such coverage and is superior based on the RBC test and in the economic risk/reward analysis. Hence, we would recommend that DFAIC adopt the alternative reinsurance program.
The analysis of loss ratios presented in the parameterization section of this paper hints at the reasons for preferring the alternative program. DFAIC's existing reinsurance program essentially covers each LOB individually. In doing so, it does not account for the diversifying effect of writing more than one LOB. In fact, it even provides coverage for large claims when aggregate losses in a particular line are lower than expected.
Thus far our discussion has focused on reinsurance, holding the company's asset allocation constant, but dynamic financial analysis can also be used to evaluate and set strategic asset allocation (SAA) guidelines for property-casualty insurance companies. Strategic asset allocation is the basis of a sound investment process that includes tactical asset allocation and security selection (see Figure 3). We will demonstrate that the company's reinsurance and asset strategies are interdependent and that by adopting the alternative reinsurance program DFAIC can alter its asset strategy to improve returns and reduce risk in both economic and statutory terms. Furthermore, our analysis of reinsurance and asset allocation will rely upon identical risk/reward metrics rather than traditional, but not comparable, strategy specific measures (e.g., loss ratios, return on assets, etc.).
Figure 3: Investment Process