With Static Analysis, each component of the insurer’s operations were examined separately. Reserving actuaries produced reserve indications, and financial analysts estimated investment returns.
Each component was treated separately in monitoring the business setting plans, company’s overall performance, and formulating the corporate strategy. Rising inflation would raise the reserve indications, rising interest rates would depress the values of bonds, mortgages, and CMOs.
Interest rates, and inflation rates often move in tandem, i.e reserving risks and investment risks are interlinked. Economic conditions, such as inflation rates or GNP growth, affect numerous aspects of the insurance enterprise. Investment returns are interwined with interest rate risks, and underwriting returns are threatened by inflation risks.
Dynamic financial analysis begins with the basic financial, economic, and business assumptions. This perspective is a great advancement over static analysis, but we see the flow of reasoning backwards.
We begin with reserving risk and investment risk , and study the underlying factors affecting each of them. Some of this factors like interest rates and inflation rates are interlinked. When we analyse the enterprise as a whole, we have to examine both the risks simultaneously. Insurance executives however, do not think solely in terms of risk correlations and covariance matrices, but they think in terms of economic and business reality.
So dynamic financial analysis inverts the questions, placing the scenario first. For e.g, it asks ” if there is a recession, or an underwriting downturn, what would be the effects on reserves, underwriting, and investments ?” . Financial models now create the links, breaking recessions or underwriting cycle movements into their component pieces, and examining the effects on insurance operations.
Technical actuarial and financial issues that are meaningful only to the initiated, such as reserve uncertainty and investment returns, metamorphose into fundamental questions of business strategy. So the risk analysis gets shifted from actuarial department to corporate boardrooms.
Extracts from “Guide for Foundations of Casualty Actuarial Science (IC-A1)” by Dr. Rakesh Agarwal. Copyright of Sashi Publications, Kolkata www.sashipublications.com and www.bimabazaar.com
