PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

290 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESequity of the firm at time zero should be limited to tax-affectedreserve adjustments (to bring carried reserves to the actuarialindicated level) and other changes that “true up” the statutorybalance sheet. Adjustments to statutory capital to compute ANWthat are not permitted under statutory accounting will not changestatutory capital and therefore will not affect free cash flows.Many financial experts, however, insist that assets be adjustedto their market value at the date of valuation. Further, goodwillcarried on the balance sheet is almost always eliminated for valuation,even though it is now a statutory asset. Experts continueto disagree on how these adjustments should be handled for valuation.Either way, if the net worth or the equity of the firm is adjustedto recognize nonadmitted assets, or reflect the market value of allassets, then the firm’s future earnings or changes in capital mustbe adjusted to prevent double counting this value. For example,if all assets are marked to market for the valuation, then futureearnings of the firm must not reflect any realized gains or lossesassociated with assets unless the market values change. Further, ifnonadmitted assets are added back to the starting net worth of thefirm, then any capital increases associated with the recognitionof nonadmitted assets must be eliminated from future financialprojections.Any adjustments to the starting capital to determine ANWwill cause the EVA and DCF valuation results to diverge unlessthe same adjustments are made for both valuation methodologies.Otherwise, for DCF, these values will be recognized on adiscounted basis through future earnings or “below the line” adjustmentsto equity. For EVA, they will be recognized at timezero, thereby reflecting no present value discount in the computationof value.The common adjustments to the starting capital (SC 0 )forvaluationare listed below. Only items 1 and 6 are consistent withstatutory accounting principles and therefore will have the sameeffect on EVA and DCF valuations. The other adjustments to