The FINANCIAL -- While life insurers have a good value proposition for their policyholders, they lack an easy and understandable way to explain to other stakeholders how they create value and earn profits.

According to Swiss Re’s latest sigma study, “Understanding profitability in life insurance”, discusses the need to arrive at a standard framework for communicating the value and performance of life insurance companies.

Unlike many other industries, life insurance is a business with long-term products and services whose profitability cannot be measured without a long-term lens. Insurers monitor and manage performance on an ongoing basis, but because life insurance policies remain in force for many years, the ultimate profitability of the business is only known years later when all policy obligations have been fulfilled. To understand competitiveness and operating performance, different stakeholders rely on different measures, making communication difficult and resulting in a kaleidoscopic view of profitability.

How do life insurers create value? Life insurers create value through insurance and investment operations. There are three principle sources of profits — underwriting margin, investment result, and fee income. The earnings profile of a company is significantly influenced by its product mix. The products that the industry offers today range from pure risk protection, such as term or disability insurance, to predominantly savings, such as unit-linked products or deferred annuities.

The drivers of profitability vary significantly along this spectrum and depend on how risks are allocated between the insurer and the policyholder. For example, insurers' results for protection products rely heavily on underwriting experience, while earnings from savings products depend mostly on fee income and the allocation of investment results.

More transparency and detailed profitability reporting by product segment may help investors to better understand and judge company performance.Why is understanding profitability in life insurance so difficult? Together, these issues result in rather opaque profitability figures which make it difficult for stakeholders to truly understand and judge a company’s earnings and sustainability in the future. However, a more forward-looking approach to measuring life insurance profitability, though it is often used only by life insurers’ top management, is available through the embedded value framework.

Embedded value-based reporting in life insurance is indispensable for holistic decision making -- Embedded value is a framework that seeks to quantify future cash flows of insurance products and the cost of capital for business lines with varying risk profiles.

While EV concepts are indispensable for internal purposes, they have not gained acceptance everywhere for external reporting to investors. Insurers face a dilemma: in many cases top management makes decisions based on embedded value concepts, while investors often rely on traditional accounting-based measures.

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