1. FIN 12: Actuarial Considerations Re Risk and Return
Related Concurrent Sessions
FIN 10: Into the Workings of DCF
FIN 11: Parameter Estimation in DCF
FIN 15: The Cost of Financing from a DFA Perspective

2. The Book: A Safe Harbor
“Actuarial Considerations…” was compiled to illustrate the wide range of sound actuarial practices
It does not contain all valid approaches, but instead encourages creative solutions
My goal as editor is for regulators to look beyond form to the substance of the rate filing

3. Benedetto Conti
Perspectives

4. Three Audiences
Senior Management
Regulators
Stakeholders

5. Three Audiences Their goals Their constituency Their language
What the actuary can provide

6. Senior Management Goals: Constituency: Language:
What the actuary can provide:
Market position and stock price
Investment Analysts and Rating Organizations
Growth and ROE
Risk-adjusted ROE’s that reflect enterprise risk

7. Regulators Goals: Constituency: Language:
What the actuary can provide:
Consumer Protection
Voters and Political Leaders
Excess, waste, profit (“Profit” has a negative tone here)
Documentation that the profit is fair in the market

8. Stakeholders Goals: Constituency: Language:
What the actuary can provide:
Value creation in the context of risk
Same investors and consumers represented by proxy so far
Invisible hand; efficient markets; supply and demand
Prices that are consistent with competitive markets

9. Two Perspectives Optimal Portfolio Optimal Price
Marginal Effect on the Portfolio
Efficient Frontier of Risk and Return
Returns Reflect Market Portfolio
Stars: Markowitz, CAPM, APT, Black-Scholes
Optimal Price
Marginal Effect on Supply and Demand
Efficient Frontier of Sales and Price
Prices Reflect Information
Stars: Adam Smith, Arrow, Debreu, Cowles, Borch

10. Two Perspectives Return-on-Equity
1. Define the product in the corporate environment
2. Use comparative ROE data to allocate surplus and set ROE
3. Adjust as needed for rate filing
Cost of Risk
1. Define risk in a general way and find the market cost of risk
2. Use that cost in product pricing in a corporate environment
3. Adjust as needed for rate filing

11. Russ Bingham
Return-on-Equity

12. Cost of Risk Supply and demand for “risk”
The underwriter takes risk premium in consideration for accepting risk transfer
The markets tell us the metric for risk, and the price per unit of risk
We can use that market cost of risk

13. Risk as a Commodity

14. Using the Market Cost of Risk
1. Find the cost of risk per unit of exposure
1.1 Determine the risk per unit of exposure
1.2 Apply the market cost per unit of risk
1.3 Determine the premium rate level
2. Optimize the portfolio
2.1 Determine the marginal risk and return to the firm from selling the product (e.g., by using DFA)
2.2 Set volume and price targets to maximize the value of the firm

15. Communicating to Management
Allocate surplus and select ROE. Then, find the premium rate from DCF calculation.
Find the premium/ price goals that maximize the value of the firm. Then, express these as allocated surplus and ROE.

16. Communicating to Regulators
DCF calculations
Profit provisions
, a cost per unit of exposure
Q*R, a provision for profit and contingencies in the rate
L*(1+), a risk loading
Choice of conservative assumptions

17. Questions

18. Calculation of 