Brehm ch.2 Flashcards
1
Q
what is decision analysis?
Brehm ch.2
A
using simulations to drive corporate decision making
2
Q
list the three steps of the decision analysis process
Brehm ch.2
A
- deterministic project analysis
- risk analysis
- certainty equivalent
3
Q
what is deterministic project analysis?
Brehm ch.2
A
uses a single deterministic forecast for projecting cash flows to produce an objective function like present value or internal rate of return
4
Q
how is uncertainty handled in a deterministic project analysis?
(Brehm ch.2)
A
judgmentally (rather than stochastically)
5
Q
what might a deterministic project analysis reveal?
Brehm ch.2
A
sensitivities to critical variables
6
Q
what is risk analysis?
Brehm ch.2
A
forecasts of distributions of critical variables are input into a Monte Carlo simulation process to produce a distribution of the present value of cash flows
7
Q
what is the certainty equivalent step of decision analysis?
Brehm ch.2
A
- expands upon risk analysis step by quantifying the intuitive risk judgment using a utility function (i.e. corporate risk preference)
- utility function does NOT replace judgment, just formalizes it in order to consistently apply
8
Q
why do some believe that the efficient market theory removes the need for the certainty equivalent step of decision analysis evolution?
(Brehm ch.2)
A
- since investors can diversify away firm-specific risk, it doesn’t have a risk premium and should be ignored
- goal of firm managers is to maximize shareholder value, so they should ignore firm-specific risk as well
9
Q
what is the issue with the argument that efficient market theory removes the need for the certainty equivalent step of decision analysis?
(Brehm ch.2)
A
does not provide any practical advice for handling risk management within a firm:
- difficult to determine which risks are firm-specific and which are systematic
- market-based risk signals (ex: risk-adjusted rate) often lack the refinement needed for managers to mitigate or hedge the risk
10
Q
what does the fifth element of internal risk modeling include?
(Brehm ch.2)
A
- corporate risk tolerance
- cost of capital allocation
- cost-benefit analysis for mitigation strategies
11
Q
we desire a mechanism for internal risk modeling that achieves what four steps?
(Brehm ch.2)
A
1-starts with aggregate loss distribution, with many sources of risk
2-quantifies the impact of possible aggregate loss outcomes on the corporation
3-assigns a cost to each amount of impact
4-attributes the costs back to the risk sources
12
Q
what is corporate risk tolerance?
Brehm ch.2
A
the organization’s size, financial resources, ability, and willingness to tolerate volatility
13
Q
what is an efficient frontier of possible insurance portfolios?
(Brehm ch.2)
A
portfolios that minimize risk for a given rate of return
14
Q
how is a standard efficient frontier graph plotted?
Brehm ch.2
A
- x-axis is risk
- y-axis is return
15
Q
what three questions must a firm answer in order to select an efficient portfolio?
(Brehm ch.2)
A
- how much risk is the firm willing to tolerate?
- how much reward is the firm willing to give up for a given reduction in risk, and vice versa?
- are the risk-reward tradeoffs available along the efficient frontier acceptable to the firm?
16
Q
historically, what has capital allocation referred to?
Brehm ch.2
A
allocating capital itself
17
Q
why isn’t the historical concept of capital allocation useful for financial firms?
(Brehm ch.2)
A
-risk capital is theoretical -> when insurer writes an automobile policy, no actual risk capital is transferred to the policy
18
Q
what should financial firms rely on instead of capital allocation?
(Brehm ch.2)
A
allocating the COST of capital
19
Q
what is one way to allocate the cost of capital?
Brehm ch.2
A
by allocating risk capital first and then using it to assign the cost of that risk capital to portfolio elements
20
Q
what is the Return on Risk-Adjusted Capital?
Brehm ch.2
A
the product of the risk-adjusted capital and a hurdle rate
21
Q
what is Economic Value Added and a use for it?
