The Unfulfilled Promise of DFA for PC Insurance

The Unfulfilled Promise of DFA for P&C Insurance Companies 2001 DFA Seminar Bill Wilt, VP/Sr. Analyst Property & Casualty/Reinsurance Moody's Investors Service June 7 & 8, 2001

The Unfulfilled Promise of DFA Discussion Points n The Case for DFA in P&C Capital Management n The Reality of DFA Use Among P&C Insurers n Barriers to Wider Adoption of DFA in P&C n Role of DFA in Rating Process Moody's Investors Service

The Case for DFA n Conclusion – Holds ‘great promise’ for insurers’ efforts to optimize use of capital – Although slow to evolve - optimism is warranted n Impetus for DFA – Among several…shareholder pressures Moody's Investors Service

The Case for DFA n Benefits of DFA – Among several…. balance competing demands of security (PH), return/risk (shareholder) and mix of two (creditors n Challenges Related to DFA Modeling – Sophistication Vs. ease of use – Event Risk. . . “yeah, but what about…” Moody's Investors Service

The Reality of DFA Use n Use Among Specialty Mono-lines n A Growing Commitment to Study n Internal Development Yet to Translate into Broad Usage n Less Sophisticated Capital Management Approaches Still Hold Sway Moody's Investors Service

Barriers to Wider Adoption in P&C n Challenges Inherent in Building Models – Modest ambitions, evolve into complex models n n Model Complexity Can Erode Confidence in Output Significance of Underwriting Discipline to P&C – Competing resources, detractions from Job One n Precedence of Other Business Constraints – Regulatory, industry norms, rating agencies. . . Moody's Investors Service

Role of DFA in Moody’s Analytical Process n By all means…let’s discuss it – “…thoughtful, sophisticated and rigorous analysis on the part of business managers is always a good thing. ” n Use of Models integral in ratings of – Monoline Cat reinsurers; Financial Guarantors; Finite Risk and Credit Insurers Moody's Investors Service

Role of DFA in Moody’s Analytical Process n Observations…Rating Process and DFA – Rating Process: » Industry Assessment » Company evaluation: n Where is the company today…look through financial statements n Where is the company going…quality of management, risk management process, risk appetite, etc. – DFA » Attempts to marry these concepts…this is a tall order Moody's Investors Service

Role of DFA in Moody’s Analytical Process n An Alternative…in the interim – Separate Past from Future » Consider use of existing tools to perform probability of ruin analysis on company » Separately…discuss proforma results, ranges of earnings estimates, capital consumption – Benefits » » » Immediate use of existing tools Elevate familiarity with company tools and assumptions Avoid being ‘bogged down’ in go-forward assumptions Moody's Investors Service

Role of DFA in Moody’s Analytical Process n Some Specifics – Discussion of process in creating model – Focus on Prob. (Default) and E(Severity Default) – Focus on assumptions, analysis of adverse outcomes – Discuss how used internally, has it had a meaningful impact on company’s business decisions or strategic plans? – Be prepared to discuss annually -- whether results are favorable or unfavorable Moody's Investors Service