Insurer Financial Management RMI 4700

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Insurer Financial Management RMI 4700

  1. 1. Insurer Financial Management RMI 4700 Insurance Operations Robert Klein 4/15/09
  2. 2. Common Themes <ul><li>Financial intermediation and fiduciary functions of insurers increase the importance of proper financial management. </li></ul><ul><ul><li>Insurers manage large amounts of funds on behalf of owners & policyholders – “small” mistakes can have big impact. </li></ul></ul><ul><li>Key Areas </li></ul><ul><ul><li>financial analysis and planning </li></ul></ul><ul><ul><li>contract obligations & exposure management </li></ul></ul><ul><ul><li>risk transfer/financing (e.g., reinsurance) </li></ul></ul><ul><ul><li>cash flow & asset management </li></ul></ul><ul><ul><li>financial reporting </li></ul></ul>
  3. 3. Analysis and Planning <ul><li>Short-term (tactical) and long-term (strategic) </li></ul><ul><li>Involves key departments (e.g., actuarial, investments, marketing, underwriting, claims, etc.). </li></ul><ul><li>Importance of Evaluating All Risks </li></ul><ul><ul><li>“ Old” approach was to evaluate & manage risks individually (the “silo” approach). </li></ul></ul><ul><ul><li>The “New” approach is to evaluate all risks individuals & together with modeling tools. </li></ul></ul><ul><ul><li>The new, “financial” view examines impact of various risks on firm economic value, aggregating and considering interaction (covariance) of various risks. </li></ul></ul>
  4. 4. Analysis and Management Tools <ul><li>Standards and Reports </li></ul><ul><li>Underwriting Authority and Limits </li></ul><ul><li>Exposure Management </li></ul><ul><li>Investment Guidelines or Strategies </li></ul><ul><li>Incentive Compensation Schemes </li></ul><ul><li>Reinsurance & Other Risk Financing Methods </li></ul><ul><li>Modeling & Dynamic Financial Analysis </li></ul>
  5. 5. Exposure Management <ul><li>Avoid high concentrations of risk exposures that could cause catastrophic losses. </li></ul><ul><li>Utilize line and geographic diversification to lessen risk. </li></ul><ul><li>Consider timing & uncertainty of cash flow demands. </li></ul><ul><li>High volatility in certain lines present special challenges for good cash flow management. </li></ul><ul><li>Consider exposures subject to significant cost escalation, e.g., product and pollution liability. </li></ul><ul><li>Regulatory “traps” also could be hazardous. </li></ul>
  6. 6. Investment Management <ul><li>“ Match” investments with structure of liabilities & risk exposures to be able to meet expected and potential cash demands in the future. </li></ul><ul><li>Balance returns on investments with how well they will cover insurer’s future cash demands. </li></ul><ul><li>Considerations: </li></ul><ul><ul><li>duration matching </li></ul></ul><ul><ul><li>interest rate, market and credit risks of investments </li></ul></ul><ul><ul><li>liquidity </li></ul></ul><ul><ul><li>returns on investments that affect insurers’ prices and coverage terms/benefits to insureds </li></ul></ul>
  7. 7. Risk Financing <ul><li>Reinsurance </li></ul><ul><li>Pooling & risk sharing with insureds. </li></ul><ul><li>Contingent capital arrangements, e.g., letters of credit. </li></ul><ul><li>Use of options to hedge certain risks, e.g., interest rate changes, exchange rate changes </li></ul><ul><li>Securitization </li></ul><ul><ul><li>catastrophe options and swaps </li></ul></ul><ul><ul><li>catastrophe bonds </li></ul></ul>
  8. 8. Modeling & Dynamic Analysis <ul><li>Used to determine insurer’s performance under different scenarios & optimize financial decisions. </li></ul><ul><li>Gather information on risks from all areas to develop basis for assessment of potential impacts. </li></ul><ul><li>Fit one or more statistical distributions to historical data (supplemented by qualitative and “what if’s”) and run simulations of future financial results. </li></ul><ul><li>Deterministic models yield consistent results for given set of inputs; used to test impact of change of factor (1% ∆ in interest rates). </li></ul><ul><li>Probabilistic (stochastic) models produce results based on inputs and random variation. </li></ul>

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