Management Strategies and Dynamic Financial Analysis Martin Eling, University of Ulm CAS Spring Meeting Thomas Parnitzke, Baloise Holding San Diego, May 23-26, 2010 Hato Schmeiser, University of St. Gallen
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
Outline
1. Motivation 2. Model Framework 3. Management Strategies 4. Performance Measurement 5 Simulation 5. Si l ti Study St d 6. Role of Non-linear Dependencies 7. Conclusion and Outlook
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
1. Motivation: Three pillars of Solvency II
Solvency II First pillar: Quantitative regulations for capital requirements
Second pillar: Qualitative elements of supervision
Third pillar: Market transparency and disclosure requirements
→ Technical provisions provisions, minimum capital, target capital → Use of standard models and internal models (Dynamic Financial Analysis)
→ Appropriate processes and decisions in the context of a risk management system → Principles for internal risk management and control
→ A transparent process will require less regulation as market participants themselves force appropriate insurer behavior → Harmonization with IFRS
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
1. Motivation: Dynamic Financial Analysis (DFA) • Projects results under a variety of possible scenarios, showing how outcomes might g be affected byy changing g g internal and external conditions • Used in practice for
Assets
Liabilities
cash flow projection and decision support
Risk Management
Competition
• Aim Ai off this thi paper:
Insurance Company
Capital Market
Regulation
1. Implement management strategies in a DFA framework 2 Study the effects on the insurer 2. insurer’s s risk and return position 3. Give helpful insights for the development of DFA tools
Environment
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
2. Model Framework
•
Simplified model of a property-liability insurer
•
Balance sheet (t=0):
Assets
Investments Equity (stocks, bonds, Reserves etc.) (Premiums)
Investment Result
•
Statement of Income (t=1):
Liabilities
Underwriting g Result Premiums - Claims - Costs (Upfront, Claim Settlement) = Underwriting Result + Investment Result = Earnings
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
2. Model Framework: Earnings
(1) ECt ECt 1 Et
Assets
Competition
Et : Earnings E i I t : Investment Result U t : Underwriting Result tr : Tax rate
Insurance Company
Risk Management
(2) Et I t U t max(tr ( I t U t ),0) ) 0)
ECt : Equity Capital at the end of period t
Liabilities
Capital Market
Regulation
Environment
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
2. Model Framework: Investment result
(3) I t rpt ( ECt 1 Pt 1 ExtP1 )
Assets
Competition
Pt 1 : Premiums ExtP1: Upfront costs (depending on premiums)
t 1 : Portion invested in high-risk investments r1t : Return Ret rn of high-risk high risk in investment estment (e.g., (e g stocks) r2t : Return of low-risk investment (e.g., bonds)
Insurance Company
Risk Management
(4) rpt t 1 r1t 1 t 1 r2t
rpt : Return of investment portfolio
Liabilities
Capital Market
Regulation
Environment
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
2. Model Framework: Underwriting result
(5) U t Pt 1 Ct ExtP1 ExtC (6) Pt 1 crt 1
ECt 1
Assets
Liabilities
Insurance Company
Risk Management
t 1 t 1 MV Competition
Capital Market
Regulation
Environment
• Consumer response (cr) to changes in solvency
cr 1, if ECt MCR cr 1, 1 if ECt MCR • Underwriting cycle (π): Markov chain with different states • Claims: Ct Ccat t Cncat t
ExtC : Claim settlement costs cr
: Consumer response
t
: Underwriting cycle
MCR : Minimum capital required (Solvency I)
t 1
: Portion in the underwriting market
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Eling, Parnitzke, Schmeiser| Management Strategies and Dynamic Financial Analysis
2. Model: Implementation in R (simplified one period example) E=0 EC=15 MV 200 MV=200 β=0.2 P=MV*β ExP