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The Value Proposition of DFA

The Value Proposition of DFA. Presented by: Susan Witcraft Manuel Almagro June 7, 2001. Susan Witcraft. FCAS, MAAA Current employment: Vice President and Chief Actuary, RTW, Inc. Prior employment: Consulting Actuary, Milliman & Robertson, Inc. Manuel Almagro. FCAS, MAAA

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The Value Proposition of DFA

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  1. The Value Proposition of DFA Presented by: Susan Witcraft Manuel Almagro June 7, 2001

  2. Susan Witcraft • FCAS, MAAA • Current employment: Vice President and Chief Actuary, RTW, Inc. • Prior employment: Consulting Actuary, Milliman & Robertson, Inc.

  3. Manuel Almagro • FCAS, MAAA • Current Employment: Senior Vice President and Chief Actuary, Guilford Specialty Group • Prior Employment: Consulting Actuary, Tillinghast-Towers Perrin Vice President, Swiss Re Investors

  4. The Transition from Consulting to a Small Insurer: Pros and Cons Presented by: Susan Witcraft Manual Almagro June 7, 2001

  5. For What is DFA Valuable? • Asset allocation • Reinsurance programs • Capital adequacy • Capital allocation • Line of business mix • Understanding income statement and balance sheet risks

  6. For What is DFA Valuable? • Enhancing corporate communication • Expanding actuaries’ horizons • Overall company management • Investments • Improved analysis tools • Enterprise riskmanagement

  7. Enhancing Corporate Communication • Successful DFA implementation requires participation of all corporate departments. • Topics of discussion are wide-ranging. • Participants have varying levels of knowledge of these topics.

  8. Expanding Actuaries’ Horizons: Overall Company Management • Actuary • Oversees or implements model. • Understands issues important to all constituents. • Interprets results. • Participates in decision-making process.

  9. Expanding Actuaries’ Horizons: Finance and Investments • Enterprise risk management models include all corporate financial activities. • Actuaries • Traditionally most familiar with underwriting issues. • Must become at least conversant with economic modeling, investment issues and finance to implement model and interpret results.

  10. Expanding Actuaries’ Horizons: Analysis Tools • DFA has required actuaries to refine and expand analysis techniques. • Examples include modeling of: • Small, large and cat claims. • Development of booked reserves. • Payment pattern variability. • Links between losses and economic conditions. • Pricing process.

  11. Improved Analysis Tools: Case Study • Analysis tools can be used for other applications. • Examples: • Reserve development and payment pattern variability for evaluating adverse development covers. • Separation of losses into small, large and cat for evaluating excess of loss or cat covers or for evaluating adequacy of rates for lines with facultative covers.

  12. Case Study:Loss Portfolio Transfer • Questions faced by company: • What is the economic cost of each loss portfolio transfer/adverse development cover proposal? • Does each proposal meet the auditors requirements for transfer of risk?

  13. Background • $200 million of loss and LAE reserves as of 12/31/99. • Considering capital contribution or merger. • Significant uncertainty surrounding reserve estimates. • Want balance sheet protection.

  14. Three Proposals 1. $75 million excess $175 million for $30 million. 2. $50 million excess $200 million for $15 million. 3. $250 million excess $0 for $190 million. All 3 include experience account with 7% interest credit guaranteed by ceding company and a reinsurers’ margin of $10 million {$15 million for (3)}.

  15. Analysis Approach • Simulate possible future payments by calendar year. • Reflect differences in emergence patterns under varying historical reinsurance programs. • Apply reinsurance terms to each scenario. • Auditor defines risk transfer test. • Calculate economic cost and risk transfer test.

  16. Overall Approach Calendar Year Payments By Accident Year Beginning Reserve By Accident Year Ending Reserve By Accident Year

  17. Actual Payments = Beginning Reserve x Actual Claim Inflation x Expected Claim Inflation + (Payment Ratio Random Component) Payments

  18. = Ending Reserve Beginning Reserve x æ ö Current Expected Future Claim Cost Inflation ç ÷ x ç ÷ ç ÷ ç ÷ Prior Expected Future Claim Cost Inflation ç ÷ ç ÷ è ø + Change in Reserve Random Component æ ö ç ÷ ç ÷ è ø Ending Reserve

  19. Total Payments

  20. Present Value of Payments

  21. Evaluation of Proposals * Assumes no development.

  22. Enterprise Risk Management: Case Study • Analysis of investment strategy • • • • •

  23. The Value Proposition of DFA Presented by: Susan Witcraft Manuel Almagro June 7, 2001

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