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Summary
Dynamic Financial Analysis (DFA) represents a new area of study for insurance
researchers, an area requiring new tools and new expertise. The need for DFA
developed as the financial world became a more risky place, a trend that
started in the 1970s when foreign exchange rates and interest rates became more volatile. DFA is a powerful
business planning tool that will allow researchers to assess the financial risk of individual
insurers and of different business strategies. It can be used to highlight the financial or
operating conditions that might generate unfavorable outcomes, allowing company
managers to deal with these potential conditions appropriately. DFA can
provide a calibrated tool to replace rough intuition for measuring the effects of
operational decisions.
The actuarial consulting firm Miller, Herbers, Lehmann & Associates has
developed a public-access DFA model that is available, via the internet, at no
charge.
The general approach used in this model, the key risks of U. S. property-liability insurers
subject to modeling, the parameters incorporated in the financial aspects of the model,
and examples of the output from the model are described in D'Arcy, Gorvett, et al. (1997
and 1998). One of the objectives of this model is to serve as a learning tool for
researchers interested in obtaining hands-on experience with DFA. To further this
objective, we propose to utilize the public access DFA model to analyze the effect of
growth on property-liability insurers. One benefit of this project will be to illustrate the
data requirements of the model, the parameter selection process, the system
and time requirements for running the model, the output from the model, and
how a researcher can utilize the model to understand the financial or
operational positions of an insurer.
Additionally, this project will provide an analysis, using the DFA model, of the
impact of growth rates and persistency on insurance profitability.
For a property-liability insurer, the growth rate can have a number of important
effects as companies that grow rapidly face several problems. First, as
premiums increase, the premium-to-surplus levels rise, which increases
leverage under solvency analysis. Additionally, the growth rate itself is one of
the factors considered in insurance solvency analysis under the IRIS system.
Finally, new business generally has both a higher loss ratio and a higher
expense ratio than more seasoned business, which reduces profitability (D'Arcy
and Doherty (1989 and 1990), Feldblum (1996)). The relationship between an
insurer's growth rate and profitability is complex and requires consideration
of the long-term impact, an analysis that can more effectively be accomplished
through the use of a DFA model.
The public-access model has been developed and extensively tested. The
authors have used this model on numerous occasions, both for research
purposes and for applications to specific insurance companies. Prior
applications have illustrated the importance of the growth rate as one of the
key strategic operating decisions. Thus, this work will focus on that key variable. |
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He is a Professor of Finance at the University of Illinois at Urbana-Champaign. He is a Fellow of the Casualty Actuarial Society, a member of the American Academy of Actuaries, Past-President of the American Risk and Insurance Association and currently a member of the Board of Directors of the Casualty Actuarial Society.
He received his B.A. in Applied Mathematics from Harvard College and his Ph.D. in Finance from the University of Illinois. The courses he teaches include an introduction to insurance, property-liability insurance, casualty actuarial mathematics, advanced corporate finance, employee benefits and financial risk management of insurance enterprises.
He teaches a seminar on finance and an on-line course on financial risk management for the Casualty Actuarial Society. His research interests include dynamic financial analysis, financial pricing models for property-liability insurers, catastrophe insurance futures, pension funding and regulation.
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