Brehm3 Flashcards
determining which reinsurance program to pursue using cost-benefit analysis
calc risk capital for gross, option1, option 2
calc cost of capital = risk capital * hurdle rate
calc reduced capital cost = cost of risk capital (curr) - cost of risk capital (option i)
calc net reinsurance cost = ceded prem - E[recoveries]+commission
calc net benefit=reduced capital cost - net RI cost
**should pursue option that has a positive net benefit
*benefit is reduced cost of capital
determining which reinsurance program to pursue using EVA
EVA = NPV return - cost of capital
NPV return = expected net cost of reinsurace
cost of capital = benefit of reduced cost of capital
asset liability matching
establishing and maintaining an investment portfolio with same durating as liability portfolio
asset liability management
comprehensive analysis and management of asset portfolio with respect to current liabilities and future cash flows from asset/liability portfolios and future premiums
difference between asset liability matching and asset liability managment
asset-liability matching just looks at interest rate risk, but ALM incorporates other risks (inflation, credit, market)
management also considers impact of hedges such as equities for inflation or reinsurance
risk of holding short term assets
reinvestment risk: if interest rates drop, bonds will be reinvested at lower interest rates and investment income may be too low to cover the liabilities
risk of holding long term assets
if interest rates increase, value of bonds fall and they may need to be liquidated at depressed prices to fund liabilities
approach to reduce risk to surplus
duration matching
consideration that should be included in asset-liability analysis to make it more realistic
insurance liabilties are variable in amount and timing, making duration matching impossible
company can pay claims from premium cash flows, so enterprise-wide model is needed
tax considerations will also impact optimal investment strategy
reinsurers are in business to make money
insurer should expect reinsurance to have an expected net cost
reinsurance provides stability
reinsurnace protects surplus, improve predictability or earnings growth and assures customers of insurer stability
measuring value of reinsurance for insurer
reinsurance frees up capital
calculate amount of freed up capital by purchasing reinsurance
ratio of net cost of reinsurance-to-capital freed up = ROE cost of reinsurance
if ROE cost is < target return, then purchasing reinsurance is good decision
efficient frontier
risk measure as x
risk return as y
if option is below frontier, risk-return tradeoff is inefficient
company risk preferences and budge constraints should be considered
modest improvements in return might not be worth it
calc before-tax marginal ROE
net cost = ceded prem - expected ceded loss - reins commission
delta Net benefit=Net cost(curr)-Net cost(new)
capital consumed = risk capital (new) - risk capital (curr)
marginal ROE = delta net benefit/capital consumed
if option has highest marginal ROE and it is > cost of capital, then pick this option
3 paradigms for measuring value of different reinsurance options
reinsurance provides stability
reinsurance frees up capital
reinsurance adds value to firm