Brehm ch.2
A
EVA = NPV Return - Cost of Capital
method of determining if an activity is worth pursuing
22
Q
under a cost-benefit analysis and using the EVA approach where the cost of risk capital is determined directly, which mitigation strategies would be implemented?
(Brehm ch.2)
A
strategies that produce positive incremental EVA
23
Q
under a cost-benefit analysis and using the capital allocation approach where we’ve allocated risk capital, what activities would we pursue?
(Brehm ch.2)
A
pursue activities where the benefit (decrease in required capital) exceeds the costs of implementation
24
Q
what does economic capital typically refer to?
Brehm ch.2
A
VaR (value at risk) at a remote probability, such as 1-in-3000 (i.e. 99.97% percentile)
25
what are four advantages of using economic capital?
| Brehm ch.2
- provides [F]ramework for setting acceptable risk levels for organization as a whole AND individual business units
- [U]nifying measure for all risks across an organization
- more [M]eaningful to management than RBC or capital adequacy ratios
- forces firm to [Q]uantify the risks it faces and combine them into a probability distr
26
how is VaR usually calculated for the organization as a whole and individual business units? and why is it beneficial?
(Brehm ch.2)
- usually calculated for all risks combined and then allocated down to individual business units
- NOT by summing up contributions of individual business units
- beneficial because it provides a consistent measurement of risk across units
27
how is the probability level selected for economic capital?
| Brehm ch.2
- usually a round number for target level
- usually selected s.t. economic capital is slightly less than the actual capital being held (i.e. if insurer is holding capital at 1-in-3467 level, chose 1-in-3333)
- important to note that probability levels like 1-in-3000 are not in range of current modeling for insurers
28
what are moment-based risk measures?
| Brehm ch.2
uses the moment of a random variable, such as the change in capital over an accounting period
29
what are two examples of moment-based risk measures?
| Brehm ch.2
- variance
| - standard deviation
30
what are two disadvantages of using variance or standard deviation as risk measures?
(Brehm ch.2)
- favorable deviations are treated same as unfavorable
- as quadratic measures (ie variance based on second moment) may not adequately capture market attitudes to risk (ie they understate risk)
31
what are three alternatives to variance or standard deviation as risk measures?
(Brehm ch.2)
- semistandard deviation
- skewness
- exponential moments
32
how does semistandard deviation address an issue of using variance/SD as risk measures?
(Brehm ch.2)
only uses unfavorable deviations
33
how does skewness address an issue of using variance/SD as risk measures?
(Brehm ch.2)
since it uses a higher moment, might better capture market attitudes
34
how do exponential moments address an issue of using variance/SD as risk measures?
(Brehm ch.2)
these types of measures capture the effect of large losses on the risk exponentially -> might better capture market attitudes
35
what do tail-based risk measures emphasize, and what is a disadvantage to this emphasis?
(Brehm ch.2)
- emphasize large losses only
| - losses do not have to be large to cause problems for an insurer
36
what are five examples of tail-based measures?
| Brehm ch.2
- VaR
- TVaR (tail value at risk)
- XTVaR (excess tail value at risk)
- EPD (expected policyholder deficit)
- Value of default put option
37
what is VaR (value at risk)?
| Brehm ch.2
percentile of the probability distribution
38
what is TVaR (tail value at risk)?
| Brehm ch.2
expected loss at a specified probability level and beyond
39
what is XTVaR (excess tail value at risk)?
| Brehm ch.2
- calculated as TVaR minus the overall mean
- when mean is financed by other funding (something other than capital), then capital is only needed for losses above the mean
40
what is EPD (expected policyholder deficit)?
| Brehm ch.2
- calculated by multiplying (TVaR - VaR) by the complement of the specified probability level
- UNCONDITIONAL expected value of defaulted losses
41
what is the difference between XTVaR and EPD?
| Brehm ch.2
- XTVaR is CONDITIONAL expected value of TVaR - overall MEAN
| - EPD is UNCONDITIONAL expected value of TVaR - !!VaR!!
