CAS Ratemaking Seminar RCM2 What are we Debating

CAS Ratemaking Seminar RCM-2 What are we Debating About? Remarks by Glenn Meyers Insurance Services Office, Inc. March 11, 2004

Insurer Risk and Capital Management Perspective • Risk based capital – The insurer's risk, as measured by its stochastic distribution of outcomes, provides a meaningful yardstick that can be used to set capital requirements. • Insurer risk management – The insurer manages its business to minimize its cost of financing, i. e. its cost of capital plus the net cost of reinsurance.

Insurer Risk Measurement • Use a coherent measure of risk r(X) – e. g. Tail Value-at-Risk • Define random variables: – A = Assets – X = Liabilities • Insurer has sufficient assets if r(X – A) = 0 • Define: Capital = E(A) – E(X)

Insurer Risk Management • Choose insurance portfolio (lines of business and reinsurance strategies) to minimize cost of financing insurance. • Two equivalent techniques – Efficient frontier management – Marginal cost of capital analyses • Capital Allocation – In general unnecessary, but it is desirable for communicating financially oriented objectives.

Insurer Risk Management • Reserve Risk contributes to the need for capital and hence it contributes to the ($) cost of capital. • How long you need to hold capital is a consideration in determining an acceptable price. • Easy to implement by allocating capital (see RCM-4).

Prediction This how actuaries will include the cost of capital in future insurance costing. Obstacles to Overcome • Fuzzy relationship between risk and capital – See Recent work by IAA working party http: //www. actuaries. org/members/en/committees/WGRBC/documents. cfm • Quantification of all risks – – Underwriting risk - See RCM-4 Asset risk - Several commercial models Operational risk Other • Consensus – Will not come until above issues are substantially settled.