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Chapter 14. Ruin Theory (Capital Requirements: (Evaluating Capital at Risk…
Chapter 14. Ruin Theory
Probability (e) that capital will fall below a certain value (V(t)) within some time frame, given we start with V(0)
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Risk of Ruin:
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Set up our initial capital to lower this probability to an acceptable risk appetite level of ruin prob
Can also scenario test how sensitive the outcomes are to different inputs/parameters (scenario and stress test)
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Capital Requirements:
Evaluating Capital at Risk - run multiple simulations and find a lower confidence bound (allowing changes in assumptions like business cycle and return on investment)
Specific to an Insurer - can allow the lower bound to be MCR.
Probably have a higher warning boundary (like SCR or something higher still)
Could also have an Upper Limit, to know when to distribute dividends (money can be put to better use, i.e better returns)
Must allow for actions of mgmt (not static) - such as changing strategy, rating practice, outward RI
Allow for Dynamic Programming - allowing for mgmt decision in certain situations by using DFA and the goals/strategy of the company
Use all of this to find an acceptable ruin probability.
In the end a decision need to be made on the risk-return model
Need a few assumptions, like initial free-reserves, premium, dividends, profit loading, sales