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

286 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESmium, supporting loss reserves and UEPRs until all of the claimsare paid, and (iii) investment income on the capital base supportingthe writing of the new business.Developing financial projections (income statements, balancesheets, and cash flows) related to running off the existing balancesheet liabilities, assuming no new or renewal business iswritten, will provide the basic elements for valuing the companyin runoff. The key factors involved are (i) the payout ofthe loss reserves, (ii) the ultimate losses and expenses associatedwith the unearned premium reserve, (iii) the payout of the lossesand expenses associated with the unearned premium reserve, (iv)the capital needed each year to support the company in runoff,and (v) the investment yield earned on assets until all claims arepaid and all capital is released. In practice, when running offa company that writes personal lines business, renewals may bemandated for several years by the regulatory authorities. In thoseinstances, running off the company might also reflect the writingof some renewal business.When it is important to understand the value associatedwith the runoff of the business separate from value associatedwith the writing of new (or renewal) business, we recommendthe following approach. Value the company in runoff reflectingthe level of capital required to run off the company. Then,value the company reflecting earnings and capital needs associatedwith maintaining the company as a going concern. Thatis, earnings projections and capital needs are developed for thecombination of running off the existing balance sheet and writingnew business. The value of solely writing new business shouldbe computed as the difference between the two valuations.The suggested approach is beneficial on both a practical anda theoretical basis. On a theoretical basis, the valuation of therunoff company relative to the going concern improves the determinationof capital required for new business. On a practicalbasis, both valuations will use the same starting balance sheet.