review the calculations and was particularly strong for firms that also belonged to the CFO Forum. Why might information asymmetry be lower for such firms? 2. Suggest and explain reasons why Manulife's December 31, 2016, common share market value ($17.82) was so much less than its embedded value per share ($23.57).
Some insurance companies voluntarily report assumptions about discount rates, investment conembedded value as supplementary information. ditions, and life expectancies. Many of these This is a form of present value accounting that esti- assumptions are based on actuarial calculations. mates the present value of future earnings available The table below is adapted from the embedded to shareholders from insurance business currently value information of Manulife Financial Corporation, in force. It is calculated as the sum of net asset value a large Canada-based multinational provider of plus discounted present value of policy amounts to insurance and related financial services. be collected, net of costs (i.e., value in use). These Serafeim (2011) studied a worldwide sample of costs consist of income taxes, and a charge for the 350 insurance companies over the period 1991capital the company is required to hold as a reserve 2009 , of which 93 disclosed embedded value. He for policy commitments. The discount rate to com- reported a lower bid-ask spread (see Chapter 1, pute present value is based on a risk-free rate plus Note 26) for shares of firms reporting embedded a risk premium. Embedded value does not include value information than for firms that did not report the present value of expected future business. Thus, this information. This implies greater investor confiit is not a full current valuation of the business. dence in the overall quality of these firms' financial Nevertheless, by providing an estimate of the pres- reporting (i.e., less information asymmetry between vide highly relevant information. only for firms for which an outside auditor or conSince insurance policies typically extend well sultant certified the calculations, and was particuinto the future, embedded value requires larly strong for firms that belonged to the CFO Forum, an insurance industry group with objectives due to concerns about risk and reliability. From that include promoting transparent reporting. Table 2.1, changes in experience and exchange The market price of a Manulife common share rates represent major corrections of assumptions on December 30, 2016, was \$17.82. One might made in 2015, suggesting considerable variability ask, why is share price lower than embedded value in estimates. However, as noted above, Manulife per share of $23.02, particularly since embedded uses risk-adjusted discount rates in its present value value does not include expected future business? calculations. Also, although Manulife does not One possibility is that investors were not aware of belong to the CFO Forum, its embedded value is current embedded value, since Manulife's 2016 certified by an outside consultant, reducing reliembedded value report was not released until May ability concerns. At any rate, Manulife's common 3, 2017. Alternatively, investors may have had rea- share price of $24.08 just before May 13 increased sonably accurate estimates of what the embedded to $24.59 a few days later, not inconsistent with value would be, but downgraded the estimates the above findings of Serafeim. Table 2.1 Manulife Financial Corporation, Extracts from 2017 Report on Embedded Value Some insurance companies voluntarily report assumptions about discount rates, investment conembedded value as supplementary information. ditions, and life expectancies. Many of these This is a form of present value accounting that esti- assumptions are based on actuarial calculations. mates the present value of future earnings available The table below is adapted from the embedded to shareholders from insurance business currently value information of Manulife Financial Corporation, in force. It is calculated as the sum of net asset value a large Canada-based multinational provider of plus discounted present value of policy amounts to insurance and related financial services. be collected, net of costs (i.e., value in use). These Serafeim (2011) studied a worldwide sample of costs consist of income taxes, and a charge for the 350 insurance companies over the period 1991capital the company is required to hold as a reserve 2009 , of which 93 disclosed embedded value. He for policy commitments. The discount rate to com- reported a lower bid-ask spread (see Chapter 1, pute present value is based on a risk-free rate plus Note 26) for shares of firms reporting embedded a risk premium. Embedded value does not include value information than for firms that did not report the present value of expected future business. Thus, this information. This implies greater investor confiit is not a full current valuation of the business. dence in the overall quality of these firms' financial Nevertheless, by providing an estimate of the pres- reporting (i.e., less information asymmetry between vide highly relevant information. only for firms for which an outside auditor or conSince insurance policies typically extend well sultant certified the calculations, and was particuinto the future, embedded value requires larly strong for firms that belonged to the CFO Forum, an insurance industry group with objectives due to concerns about risk and reliability. From that include promoting transparent reporting. Table 2.1, changes in experience and exchange The market price of a Manulife common share rates represent major corrections of assumptions on December 30, 2016, was \$17.82. One might made in 2015, suggesting considerable variability ask, why is share price lower than embedded value in estimates. However, as noted above, Manulife per share of $23.02, particularly since embedded uses risk-adjusted discount rates in its present value value does not include expected future business? calculations. Also, although Manulife does not One possibility is that investors were not aware of belong to the CFO Forum, its embedded value is current embedded value, since Manulife's 2016 certified by an outside consultant, reducing reliembedded value report was not released until May ability concerns. At any rate, Manulife's common 3, 2017. Alternatively, investors may have had rea- share price of $24.08 just before May 13 increased sonably accurate estimates of what the embedded to $24.59 a few days later, not inconsistent with value would be, but downgraded the estimates the above findings of Serafeim. Table 2.1 Manulife Financial Corporation, Extracts from 2017 Report on Embedded Value
