Shared Flashcard Set

Details

Robbin
Underwriting Profit Provision
45
Finance
Professional
01/16/2012

Additional Finance Flashcards

 


 

Cards

Term
CY investment offset description
Definition
Adjust traditional UW profit by investment income
Term

Method #1 Calendar Year Investment offset Procedure

Formula

Definition

U = U0 - iafit * PHSF

U0 traditional UW provision

PHSF = Policy Holder Surplus Funds

Term

(3) Advantages of

Calendar Year Approaches

Definition

1) Data is easily obtained and verified from Annual Statement

2) Filed Figures more likely to be accurate (no pessimistic estimates

3) Calendar Year investment Portfolio yield is relatively stable

Term

Disadvantage (1)

Calendar Year Approaches

Definition
1) Calendar Year results are retrospective may not be applicable to prospective ratemaking
Term

Policy Holder Surplus Funds

Equation

 

Definition

PHSF=LR/INC *Permissible LR +

(UNPR *( 1-PPACQ)  - PRECV)

Reserves/Premium + UNPR %

Term
(2) Disadvantages of Calendar Year Investment Offset method
Definition
1) Lack of Economic Theory supporting
2) Results are distorted if change in reserve adequacy
Term
(2) Advantages of Calendar Year Investment Offset method
Definition
1) Figures are easy to get from filed documents
2) Calculation is straightforward
Term
Method #2: Present Value Offset Method
Definition
Adjusts the traditional UW provision for investment income by the
PV(losses) from reference line and
PV(losses) from actual line
Term
(3) options of yield rates for PV Offset Method
Definition
1) New Money Yield
2) Portfolio yield from recent year
3) Estimated portfolio yield for when rates will be in effect
Term
Formula for PV Offset Method
Definition

U =

U0 - PLR * (PV[Ref line] -

PV[New Line])

Term
(3) Advantages of PV Offset Method
Definition

1) Accounts for Investment Income in simple manner

2) Not distorted by rapid growth/decline

3) No need to select target return or allocate surplus

Term
PV Offset Method Fundamental Formula
Definition

P = L * PV(X) + EXP + Uo*(P) +

L*[ 1- PV(Xo)]

Term
Method #3: Calendar Year ROE
Definition
This method selects an UW profit provision necessary to acheive the target ROE
Term
CY ROE Basic Formula
Definition

ROE = [U*P + II - FIT ]/

GAAP EQ

 

Term
CY ROE detailed Formula for U
Definition

U = 1/(1-tu) * [r *QSR/PSR -

Iafit * ( PHSF + 1/PSR)]

  • QSR = Equity Surplus Ratio
  •  PSR = Premium Surplus Ratio
  • r = target return on equity
Term
(2) Advantages CY ROE Method
Definition
1) Figures are easy to verify
2) Produces an ROE similar to GAAP ROE
Term
(3) Disadvantage of CY ROE Method
Definition
1) Since it is CY method, distorted by large growth or reserve changes
2) Need to select a Target Return
3) Need to select a Leverage Ratio
Term
Method #4 PVI/PVE Method Description
Definition
Selects a UW profit provision necessary to achieve a target present value return (income over equity)
Term
Average Equity Balance EQBi
Definition

Σj=1(EQB)*vj-1j=1vj-1

Use to turn quarterly balances into annual

 

Term
PVI/PVE method Discount rates
Definition
Can use target rate of return or rf
Term
PVI/PVE method Advantages (1)
Definition
Measure is comparable to GAAP ROE
Term
PVI/PVE Disadvantages (2)
Definition
  1. Need to Select a discount rate
  2. Need to Select a target rate of return
Term
Method 5: PV of Cashflow Return Model description
Definition

Select an UW profit provision necessary to produce a PV of total cash flow (discounted at Investment RoR) = PV of Changes in equity (discounted at target

RoR)

Term
PV Cashflow Return Formula
Definition
PV(Δ Equity;target {r}) = PV(total cashflow; investment {i})
Term
PV Cashflow breakdown
Definition
Cashflow for a single policy: UW Income + Investment Income - Tax
Term
PV Cashflow method Advantages (1)
Definition
PV of underwriting cashflows are what most people think conceive as UW profit
Term
PV Cashflow method Disadvantages (1)
Definition
Unclear exactly what type of profit is being measured. Different timing than GAAP.
Term
Method 6: Risk Adjusted Discounted Cash Flow Model
Definition
This method calculates a fair premium, and derives the Profit Provision Fair premium = Risk adjusted present value of UW cash flows + PV(taxes) taxes.
Term
Risk Adjusted Discount rate is calculated  using
Definition

ß=cov(market return, return of the item being valued)

Ir = if + ß(im - if )

Difficult for liabilities

 

 

Term
Discount rates for Risk Adjusted
Definition
Losses discount at Risk Adjusted rate, other CF as Rf Discount to time zero
Term

Risk Adjusted Discount Cashflow Model

Advantages (3)

Definition
  1. Great Intuitive appeal
  2. Grounded in modern financial theory
  3. Not Necessary to determine a target rate of return
Term

Risk Adjusted Discount Cashflow Model

Advantages (1)

Definition
Not easy to determine Beta
Term
Risk Adjusted Discounting CF formula
Definition

PV(P;if)=PV(L:ir)+PV(FX;if)+PV(FIT;if)

PV(FIT) = PV(TUW) +PV(TII)

PV(TUW) = [(P-E)/(1+rf)-L/(1+ra)]*tu

PV(TII) = (P-E+S)*rf*ti /(1+rf)

Term
Risk Adjusted Discount ALT Formula
Definition

PV(P;if)=PV(L;ir)+PV(FX;if)+

t * PV(II on Surplus)/(1-t)

Term

Beta in Risk Adjusted CF 

ß

Definition
Note the stock beta of invested asset portfolio must equal the weighted average of liability beta and firm's equity
Term
Insurance premium discount factor
Definition
Should be below the risk free rate, since risk is being passed off by policyholder, implying lower return
Term
Method 7: Internal Rate of Return Model description
Definition
select a premium that achieves a specified target return on equity flows between company and shareholders
Term
IRR key equation
Definition
Equity Flow = Income - Chg in Stat Surplus
use single policy
Term
IRR method advantages (2)
Definition
1) Return to Stockholders is similar to rate on a loan
2) Reflects the accounting rules via CF impacts
Term
IRR method disadvantages (2)
Definition
1) Necessary to select a target return
2) Necessary to select a surplus requirement
Term
Model Construction questions (5)
Definition
1) Should surplus be included in the model 2) How should surplus requirement be determined? 3) how should risk be included the model? 4) is it better to use cash flows or income flows? 5) how to reflect income taxes?
Term
Parameter Selection questions (2)
Definition
1) what discount rate should be used? 2) What is the right target return?
Term
(2) regulation approaches
Definition

1)Rate of return approach

2)Constrained market theory

Term
PV Offset formula if UPP for reviewed line is known
Definition
P = (L + FX)/(1 - VX - U)
Note that losses are undiscounted! Discount is included in U.
Term
CAPM method equity vs liability discounting equation
Definition

PV(LR)(r-in) = equity(R - rf)

R = return on equity

PV(LR) = discounted loss reserves

in =discount on reserves

R = return on equity

in words, what ever points you lose on reserves, you make up for in equity

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