42
what is the 'value of default put option' risk measure?
| Brehm ch.2
- when capital/reinsurance is exhausted, firm has the right to default on its obligations and put the claims to the policyholders
- market value of this risk = default put option
43
how do probability transforms measure risk?
| Brehm ch.2
shifting probability towards unfavorable outcomes and then computing a risk measure with the transformed probabilities
44
why are transformed means useful risk measures?
| Brehm ch.2
- they often provide the market value of the risk being measured
- can be used for pricing purposes
45
what two transforms does the theory of pricing incomplete markets use, and what do they approximate?
(Brehm ch.2)
- minimum martingale transform
- minimum entropy martingale transform
- approximate market prices of reinsurance
46
what does the Wang transform approximate?
| Brehm ch.2
-market prices of standard bonds and catastrophe bonds
47
how can transformed probabilities overcome the criticism of TVaR's linearity in the tail?
(Brehm ch.2)
- under transformed probabilities, TVaR becomed WTVaR (weighted TVaR)
- NOT linear in tail
- considers a loss that is twice as large to be more than twice as bad
48
what are generalized moments?
| Brehm ch.2
expectations of a random variable that are NOT simply powers of that variable
49
what are spectral measures? (in words)
| Brehm ch.2
-a specific class of generalized moments that includes many of the tail-based measures
50
how can spectral measures be written?
| Brehm ch.2
E[Y * eta(F(Y))]
| for non-negative scalar function eta
51
if we want to choose a risk measure closer to market value, what measures might we choose?
(Brehm ch.2)
- WTVaR
- minimum entropy transform
- exponential moment
52
what are three examples of variables that influence the amount of capital an insurance company holds?
(Brehm ch.2)
- customer reaction
- capital requirements of rating agencies
- comparative profitability of new and renewal business
53
how does customer reaction influence the amount of capital an insurance company holds?
(Brehm ch.2)
- some customers care deeply about the amount of capital being held by insurers / the financial rating of an insurer
- often, declines in financial ratings -> declines in business
54
how do the capital requirements of rating agencies influence the amount of capital an insurance company holds?
(Brehm ch.2)
different rating agencies require different amounts of capital to be held by an insurer
55
how does the comparative profitability of new and renewal business influence the amount of capital an insurance company holds?
(Brehm ch.2)
- renewal business tends to be more profitable due to more informed pricing and underwriting -> important to retain renewal business
- if renewals comprise 80% of book -> insurer should be able to maintain 80% of its capital in a bad year -> should hold enough capital so that 20% of its capital could cover a fairly adverse event
56
what are two examples of what risk allocation can be used for?
(Brehm ch.2)
- setting premium and limits by line
| - computing risk-adjusted profitability
57
what are two ways that risk allocation can be done?
| Brehm ch.2
- allocate overall risk to individual business units
| - estimate the contributions of individual business units to the overall risk
58
how would an insurance company allocate overall risk to individual business units?
(Brehm ch.2)
- calc overall risk measure
- calc risk measure for each individual business unit
- allocate overall risk measure to individual business units in proportion to their individual risk measures
59
how would an insurance company estimate the contributions of the individual business units to the overall risk?
(Brehm ch.2)
- define risk measure as an average of company results under certain conditions (conditional generalized moment)
- contribution from each business unit is the average of the business unit's results under the same conditions
60
how is TVaR a co-measure?
| Brehm ch.2
-each business unit's contribution to the overall TVaR is the business unit's average loss when the overall company loss exceeds the specified probability level
61
what does it mean for VaR to be an additive decomposition?
| Brehm ch.2
the business units' contributions to VaR add up to the overall company VaR
**different from marginal (marginal involves derivative)
62
what does it mean for a risk decomposition method to be marginal?
