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CAS Ratemaking Seminar
RCM-2 What are we Debating About?
Remarks by Glenn Meyers
Insurance Services Office, Inc.
March 11, 2004
Insurer Risk and Capital
Management Perspective
• Risk based capital
– The insurer's risk, as measured by its
stochastic distribution of outcomes, provides a
meaningful yardstick that can be used to set
capital requirements.
• Insurer risk management
– The insurer manages its business to minimize
its cost of financing, i.e. its cost of capital plus
the net cost of reinsurance.
Insurer Risk Measurement
• Use a coherent measure of risk r(X)
– e.g. Tail Value-at-Risk
• Define random variables:
– A = Assets
– X = Liabilities
• Insurer has sufficient assets if
r(X – A) = 0
• Define:
Capital = E(A) – E(X)
Insurer Risk Management
• Choose insurance portfolio (lines of
business and reinsurance strategies) to
minimize cost of financing insurance.
• Two equivalent techniques
– Efficient frontier management
– Marginal cost of capital analyses
• Capital Allocation
– In general unnecessary, but it is desirable for
communicating financially oriented objectives.
Insurer Risk Management
• Reserve Risk contributes to the need for
capital and hence it contributes to the ($)
cost of capital.
• How long you need to hold capital is a
consideration in determining an
acceptable price.
• Easy to implement by allocating capital
(see RCM-4).
Prediction
This how actuaries will include the cost
of capital in future insurance costing.
Obstacles to Overcome
• Fuzzy relationship between risk and capital
– See Recent work by IAA working party
http://www.actuaries.org/members/en/committees/WGRBC/documents.cfm
• Quantification of all risks
–
–
–
–
Underwriting risk - See RCM-4
Asset risk - Several commercial models
Operational risk
Other
• Consensus
– Will not come until above issues are substantially settled.