dynamic financial analysis what does it look like?
DESCRIPTION
DYNAMIC FINANCIAL ANALYSIS What Does It Look Like?. Casualty Loss Reserve Seminar September 14, 1999 Presented by: Susan E. Witcraft Milliman & Robertson, Inc. WHAT IS DFA?. Management tool Regulatory tool. USES FOR DFA. Estimate probability of attaining certain results - PowerPoint PPT PresentationTRANSCRIPT
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Casualty Loss Reserve Seminar September 14, 1999
Presented by: Susan E. WitcraftMilliman & Robertson, Inc.
DYNAMIC FINANCIAL ANALYSISWhat Does It Look Like?
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WHAT IS DFA?
Management tool
Regulatory tool
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USES FOR DFA
Estimate probability of attaining certain results
Identify risks to company Capital allocation Evaluation of alternate strategies
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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INPUT
PREMIUM Amount
Earning pattern
Collection pattern
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INPUT
LOSSES AND LAE Loss ratio on small claims Frequency of large claims Severity of large claims Catastrophes Reserve adjustments Payment patterns
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INPUT
EXPENSES
Fixed
Variable
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INPUT MODELS
Premium volume Losses and LAE Reserve development Payment patterns Expenses
Assets
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LOSS RATIO MODEL
where i is the year
l/r is the undiscounted loss ratio
int is the short-term yield
inf is the inflation rate
a, b, c, and d are constants
e is a random error term
l/ri = a(l/ri-1 ) + b(inti-1 - int) + c (infi - inf) + d + ei
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EXPENSE MODEL
Fixed expensesi = Fixed expensesi-1 x (1 + infi) + ei
where i is the years
inf is the inflation rate
e is a random error term
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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STRATEGIES
Investment Reinsurance Business mix Pricing
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STRATEGIES
Asset Type CurrentMore
CorporatesStocks &
CorporatesMore Non-Taxables
DurationMatch
Government Bonds 40% 10% 0% 5% 40%
Non-taxable Bonds 25% 25% 14% 60% 25%
Corporate Bonds 20% 50% 50% 20% 20%
Common Stocks 4% 4% 25% 4% 4%
Cash 11% 11% 11% 11% 11%
Bond Maturity 10 yrs. 10 yrs. 10 yrs. 10 yrs. 5 yrs.
Distribution of New Investments Among Types
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PORTFOLIO OPTIMIZER
Entire business (both assets and liabilities) viewed as a single portfolio
Considers risk from the perspective of the entire organization
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PORTFOLIO OPTIMIZER
Calculates line of business and asset mix that maximizes expected return for any given level of standard deviation
- OR - Calculates mix that provides lowest risk
for a given level of return
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PORTFOLIO OPTIMIZER
Inputs Reserve to premium ratios for each line of business Expected underwriting and asset returns and standard
deviations Correlation matrix between underwriting returns, asset
returns, and between underwriting and asset returns Constraints
Constraints on line of business mix and percentages of asset portfolio invested in various asset classes
Reserve to surplus ratio (alternatively, premium to surplus ratio)
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OPTIMAL ASSET MIX
Asset Type 7% 8% 9% 10% 11%
Government Bonds 44% 39% 33% 26% 20%Non-taxable Bonds 0% 1% 8% 15% 21%Corporate Bonds 48% 48% 42% 36% 30%Common Stocks 6% 12% 17% 23% 29%Cash 2% 0% 0% 0% 0%
Standard Deviation 21% 22% 24% 26% 29%
TARGET RETURNSTARGET RETURNS
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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SCENARIOS
Economy Underwriting cycle Catastrophes Large claims Failure of reinsurer Mass torts
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ECONOMIC SCENARIOS
GDP growth Inflation Interest rates
Short-term Long-term
Stock returns Bond default rates
Produce simulated projections of:
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ECONOMIC VARIABLES
-4%
-2%
0%
2%
4%
6%
8%
10%
1998 1999 2000 2001 2002 2003 2004 2005 2006-40%
-20%
0%
20%
40%
60%
80%
100%
Short Term Yields Inflation Dividend Yields Stock AppreciationNote: Stock Appreciation is plotted against the axis on the right of the graph.
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ECONOMIC SCENARIOS
Output used as inputs for income and balance sheet variables
Each scenario provides consistent set of assumptions for projection of future financial results
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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FINANCIAL CALCULATOR-UNDERWRITING
Project net premium, losses and expenses Income statement basis
Cash basis
Tax basis
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FINANCIAL CALCULATOR-ASSET MODEL Calculate investment income Add cash from operations, asset
maturities and asset sales Produce total funds available for investment each
projection period Invest total funds available for investment
Strategy specified by user State end-of-year balance sheet
Carried forward to next projection period
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OVERVIEW OF PROCESS
Input
Scenarios
Output
SelectStrategy
FinancialCalculator
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CHANGE IN SURPLUS
-150%
-100%
-50%
0%
50%
100%
150%
200%
250%
1998 1999 2000 2001 2002 2003 2004 2005 2006
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FINDINGS
Strategy
Average AnnualSurplus Growth
to 2006
Probability ThatSurplus Growth Is
Less than 10%
Current 7.7% 69.9%
More Corporates 7.8% 69.1%
Stocks & Corporates 10.0% 73.3%
More Non-Taxables 7.5% 70.1%
Duration Match 7.1% 72.9%
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RISK/REWARD ILLUSTRATION
A
B
CD E
Risk
Rew
ard X
+ +
++
+
++
+
+
++
+
++
++
+
+
+
+
+
+
++ + +
++
+
+
+
+
+
+
++
++
+
+
++ ++ +
+
+
+
+
+ ++
++
+ +
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RISK/REWARD SUMMARY
4%
6%
8%
10%
12%
68% 69% 70% 71% 72% 73% 74%Ave
rage
Ann
ual S
urpl
us In
crea
se
Probability Net Income/Surplus < 10%
21 4 5
3
1. Current 2. More Corporates 3. Stocks & Corporates 4. More Non-Taxables 5. Duration Match
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RISK/REWARD SUMMARY
4%
6%
8%
10%
12%
20% 22% 24% 26% 28% 30%
Ave
rage
Ann
ual S
urpl
us In
crea
se
Standard Deviation of Surplus Increase
5
42
1
3
1. Current 2. More Corporates 3. Stocks & Corporates 4. More Non-Taxables 5. Duration Match
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Casualty Loss Reserve Seminar September 14, 1999
Presented by: Susan E. WitcraftMilliman & Robertson, Inc.
DYNAMIC FINANCIAL ANALYSISWhat Does It Look Like?