Economic IRR and its application

Economic IRR and its application

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Speaker: Naoki Sunamoto

Integrated management of capital, risk and return is essential for the contemporary ERM. The relationships between three elements are measured by three metrics: ESR, ROE and RORC. The risk adjusted return metrics represented by RORC have an important role in decision making because they are inextricably linked to strategic planning and its analysis. RORC is popularly used in practice, but has limitations in that RORC itself gives little information about ESR. In this paper, we introduce a risk adjusted return metric called "Economic IRR" as a complement to RORC. Economic IRR is a form of internal rate of return which includes initial required capital as part of initial investment. After developing the models for Economic IRR, we apply them to life insurance and annuity. The derived equations will be acceptable not only theoretically, but also intuitively. Then we explore the pros and cons of Economic IRR from effectiveness of practice. We find that Economic IRR excels in effectiveness and efficiency and is very useful in decision making. After showing an example of practical use in Fukoku Mutual Life, we conclude that the integrated management of capital, risk and return should be significantly enhanced when Economic IRR is effectively incorporated into the decision making process.

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