PROCEEDINGS May 15, 16, 17, 18, 2005 - Casualty Actuarial Society

178 MODELING FINANCIAL SCENARIOSof solvency margins, cash flow testing, operational planning,and other financial analyses of insurer operations.ACKNOWLEDGEMENTThe authors wish to thank the Casualty Actuarial Society andthe Society of Actuaries for sponsoring this research, as well as thevarious members of the committees of both societies who provideddetailed reviews and numerous excellent comments.1. INTRODUCTIONThe insurance industry is increasingly relying on financialmodels. Financial models are an integral part of any dynamic financialanalysis (DFA) approach and are frequently used for solvencyregulation, capital allocation, and pricing insurance policies.Financial models can also be used to determine the economicvalue of loss reserves. As financial models become awidely used tool, actuaries have a greater need to understandcurrent models and to develop improvements.A considerable amount of research suggests that sophisticatedtools are needed to accurately evaluate the financial condition ofinsurers. Santomero and Babbel [37] review the financial riskmanagement practices of both the life and property-liability insurersand find that significant improvements are necessary. Theystate that even the most advanced insurers are not effectivelymanaging their financial risks. Research also shows that the potentialconsequences of the lack of risk measurement cannot beignored. A study by the Casualty Actuarial Society FinancialAnalysis Committee [9] discusses the potential impact of interestrate risk for property-liability insurers. Hodes and Feldblum[26] examine the effects of interest rate risk on the assets and liabilitiesof a property-liability insurer and conclude that “casualtyactuaries must understand interest rate risk thoroughly if theywish to participate in the industry discussions and to influencethe coming professional and regulatory guidelines.” Staking and