(Brehm ch.2)
change in overall company risk due to a small change in a business unit's volume should be attributed to that business unit
63
what does the marginal property of risk measures link to?
| Brehm ch.2
financial theory of "pricing proportionality to marginal costs"
64
what does the marginal property of risk measures ensure?
| Brehm ch.2
when a business unit with an above-average ratio of profit to risk increases its volume, then the overall company ratio of profit to risk increases as well
65
what two conditions are required for a marginal decomposition?
(Brehm ch.2)
- works when business units can change volume in a homogeneous fashion
- works when the risk measure is scalable
66
what does it mean for business units to change volume in a homogeneous fashion?
(Brehm ch.2)
-business units can buy quota share reinsurance and change their volume uniformly by changing the quota share percentage
67
what does it mean for a risk measure to be scalable?
| Brehm ch.2
- multiplying the random variable by a factor multiplies the risk measure by the same factor (rho(a*Y) = a*rho(Y)
- aka homogeneous of degree 1
68
what are two properties of marginal decompositions?
| Brehm ch.2
- all marginal decompositions sum up to the company risk measure
- all marginal decompositions are also co-measures
69
what are two common risk measures that can be expressed as marginal decompositions?
(Brehm ch.2)
- TVaR
| - standard deviation
70
how can marginal decompositions be found?
| Brehm ch.2
by taking the derivative of scalable risk measures
71
when does using decomposition of a risk measure to measure risk-adjusted profitability of business units work best?
(Brehm ch.2)
- if the risk measure is proportional to the market value of the risk -> ratio of a unit's profit to its risk measure would be proportional to the ratio of the profit to the market value
- >> business units with higher ratios yield more profit
72
how could the cost of capital be allocated (instead of capital itself)?
(Brehm ch.2)
- set minimum profit target of a business unit equal to the value of its right to call upon the capital of the firm
- excess of the unit's profit over this cost of capital is added value for the firm
73
why is the business unit's right to call upon the capital of the firm considered a cost to the firm?
(Brehm ch.2)
-company is carrying the risk of the unit's right to access the insurer's entire capital
(implicit stop-loss agreement where a business unit can either make money or break even)
74
what is an alternative to option pricing theory for computing the capital cost of the right of a business unit to access the firm's capital?
(Brehm ch.2)
-calculate the expected value of a stop-loss for the business unit at the break-even point
(meaning business unit cannot lose money)
75
how does the economic value of implicit stop-loss compare to its expected value, and what do the authors suggest to address this?
(Brehm ch.2)
- economic value > expected value
- suggest incorporating full distribution of the profit results for each business unit to obtain a better measure of the true economic value
76
what is an example of a simpler approach to capturing the economic value of the implicit stop-loss?
(Brehm ch.2)
-mean plus thirty percent of standard deviation
77
what are two examples of leverage ratios that were historically used to evaluate capital adequacy?
(Brehm ch.2)
- premium-to-surplus ratio
| - reserve-to-surplus ratio
78
what are two disadvantages of leverage ratios?
| Brehm ch.2
- do not distinguish among business classes
| - do not incorporate risks other than underwriting risks
79
what are seven examples of IRIS ratios?
| Brehm ch.2
- gross WP to surplus
- net WP to surplus
- change in writings
- surplus aid to surplus
- two-year operation ratio
- investment yield
- liabilities to liquid assets
80
how do RBC (risk-based capital) models assess risk?
| Brehm ch.2
combine measures of different aspects of risk into a single number
81
what four aspects of risk are generally included in RBC models?
(Brehm ch.2)
- invested asset risk
- credit risk
- premium risk
- reserve risk
82
how do RBC ratios quantify risk?
| Brehm ch.2
- each aspect of risk is measured by multiplying factors by accounting values
- magnitude of factors varies by quality and type of asset, LOB
83
what is an example of accumulation risk?
| Brehm ch.2
exposure to catastrophic events affecting a large number of insureds
84
how do RBC models typically recognize accumulation risk?
| Brehm ch.2
- via stress testing of the impact of a second severe event
| - through use of annual AGGREGATE loss amounts rather than per-occurrence losses
85
why are there significant differences among RBC models (US, Canada, Japan, A.M. Best, S&P) in the levels of factors?
