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 considers the question of whether the growth in the size of financial statements witnessed over the last several years has yielded an increase in the quality of disclosure around issues of financial risk and to what extent this disclosure is satisfying the perceived needs of readers of the financial statements, as represented by the investment analyst community.

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: This paper introduces a rich stochastic modeling framework for understanding risks in multiple-decrement contracts. The example in the paper is a 20-year Term insurance contract. Not only are mortality and lapsation considered stochastic, but the parameters governing them are. For example, mortality risk is composed of four risk elements, including error generated in the underwriting process, volatility around the best estimate, catastrophic events that impact mortality, and the trend in mortality improvement or deterioration. When stochastically modeled, the relative contribution and risk profile of each risk element can be evaluated. Generating stochastic mortality results provides a distribution of results that an organization faces and the severity and incidence of the tail events.

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.