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Chapter 10 Financial planning (A good model should (Valid, rigorous…
Chapter 10
Financial planning
A good model should
Valid, rigorous enough for purposes and well documented
reflect risk profile of financial products, schemes, transactions or contracts
parameters should allow for all features of the business could significantly affect advice being given
inputs to the parameter values should be appropriate
working of model should be easy to appreciate and communicate
Outputs should be capable of independent verification and easy to communicate
Model should not be overly complex
Model should be capable of development and refinement
range of methods of implementation; facilitate testing, parameterisation and focus of results
Why do insurers use models
solvency
business planning
premium calculation
The financial plan
one or more goals
strategy to be followed to achieve goals
set of targets that will enable success or failure of strategy to be measured
a financial projection(s)
trade off between growth and expenses of developing the business
Modelling process involve making key assumptions about
the time horizon
risk measures
the economic environment
investment return
the insurance cycle
future written premium income
future claims
reinsurance
future expenses
DFA (Dynamic Financial Analysis)
Provides management with information on:
interaction of decisions from different areas of company operation
risk-and-return-trade-offs
evaluating market alternatives
Helps management in the following aims:
absorbing the transfer of policyholders' risk
earning an appropriate return on capital
minimising exposure to insolvency
Integrated DFA model should:
apply same macroeconomic conditions across the business
allow management to consider operating needs and conditions in financial markets
examine risk-and-return-trade-offs
help with reinsurance decisions
DFA helps with:
business planning
product and market development
claims management
capital allocation and management
liquidity
reinsurance structure and cost
asset and investment strategy
rating agency support
merger and acquisition opportunities
business closure
To build a DFA model:
select a model structure
decide the variables and their relationships
determine types of scenarios
estimate parameters
test the assumptions and their interactions
monitor and update (if necessary) regularly