(Brehm ch.2)
- use of the models
| - presences of a covariance adjustment
86
how are the different RBC models used [differently]?
| Brehm ch.2
- AM Best and S&P models are used to determine whether company will be viable in long term -> rating agencies should have higher factors
- regulatory models are used to evaluate one-year likelihood of insolvency
87
why do many RBC models have a covariance adjustment?
| Brehm ch.2
intended to reflect the independence of the various risk components
88
what is the impact of a covariance adjustment on required capital via RBC models?
(Brehm ch.2)
-total required capital is less than the sum of the individual risk charges
89
what does the reduction in required capital due to a covariance adjustment depend on?
(Brehm ch.2)
-relative magnitudes of the risk charges -> greater reductions occur when risk charges are similar in size
90
what is the largest component of credit risk in an RBC?
| Brehm ch.2
reinsurance recoverables
91
how does the calculation of credit risk due to reinsurance recoverables vary by RBC models?
(Brehm ch.2)
- several models use risk factors that vary with credit quality of reinsurer
- AM Best increases credit risk charge for companies that are heavily dependent on reinsurance
92
what does Canada's Dynamic Capital Adequacy Test measure?
| Brehm ch.2
capital impact due from a predefined list of static scenarios
93
what are recent best practices for RBC used by regulators?
| Brehm ch.2
- RBC model as base metric
- insurer performs own internal assessment, often including scenario testing/stochastic modeling
- regulator reviews company's analysis and has right to provide alternative capital requirement based on company's assessment
94
what does scenario testing for measuring capital adequacy typically involve?
(Brehm ch.2)
-preparation of a one to five year financial projection model -incorporation of probability distributions for as many sources of uncertainty as can be modeled
95
what are two critical features of projection models?
| Brehm ch.2
- correlations among risk
| - reflections of management responses to adverse financial results (for multi-year models only)
96
why is an increase in surplus by issuing surplus notes LESS than a dollar-for-dollar increase in adjusted surplus? (3)
(Brehm ch.2)
1) interest on surplus note may exceed rating agency's estimate of insurer's annual return on capital
2) amount of surplus note may exceed a threshold %age of capital
3) rating agency may reduce benefit of surplus notes for those reasons
97
what does asset-liability matching ensure?
| Brehm ch.2
ensures that duration of investment portfolio of a firm matches the duration of the liabilities that those assets support
98
what does asset-liability management do (beyond duration)?
| Brehm ch.2
considers additional factors such as inflation risk, credit risk, and market risk item
99
in a stand-alone asset portfolio with no liabilities, what are risk-free and risky investments?
(Brehm ch.2)
- short-term treasuries are considered risk-free
| - high-yield assets (such as stocks and bonds) are considered risky
100
what risk is introduced when we add fixed-duration liabilities to a stand-alone asset portfolio?
(Brehm ch.2)
reinvestment risk:
- if interest rates drop, total investment income may not be sufficient to cover liabilities
- if interest rates rise, longer-term investments (with durations > liabilities) introduce risk as well if depressed assets must be liquidated to fund liabilities
101
what is a good strategy to neutralize interest rate changes for fixed-duration liabilities?
(Brehm ch.2)
duration matching
102
what is a good strategy for an asset portfolio with liabilities with variable timing and amount?
(Brehm ch.2)
- duration matching no longer possible (duration is unknown)
| - model incorporating asset and liability fluctuations would be needed to determine optimal investment portfolio
103
under statutory accounting, what should be noted about finding the 'optimal' investment portfolio?
(Brehm ch.2)
- bonds are amortized
- liabilities are not discounted
- -> assets provide little hedging to liabilities
104
under GAAP accounting, what should be noted about finding the 'optimal' investment portfolio?
