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DFA Insurance Company Case Study, Part I: - page 4 / 40





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For these reasons we were excited to embrace this call paper program exercise. While the original concept may have been designed to evaluate different DFA modeling techniques and the resulting analyses as they relate to a common problem and common data, we decided it was a perfect opportunity to show how DFA might work in the insurance company of tomorrow. The ultimate benefit to the company is not just the final answer, but rather the increased understanding and the common grounds of communication that comes from going through the DFA process.

The proposed situation involves DFA Insurance Company (DFAIC), a multi-line property- casualty insurance company that is unknowingly the target of a potential acquisition. The analysis was conducted from the point of view of the acquiring company. We will define the acquiring company, Falcon, as a newly capitalized holding company that is organized and structured to run its business in a holistic manner. As such Falcon has a financial risk management unit led by its Chief Risk Officer (CRO) who reports directly to the CEO. The CEO has asked that the following questions about DFAIC be addressed:

1. Is the Company adequately capitalized? Is there excess capital? How much capital should the Company hold as a stand-alone insurer?

  • 2.

    How should the capital be allocated to line of business?

  • 3.

    What is the return distribution for each line of business and is it consistent with the

risk for the line?

4. Should the Company buy more or less reinsurance? What type? How efficient is its current reinsurance program?

5. How efficient is the asset allocation?

In a traditional insurance company these questions would be farmed out to different business units within the organization. These units would include but not be limited to the actuarial department, the reinsurance department and the investment department. Each unit would perform their stand-alone analysis and report back to the CEO using terminology and metrics appropriate to their assigned task. The CEO would be left to assimilate all the individual analyses and use her professional judgment and insights to build a complete picture of the attractiveness of the potential acquisition.

Falcon, however, is organized in such a way that the complete analysis can be performed within the financial risk management unit with input from professionals in each of the above-mentioned departments. The results of the analysis can thus be presented to the CEO using a single set of terminology and metrics that consider both the individual and joint dynamics of the issues in question.

Due to the scope and breadth of the required analysis, we will present the DFA study in two papers. This paper will deal with the efficiency of the reinsurance and asset allocation strategies and a sister paper will concentrate on capital allocation and capital adequacy issues. Note that despite breaking the analysis up into two papers, the overall analysis is the result of a common DFA model and process.

DFA, being holistic, allows a company to deal with all of its major strategic decisions simultaneously within a single framework. As such it is not unusual to have an analysis


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