InvestmentandReinsuranceRisk.docVIP

1998 CAS DFA Seminar Managing Risk in a Portfolio Context Reinsurance and Reserves Gary G. Venter Sedgwick Re Insurance Strategy, Inc. (INSTRAT)Investment and Reinsurance Risk Goal Manage investment and reinsurance risk simultaneously Test strategies by their impact on bottom line income probability distributions Create risk/return efficient frontiers from strategies tested Risk/Return Efficient Frontier @ probability = p Any strategy above or to the right of the efficient frontier provides less benefit than points on or below the efficient frontier. Inefficient options can be quickly recognized. By establishing an efficient frontier of options, one can discover and create new or hybrid solutions that provide greater benefit Measuring Risk Problems with standard deviation Inconsistent meaning among distributions Treats upside and downside risk the same Look at key individual percentiles Preference might be to increase mean return, reduce downside risk by giving up chance of big gain Risks to Income Investment performance Market results Need to liquidate to pay losses Underwriting result Current year Reserve development Reinsurance Modeling Requirements Model the risk elements Investment market, current u/w, develop-ment, reinsurance, cash flow, taxes, GAAP, statutory Get probability distribution of income for each strategy to find efficient frontier of strategies at each probability level Need to generate scenarios by probability, not just wide variety Modeling Investment Risk Yield curve Diffusion model Other assets Regression models Why a Diffusion Model? Rates are moving continuously Process generating movement of short-term rates also generates yield curve Can guarantee arbitrage-free yield curve movements in model Can calibrate to market - e.g., to bond options The CIR Model dr = a(b - r)dt + sr1/2dz. r is short-term rate b is reverting mean a is speed of reversion s is volatility measure What is z? z is standard Brownian motion Starts