Description: This paper is Part 1 of a two-part submission. Part 2, “An Alternative Approach to Capital Allocation,” discusses using risk-replicating techniques that directly calculate the cost of capital. Such techniques can be used as a substitute for capital allocation. This paper expands upon current capital analysis by introducing a practical approach that considers the objectives of all stakeholders of an insurance company in setting appropriate capital targets.

Description: This paper expands upon current capital analysis by introducing a practical approach that considers the objectives of all stakeholders of an insurance company in setting appropriate capital targets. In addition, the paper introduces a technique for estimating capital adequacy that is based on mapping stochastic distributions of regulatory and rating agency capital measures to observable financial rating transition matrices.

Description: The authors introduce an alternative to Tail Contribution Analysis TCA for analyzing business segments and strategies called Economic Profit Analysis EPA. They discuss EPA’s key feature, “volatility replication,” an intuitively appealing process of building investor expectations and capital market information into the risk-and-return measurements used to evaluate strategic decisions. Finally, they illustrate the benefit of using EPA in overcoming the problems of TCA and thereby providing concise reliable information for business decision making.