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DFA Insurance Company Case Study, Part I: - page 21 / 40

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increase in" flexibility, however, has the result of movin16. a significant burden from the model, to the model user and the model assumpt=ons .

Whereas the majority of the technical calculations are generated in Step 4 of the DFA process, after gaining an appropriate level of understanding of the modeling system, there is little the DFA professional is required to do in this step other than to tell the computer to begin processing.

Step 5: Analysis

The DFA process does not end with the running of the model; rather, the "analysis" phase within the DFA process begins. Dynamic financial analysis models generate large amounts of pro forma financial statement data. The Swiss Re Investors FIRM System, for example, generates financial statement details on a GAAP, statutory, tax and economic basis for each year and simulation. Since we are running a five-year horizon and 1000 simulations, we end up with over 20,000 individual pro forma financial statements. Thus, being able to work with such a large amount of data and condense it into a clear and concise analysis is key to successful DFA.

DFAIC's existing reinsurance programs include traditional forms of excess of loss, per risk excess and catastrophe coverage. As such, its ceded reinsurance program is fairly typical for a company of its size. The company ceded approximately 8% of its prior year's premium; it is not an extensive consumer of reinsurance when viewed relative to written premium. However, the company's seemingly modest reinsuran,ce program generated over $200 million in ceded premium in the prior year versus a statutory net income of $186 million, so it is material to their operations.17

Like many of its peers' ceded reinsurance programs, DFAIC's is designed to manage volatility of each of its various LOBs (or small combinations thereof). I.e., it is a "silo"

approach to ceded reinsurance purchasing. It should come as no surprise that a company management structure aligned with LOB will incent managers to purchase

reinsurance that does not recognize the diversification that exists by simply writing

multiple LOBs.

In fact it would be unnatural to expect a line manager to act in a

manner inconsistent with LOB results is in the best interest of the company. centralized reinsurance purchasing to

(e.g., accept highly volatile LOB results), even Many large insurers have gravitated toward address this inefficiency. Curiously, small

if

it

companies may be well equipped to resources. If one person must wear be centralized.

make many

similar changes because of their limited hats, the management structure may already

16Interested readers can find additional information on the mechanics of the Swiss Re Investors FIRM System by'referring to the previous Swiss Re Investors DFA papers listed in the references to this paper.

~ Unfortunately, the Schedule P data provided for the case study included the impact of inter- company pooling, so DFAIC's actual 1999 ceded losses could not be determined.

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