Investment Presentation Example 2003 CAS Research Working Party: Executive Level Decision Making...

InvestmentPresentation Example

2003 CAS Research Working Party:

Executive Level Decision Making using DFA

Michael R. Larsen, FCAS, MAAA

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InvestmentPresentation Example

2003 CAS Research Working Party:

Executive Level Decision Making using DFA

Michael R. Larsen, FCAS, MAAA

2003 CAS Research Working Party 55

Goals of Study

Review Reinvestment Options

Measure Results using Simulation Model Results

Risk as Average Loss in Surplus in Worst 1% of Cases over Five Years

Return as Average Increase in Policy Holder Surplus at End of Five Years


44%

54%

0%0%2%

29%

44%

10%

15%

2%

29%

29%

25%

15%

2%

24%

24%

30%

20%

2%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Reinvestment Strategy

Cash 2% 2% 2% 2%

Common Stock Unaffiliated 0% 15% 15% 20%

Unaffiliated Bonds 0% 10% 25% 30%

Municipal 54% 44% 29% 24%

U.S. Govt Bond 44% 29% 29% 24%

Option A Option B Option C Option D

Change in Reinvestment Allocation


DFA Flow

Work CompGrow 5% a year

Multi_PerilGrow 5% a year

FinancialCalculator

Starting Policy Holder Surplus 40,000

Corporate Elements

Reinsurance Investment

Capital Mix Taxes

Financial Results

Simulated over Five Years

Analyze Results

Measures of

•Risk•Return Change in Policy

Holder Surplus


Model / Assumptions

Assumptions Behind

Simulation

Assume Underwriting Operations Not Affected• Ability to take rate changes not driven by investment results• Growth rates in exposure does not change

Investment Scenario• Long run average interest rate of 4% • Starting interest rate of 4%

Investment Models• Short term interest rate model is a mean reversion model• Long term rates are a function of short term rates• Stock returns modeled as a function of short term rates and interest rate changes• Stable relationship between bond and equity market


Policyholder Surplus Change by Reinvestment Option

Option A

0

0.04

0.08

0.12

0.16

0.2

0.24

0.28

0.32

0.36

0.4

-40 -30 -20 -10 0 10 20 30 40

Mil

Pro

babi

lity

0

0.2

0.4

0.6

0.8

1

pdf cdf

Option B

0

0.04

0.08

0.12

0.16

0.2

0.24

0.28

0.32

0.36

0.4

-40 -30 -20 -10 0 10 20 30 40

Mil

Pro

babi

lity

0

0.2

0.4

0.6

0.8

1

pdf cdf

Option C

0

0.04

0.08

0.12

0.16

0.2

0.24

0.28

0.32

0.36

0.4

-40 -30 -20 -10 0 10 20 30 40

Mil

Pro

babi

lity

0

0.2

0.4

0.6

0.8

1

pdf cdf

Option D

0

0.04

0.08

0.12

0.16

0.2

0.24

0.28

0.32

0.36

0.4

-40 -30 -20 -10 0 10 20 30 40

Mil

Pro

babi

lity

0

0.2

0.4

0.6

0.8

1

pdf cdf


Option A(10 - 90 percentiles)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

2004 2005 2006 2007 2008

Thou

sand

s

Surplus Change Over Time by Investment Option

Option B(10 - 90 percentiles)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

2004 2005 2006 2007 2008

Thou

sand

s

Option C(10 - 90 percentiles)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

2004 2005 2006 2007 2008

Thou

sand

s

Option D(10 - 90 percentiles)

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

2004 2005 2006 2007 2008

Thou

sand

s


Risk-Reward

10

11

12

13

14

15

16

17

18

19

20

10 11 12 13 14 15 16 17 18 19 20

Th

ou

san

ds

Thousands

Average Surplus Loss in Worst Case

Ave

rag

e S

urp

lus

Gai

n

Option A

Option B

Option C

Option D

Investment Option Comparison

Better

Option D Highest Return Less Risk


Risk-Reward

10

11

12

13

14

15

16

17

18

19

20

10 11 12 13 14 15 16 17 18 19 20

Th

ou

san

ds

Thousands


Ave

rag

e S

urp

lus

Gai

n

Option A

Option B

Option C

Option D


Better


Investment Presentation Example 2003 CAS Research Working Party: Executive Level Decision Making...

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