(Brehm ch.2)
- bonds are marked to market
- liabilities not discounted
- -> assets provide little hedging to liabilities
105
under economic accounting, what should be noted about choosing an 'optimal' investment portfolio?
(Brehm ch.2)
- assets are marked to market
- liabilities are discounted
- -> hedging does occur
- -> short-term portfolios increase risk and decrease return
- -> long-term portfolios increase risk and increase return
106
what does an asset-liability modeling approach start with?
| Brehm ch.2
models of:
- asset classes
- existing liabilities
- current business operations
107
what are examples of asset classes we might model?
| Brehm ch.2
- stocks
| - bonds
108
what are examples of existing liabilities we might model?
| Brehm ch.2
- loss reserves
| - receivables
109
what are examples of current business operations that we might model?
(Brehm ch.2)
- premium incomes
- incurred losses
- expenses
110
what are four parameters/assumptions that need to be defined for an asset-liability modeling approach?
(Brehm ch.2)
- risk metrics
- return (return on equity, earnings)
- timing of the analysis
- constraints
111
what goes into defining risk metrics for asset-liability modeling?
(Brehm ch.2)
- can be income-based or balance-sheet based
| - appropriate risk measure depends on risk metric
112
what should be considered when defining return for asset-liability modeling?
(Brehm ch.2)
-accounting system used should be consistent with the system used for defining risk
113
what should be considered when defining the timing of the analysis for asset-liability modeling?
(Brehm ch.2)
- are we measuring risk and reward over a single period of multiple periods?
- single period models may not fully capture true nature of a business
- multi-period models may be too complicated to implement
114
what are two considerations when defining constraints for asset-liability modeling?
(Brehm ch.2)
- which asset classes are not allowed by state regulators?
| - which investments would drive risk-based capital numbers too high?
115
what general scenarios should asset-liability modeling incorporate?
(Brehm ch.2)
variety of:
- investment strategies
- underwriting strategies
- reinsurance options
116
what should the simulations be reviewed for in the last step of asset-liability modeling?
(Brehm ch.2)
-identify conditions in which even the preferred investment/reinsurance options performed poorly --> management may be able to monitor for such conditions and respond proactively
117
what are two items of asset-liability modeling for future research?
(Brehm ch.2)
- better understand correlations between LOB and assets and liabilities
- better understand link between inflation and future loss payments
118
what is one way to handle a lack of understanding about correlations between LOB and assets/liabilities; and link between inflation and future loss payments?
(Brehm ch.2)
-include correlations and inflation sensitivity as random variables within the model
119
what are three paradigms for measuring reinsurance value?
| Brehm ch.2
- it provides stability
- it frees up capital
- it adds market value to the firm
120
what does it mean for reinsurance to provide stability?
| Brehm ch.2
- protection of surplus
- improved predictability of earnings
- customers' assured recovery of their insured losses
121
what is the "cost" of stability provided by reinsurance?
| Brehm ch.2
ceded premiums minus loss and expense recoveries
122
what is an important comparison when considering capital freed up by reinsurance?
(Brehm ch.2)
- amount paid to purchase reinsurance vs. amount of capital freed up
- ROE (ratio of amt pd to amt freed) should be less than firms target return
123
why is standard deviation misleading when comparing reinsurance programs?
(Brehm ch.2)
SD can be reduced by eliminating favorable deviations (ie compressing the distribution)
124
why is a "worst possible scenario" misleading when comparing reinsurance programs?
(Brehm ch.2)
- very very remote probability of occurring (ex: 1-in-25000 year event)
- unreasonable level to manage to -> compare at more realistic probability levels (ex: 1-in-100, 1-in-250, 1-in-10)
125
is it better to compare the probability distributions of two reinsurance programs, or the distribution of DIFFERENCES between two programs, and why?
