0. Dynamic Financial Analysis: Stephen W. Philbrick, FCAS
Swiss Re Investors
Dynamic Financial Analysis:
Taxonomy Revisited
Stephen W. Philbrick, FCAS
Swiss Re’s Value Proposition
This presentation will demonstrate the customer benefit of reinsurance and explain the underlying economic rationale for reinsurance.
Copyright Swiss Re Investors

1. Taxonomy Design Designing a Taxonomy Similar to Designing a Class Plan
Identify Distinguishing Characteristics
Objective
Measurable
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2. DFA Model Structure Initial Conditions Scenario Generator
Financial Calculator
Results
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3. Profitability Targets…Witcraft
Asset
Accounting
Economic
Scenario
Financial
Statements
Report
Generator
Liability
Accounting
Liability
Scenario
Loss
Expense
Other
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4. Applying a DFA Model…Correnti, Sonlin, Isaac
FIRMTM Process
Step 1
Evaluation and Simulation of Economy(s)
and Capital Market(s)
Step 2
Evaluation and Simulation of Balance Sheet Items
Business mix
Reinsurance strategy
Mergers, Acquisitions and Divestitures
Investment Strategy
Derivatives
Capital Allocation/Structure
Step 3
Risk/Reward Optimization
(Efficient Frontier)
Step 4
Analysis of Results:
- Decomposition of Risk
- Downside Analysis
- Solvency
Step 5
Sensitivity Testing
Strategic Business Decisions
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5. DFA Model Structure Initial Conditions Scenario Generator
Financial Calculator
Optimizer
Results
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6. Dynamic Financial Analysis
Initial Conditions
History
Premium levels
Inflation rates, etc.
Current
Balance sheet
Yield curves, etc.
Represents estimates of the model
assumptions at the start date of the
model
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7. DFA Scenario Generator
This is where taxonomy is most relevant
We will return here after completing discussion of model structure
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8. Financial Calculator - Granularity
Policy detail
Premium levels
Inflation rates, etc.
Loss generation
Pure premium
Exposure/frequency/severity
Assets
Classes of assets
Individual assets
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9. Financial Calculator - Accounting Basis
GAAP
Statutory
Both
Economic
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10. Imbedded in Market?
Strategy evaluation - contingent decisions capability
Model can be stand-alone with implied market interactions
Model can formally generate competitors who can affect marketplace
Example - corporate financial “games”
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11. Embedded in Market - Status
Ongoing work - not much available
Hard to do
Requires modeling dozens of companies
And their interactions
Without necessary information
Can’t punt on market cycle
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12. Results Financial results for each scenario
Objective function to be optimized
Ending surplus
Probability of insolvency
Cost of insolvency (expected deficit)
Variance of earnings, surplus...
Determination of “drivers” of results
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13. Metrics
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14. Categories of Metrics Simple Stat (mean-based) ROC ROMAC Cost of Cat
Simple Stat (non mean-based)
Ruin
VAR
Probability of Missing Goal
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15. Categories of Metrics (Cont.)
Multiple Valued Stat
Percentiles of:
Final Surplus
Interim Surplus
Net Loss ratio
Combined ratio
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16. Categories of Metrics (Cont.)
Single Value Incorporating Multiple Points
EPD
RAROC
Utility
Two Dimensions of Variates
Efficient Frontier
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17. ALM Efficient Frontier
Same Risk,
Higher Reward
Financial Reward
Same Reward,
Lower Risk
Current Strategy
Financial Risk
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18. Efficient Frontier
The “efficient frontier” is the set of optimal strategies that maximizes reward for each level of risk
Efficient Frontier
Financial Reward
Financial Risk
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19. Scenario Generator Single most important part of a “dynamic” model
Various categories regarding approach to:
General economic conditions
Assets
Liabilities
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20. Scenario Generator - Categories
Deterministic
Simulation
Unstructured
Structured
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21. Scenario Generator - Deterministic
Specify characteristics for each scenario of interest
Examples:
Recession scenario
Acquisition scenario
Growth scenario
Catastrophe scenario
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22. Unstructured Simulation
Specify statistical distribution for each variable
Monte Carlo simulation to randomly generate scenarios
Output can be automatically summarized as distribution
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23. Structured Simulation
Econometric relationships
Autoregressive
ARIMA
Formal relationships with correlations
Generated scenarios are internally consistent and plausible
Output can be automatically summarized as distribution
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24. Purpose Valuation Strategy analysis Exploration of dynamics
Solvency analysis
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25. Conclusions Taxonomy Model Holding up well
Significant Progress is Occurring in DFA research
Harder Than Some of us Thought
Correlation
Payment Variability
Reserving
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26. Still To-Do Correlation (Parameters) Modeling Some Assets Muni’s
Foreign Stocks
Real estate
Modeling Underwriting Cycle
Parameterizing EVERYTHING
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