Saturday Brain Storming Thought (174) 03/06/2023

ASSET VALUATION RESERVE (AVR)

An Asset Valuation Reserve (AVR) is capital required to be set aside to cover a company against unexpected debt

AVR serves as a backup for equity and credit losses

A reserve will have capital gains or losses or debited against the reserve account

Key Takeaways of Asset Valuation Reserve (AVR)

1) AVR refers to capital that is set aside to cover any unexpected debt

2) equity and credit losses can be recovered by AVR to mitigate potential business risks

3) the two components of an AVR are the default component and the equity component

4) the insurance industry and the banking industry are two industries required to have AVRs set forth by their governing body

The elements of valuation

1) Asset value – Subtract liabilities from assets to obtain the current net asset value

Asset value is the most tangible and easily calculable

2) Earning Power Value – EPV of a company is equal to adjusted earnings times 1/R where R is the current cost of asset

Earning power requires more assumptions, but can be a useful piece of the puzzle

3) Value of Growth – growing revenues do not always translate to an increase in value

Growth is notoriously hard to estimate and does not always correlate with an increase in value

AVR – provision for unexpected losses

1) AVR is a liability, set aside in life annual to absorb losses and protect statutory surplus against large flactuations

2) AVR acts like a fund that moves up and down depending upon company’s loss experience, subject to a maximum – a smoothing mechanism

3) AVR objective was set to cover default losses at the 85%

4) AVR is part of total adjusted capital

5) an individual company’s AVR balance has no bearing on the calculation of required capital or the RBC ratio

AVR Details

1) for bonds, mortgages and other fixed income assets there isa default component

2) for common stock, real estate and other equity assets there isa equity component

3) once re-measured each reporting period, the components are combined to form the total AVR

4) increases or decreases in the AVR are reported as direct adjustments to surplus, not income

Primary functions of AVR Report

1) Assure that all assets and liabilities are reported on as consistent a financial basis as is practical

2) minimise the impact of capital gains and losses arising from movements in interest rates have upon provisions for credit related losses

3) provide a reserve consistent with valuation actuary standards that adequately provides for future volatile incidence of asset losses

4) provide appropriate recognition of long term expected returns for equity type investments

Importance of AVR

1) AVR acts as a backup or safety net for companies when unexpected future financial obligations arises

2) this reserve also provides a safe landing for a company in the event of a future credit or equity loss

3) AVR amount depends upon estimating of future losses

4) AVR able to mitigate potential risks and debts in the future

AVR in Industries

1) the insurance industry in which AVR is mandated

2) NAIC requires domestic insurers to maintain AVR to cover policyholder claims in the event of financial issues at the insurer

3) NAIC also mandates a liability reserve be kept to cover claims in real estate and mortgages

4) banking sector kept AVR, requiring them to keep a certain amount of deposits in hand

5) to ensure that in times of financial stress, clients will be able to withdraw their deposits and prevent a possible bank run

Compiled by

Compiled by:

Er. Avinash Kulkarni
9822011051

Chartered Engineer, Govt Regd Valuer, IBBI Regd Valuer