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

MODELING FINANCIAL SCENARIOS 179Babbel [41] find that significant work is needed to better understandthe interest rate sensitivity of an insurer’s surplus. D’Arcyand Gorvett [14] and Ahlgrim, D’Arcy, and Gorvett [2] applymore advanced measures to determine the interest rate sensitivityof loss reserves and illustrate how these measures depend onthe interest rate model chosen. All of these articles focus on theneed for a better understanding of the financial risks facing aninsurance company.Many actuaries are now familiar with the traditional techniquesthat form the basis of asset-liability management (ALM),including the measures of duration, convexity, and the term structureof interest rates (Hull [27], Chapter 5). Duration and convexityhelp insurers understand their interest rate sensitivity andassist portfolio managers in reducing surplus volatility. However,the calculations for duration and convexity rely heavily on underlyingassumptions about the level and potential movementsof interest rates, and these issues have not been thoroughly evaluatedby the actuarial community.In order to enhance actuaries’ understanding of financial models,the Casualty Actuarial Society (CAS) and the Society ofActuaries (SOA) jointly issued a request for proposals on theresearch topic “Modeling of Economic Series Coordinated withInterest Rate Scenarios.” There were several specific objectivesof the request:² Review the previous literature in the area of economic scenariomodeling;² Determine appropriate data sources and methodologies to enhanceeconomic modeling efforts relevant to the actuarial profession;and² Produce a working model of economic series, coordinated withinterest rates, that could be made public and used by actuariesvia the CAS and SOA Web Sites to project future economicscenarios.