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Published byEmmeline Byrd Modified over 9 years ago
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C O N N I N G A S S E T M A N A G E M E N T Analyzing Reinsurance with DFA Practical Examples Daniel Isaac Washington, D.C. July 28-30, 2003
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1 Key Considerations Why are we changing? -Cost of current program -Rating agencies -Regulatory capital -Change in business mix/philosophy
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2 Key Considerations How long do we need protection? -Impacts potential reinsurers -Impacts types of covers considered How long will benefits last? -Will that change if there is a claim?
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3 Key Considerations What other changes can we make? -Asset strategy -Capital structure -Business mix How do these fit together? -Mitigate cost -Enhance benefits
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4 General Rules Use several different measures -We prefer Economic Value as primary Just considers cash flows Eliminates accounting “noise” -Also evaluate financial metrics Statutory Surplus GAAP Equity RBC Ratio
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5 Company Profile Name:Make Believe Inc. (MBI) Size:$150 MM Net Premium Growth:10 - 15% per year Mix60/40 Commercial/Personal 60/40 Liability/Property Time Horizon:5 years
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6 MBI Concerns Recently went public -Very concerned about GAAP Income -Also very concerned about volatility Wants to increase equity exposure -Very conservative asset portfolio -98% bonds -Mostly high quality (A or better) and short-term -Expect higher returns long-term
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7 Option #1 Buy traditional coverage -10 x 70 accident year loss ratio coverage -2% of earned premium -1 year cover which is annually renewed Increase equity allocation -Consider 10 and 20% allocations
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8 Results Option #1
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1010 Summary - Option #1 Reinsurance -Successfully reduces risk 25% lower standard deviation less downside -Negatively impacts income Equities -Further drop in GAAP Income -Little additional risk Overall -Hit to income is too great
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1 Option #2 Add experience account balance to Option #1 -Same coverage 10 x 70 accident year loss ratio -Increase price from 2% to 5% -5 year cover with separate limits by accident year Experience account balance -80% of reinsurance premium added for each accident year -Positive balances earn equity returns -Any time after the end of the fifth calendar year, MBI can commute the treaty and claim the positive balance No change in asset allocation
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1212 Results - Option #2
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1414 Summary - Option #2 (cont.)
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1515 Summary - Option #2 Achieves company’s goals -Improves average GAAP income -Increases equity exposure Other benefits -Lock in the price and coverage for five years -Commutation provision allows company flexibility -Lower RBC charge for reinsurance recoverable than equity
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1616 Summary - Option #2 Disadvantages - Makes stock returns currently taxable Normally, stock returns are only taxed when realized Changes in experience account balance flow through income Hurts ending shareholder equity No reduction in volatility
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1717 Summary - Option #2 Disadvantages -In good scenarios, experience account balance would become a large (-20%) portion of assets May concern regulators Muted, to some extent, by commutation provision
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1818 How Many Scenarios? Most DFA models create large number of scenarios -Monte Carlo simulation -Allows “complete” scenarios -Other methods are available Simulation creates the possibility of sampling error -Large samples reduce this possibility -Can be very time and resource consuming
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1919 How Many Scenarios? The “right” number of scenarios is based on: -Volatility of results -Metrics being used -Simulation methodology - Independent vs Dependent
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2020 How Many Scenarios? Definitions: Reward:Average ending Economic Value Risk:Mean - 1st percentile
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2121 How Many Scenarios? Sample Size based on: Reward:Net cost under $6 million Risk: Reduced at least $40 million
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2 How Many Scenarios? Different strategies are highly correlated -Same gross underwriting -Same economy Maintaining correlation in modeling process reduces sampling error -Still have to consider parameter risk
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