C.09.Cummins Allocation

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  1. RAROC & EVA(OC)
    • mgt analyzes whether each line produces sufficient return to cover its cost of capital
    • RAROC: if less than COC take action (UW, volume)
    • EVA = economic value added: EVAi = Net Inci - riCi
    • EVAOCi = Net Inci/Ci - ri
    • Ci: similar monoline (difficult), regression
  2. Friction costs
    • agency & informational: mgt opportunistic behavior
    • double taxation: cheaper to invest directly than through cpy
    • regulations: may force insr to hold inefficient inv pf
  3. Capital Allocation Techniques
    • RBC: avoid regulatory intervention (-) factors of questionable accuracy (-) based on bk not mkt (-) ignores imp sources of risk
    • VaR: P(Li > E(Li) + Ci) = ei set all lines eq ($ or /E[Li]) (-) may not have enough capital (-) no diversification (-) ignores severity
    • Insolvency Put Option / EPD ratio: Value = Le-rT - P(option) achieve same ratio (+) reflects severity (-) no diversification
    • Merton-Perold: risk capital = smallest amt invested to insure value of A against loss in value relative to rf. (-) allocates < 100%; rest = corporate
    • Myers-Read: look at impact of very small chg to loss liab (+) allocates 100%

Card Set Information

C.09.Cummins Allocation
2012-05-09 20:36:48
RBC VaR Merton Perold Myers Read

Allocation of Capital in the Insurance Industry
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