(Brehm ch.2)
- more useful to directly compare the probability distributions
- percentiles of each distribution probably do not relate to same loss event
126
when looking at a comparison graph showing the cost and loss amount at specified probability levels for various reinsurance programs, what makes a program "efficient"?
(Brehm ch.2)
to be efficient at a selected probability, a more expensive program has to have a lower loss level at that probability
127
why might combined ratio be a misleading metric when comparing reinsurance programs?
(Brehm ch.2)
if a reinsurance program has slightly stronger u/w results but far more ceded premium, then the combined ratio will actually be worse (even though absolute u/w income is better)
128
what is an example of "releasing" capital?
| Brehm ch.2
purchasing reinsurance to reduce capital needs
| --> LESS capital needed
129
what threshold of ROE is preferred when releasing capital?
| Brehm ch.2
- low marginal ROE
| - ROE lower than firm's own cost of capital is preferred
130
what is an example of "consuming" capital?
| Brehm ch.2
changing reinsurance programs to a less expensive option that requires a bit more capital
--> MORE capital needed
131
what threshold of ROE is preferred when consuming capital?
| Brehm ch.2
-higher ROE -> higher than firm's own cost of capital
132
what are two classes of models for required capital?
| Brehm ch.2
- theoretical models
| - practical models
133
what are theoretical models for required capital?
| Brehm ch.2
those that derive required capital and changes in required capital, based on calculated risk metrics from the enterprise risk model (such as VaR, TVaR, etc.)
134
what are practical models for required capital?
| Brehm ch.2
those that derive required capital based on rating agencies (ex: BCAR, S&P CAR), regulatory requirements (ex: RBC, ICAR) or actual capital
135
how is reinsurance considered for theoretical and practice models?
(Brehm ch.2)
- calculate required capital with and without reinsurance, based on chosen risk measures
- then calc change in required capital
136
what is one disadvantage of practical models for required capital?
(Brehm ch.2)
they rely on risk proxies (such as premiums and reserves) rather than relying on the risk itself
137
how can we compensate for the reliance of practical models on risk proxies?
(Brehm ch.2)
- building rating agency and regulatory models into the ERM
- capital score calculated for each scenario
- produce prob. distr. of capital scores
- required capital set at diff. prob levels
138
how do loss reserves create accumulated risks?
| Brehm ch.2
they absorb capital over multiple periods
139
what are as-if loss reserves for an AY of new business?
| Brehm ch.2
the reserves that would exist at the beginning of the AY if that business had been written in a steady state in all prior years
140
how do we obtain a proxy for the capital absorbed by an AY over time?
(Brehm ch.2)
by combining the current AY with the as-if loss reserves (which represent accumulation of reserves from prior years)
141
what are two advantages of the use of as-if loss reserves?
| Brehm ch.2
- can measure impact of accumulated risk caused by correlated risk factors across AYs
- reinsurance considered can be applied to AY and as-if reserves
142
why is it a benefit to consider the reinsurance of AY and as-if reserves?
(Brehm ch.2)
provides a more valid measure of the impact of reinsurance on accumulated risk and on capital absorbed over the full life of the AY
143
why are the results of an accumulated risk analysis highly dependent on underlying projection risk model (e.g. severity trend model)?
(Brehm ch.2)
reserves are exposed to trend risk
144
how does including accumulated risk impact the distribution of u/w results and capital onsumed?
(Brehm ch.2)
- distribution of u/w results is less compressed and has bigger tails
- capital consumed is greater
145
what is a good cost measure for reinsurance?
| Brehm ch.2
NPV of earnings expected from the program
146
what is a poor cost measure for reinsurance, and why?
| Brehm ch.2
combined ratio because it can give a distorted picture of the effects of reinsurance on earnings
147
why can measures of stability like standard deviation give misleading pictures of the stability obtained from reinsurance?
(Brehm ch.2)
can be lowered by eliminating the chances for favorable deviations
