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DFA Insurance Company Case Study, Part I: - page 35 / 40

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35 / 40

Taxable

88.0

100.0

87.9

80.3

68.7

57.7

44.4

36.7

29.8

18.3

7.3

Tax-Exempt

1.7

9.6

17.3

22.0

32.9

34.2

34.2

43.4

47.8

Duration

5.0

0.3

1.6

3.1

4.0

4.5

5.6

5.5

5.4

6.5

6.6

Equity:

11.2

10.4

10.2

14.0

20.3

22.7

29.1

36.0

38.3

44.8

J'

Exhibit 8 shows that the revised reinsurance program pushes the efficient frontier for DFAIC up and to the left. This is extremely desirable from Falcon management's perspective as this means that DFAIC can experience higher economic rewards at lower economic risk levels. The individual strategies that make up the revised efficient frontier tell a similar story to those on the original frontier. The overall lower risk profile as a result of the revised reinsurance structure, however, allows DFAIC to move to a more aggressive asset strategy without any more economic risk than the company is currently experiencing.

Again assuming that Falcon management is happy with DFAIC's current risk tolerance level, under the revised reinsurance program the investment strategy can be adjusted to that indicated by Strategy E'. This would suggest increasing the equity allocation from 11.2% to 20.3%, reducing the fixed-income duration from 4.9 to 4.5 and allocating 22% of the fixed-income portfolio into tax-exempt securities. The net effect of moving to the revised reinsurance'program and an asset strategy in line with that suggested by Strategy E' is an additional expected economic benefit of more than $121 M over the five-year planning horizon.

Fixed Income:

Current

A'

B'

C'

D'

E'

F"

G'

H'

r

1,400

~

"

Exhibit 8: DFNC's Economic Efficient Frontier (Revised Reinsurance)

  • o

    3,300

o

~ 3,200

3,100.

3,000

5O0

A 3,800 3,700 o~3,600 ~ 3.500

DFAIC Economic Value Efficient Frontier 5-Year Horizon

" ""

  • CurrentPortfolio I Current Reinsurance

CurrentPortfoli I RevisedReinsurance

1,300

Revised Frorltler

K~.

I'

J'= ~ , = "

f

C'

A'

600

700

800

900

1,000

1,100

1,200

Standard Deviation of Economic Value (millions)

93

1,500

K'

2.0 48.0 6.4

50.0

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