1. CONSTRUCTING AND EVALUATING BUSINESS PLANS b Casualty Actuarial Society b Dynamic Financial Analysis Seminar b July 19, 1999 Debra J. Roberts, CFADebra J. Roberts, CFA Carl J. Leo, ACAS, MAAACarl J. Leo, ACAS, MAAA

2. INTRODUCTION b Meet the panelists b Why business planning for insurance companies is unique b Why Dynamic Financial Analysis makes sense for insurance planning

3. WHAT DOES A BUSINESS PLAN DO FOR YOU? b Provides information for risk analysis and management b Guides the company’s operations for a specific time period, usually one to three years b Allows testing of assumptions for the company’s strategy b Communicates clearly the expected financial results of the company

4. THE PROCESS OF CONSTRUCTING A BUSINESS PLAN b The foundation is the existing business and historical financial information b The framework is the outline of basic assumptions about the future business and economic environment b The finished “building” is the result of testing the assumptions and presenting the range of possible financial outcomes for the future

5. OBSERVATIONS ABOUT THE PROCESS b Quality of the process determines the quality, or usefulness, of the results b The planning process itself is a very important opportunity to challenge assumptions and re-evaluate decisions b It is unrealistic to arrive at only one future financial result for an insurance company

6. PULLING TOGETHER THE PIECES b Collaborative effort, but needs someone in charge b Must integrate the ideas and the numbers b Apply the template, or framework, of the business strategy and make sure it fits b Communication process must be clear and free of any obstructions

7. EVALUATING THE PLAN b Checklist of “surprises” not to be overlooked: company weaknessescompany weaknesses competitive movescompetitive moves regulatory changesregulatory changes accounting changesaccounting changes natural disastersnatural disasters

8. EVALUATING THE PLAN b Incorporate “surprises” by doing “what if’s” in the financial models by using DFA methods b Avoid the danger of excessive reliance on the forecasted results by including three or more financial scenarios b Do a “reality check” on the numbers

9. What is Dynamic Financial Analysis? b Methodology for evaluating the financial impact of various “possible” future events b Intended to capture the complex interrelationships of the risk components of an insurance company b Model-based approach designed to answer a complex series of questions about future outcomes

10. How do you build the model? b Decide what you are trying to “test” Determine key questions you need to answerDetermine key questions you need to answer Define what goals you are trying to achieveDefine what goals you are trying to achieve Identify the most important variables in order to simplify the modelIdentify the most important variables in order to simplify the model

11. Two approaches for DFA risk analysis b Scenario testing Projects results using a defined set of assumptionsProjects results using a defined set of assumptions b Stochastic simulation Generates a series of random events, or “trials”, which produces a large number of different outcomesGenerates a series of random events, or “trials”, which produces a large number of different outcomes The distribution of these outcomes is analyzed to indicate overall financial strength of the companyThe distribution of these outcomes is analyzed to indicate overall financial strength of the company

12. The classifications of risk covered in a model b Balance Sheet Asset valuation riskAsset valuation risk Reserve adequacy riskReserve adequacy risk b Income Statement Underwriting riskUnderwriting risk Investment income riskInvestment income risk

13. Risks in each classification operate together in complex relationships b External events can impact more than one class of risk example: increase in interest rates causes asset values to decrease, but investment income to increase; may also adversely impact claims.example: increase in interest rates causes asset values to decrease, but investment income to increase; may also adversely impact claims. b Difficult to qualify the overall net outcome of a single external event

14. How are DFA models used? b To measure the financial strength of a company, based upon current operations and a given set of economic assumptions b To examine the financial impact of pursuing various new strategies b To analyze the current value of a company based upon a variety of future financial outcomes

15. How do you build the model? b Decide what you are trying to “test” Determine key questions you need to answerDetermine key questions you need to answer Define what goals you are trying to achieveDefine what goals you are trying to achieve Identify the most important variables in order to simplify the modelIdentify the most important variables in order to simplify the model

16. Two approaches for DFA risk analysis b Scenario testing Projects results using a defined set of assumptionsProjects results using a defined set of assumptions b Stochastic simulation Generates a series of random events, or “trials”, which produces a large number of different outcomesGenerates a series of random events, or “trials”, which produces a large number of different outcomes The distribution of these outcomes is analyzed to indicate overall financial strength of the companyThe distribution of these outcomes is analyzed to indicate overall financial strength of the company

17. The classifications of risk covered in a model b Balance Sheet Asset valuation riskAsset valuation risk Reserve adequacy riskReserve adequacy risk b Income Statement Underwriting riskUnderwriting risk Investment income riskInvestment income risk

18. Risks in each classification operate together in complex relationships b External events can impact more than one class of risk example: increase in interest rates causes asset values to decrease, but investment income to increase; may also adversely impact claims.example: increase in interest rates causes asset values to decrease, but investment income to increase; may also adversely impact claims. b Difficult to qualify the overall net outcome of a single external event without DFA

19. How are DFA models used? b To measure the financial strength of a company, based upon current operations and a given set of economic assumptions b To examine the financial impact of pursuing various new strategies b To analyze the current value of a company based upon a variety of future financial outcomes