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

310 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES1. Financial modeling assumptions underlying financialstatement projections; and2. Valuation assumptions underlying the application of theDCF and EVA methodologies yielding value estimatesof PSIC based on the financial statement projections.Exhibit 7 shows the value estimates for PSIC for each methodand the principal components for applying the valuation formulae.The fundamental financial amounts entering the valuationcalculations are current and future year-end surplus estimatesand future total income estimates. Basic financial modeling assumptionswill be discussed later in this section; the primaryfocus is the application of the valuation methodologies with themodeled surplus and income amounts given specific valuationassumptions.The valuation assumptions are the following:1. A valuation date of December 31, 2001.2. PSIC’s risk-based capital (RBC) indication at each yearenddictates the statutory surplus at the respective yearend.The example uses a surplus-to-RBC relationship of2-to-1 where the RBC indication is the Company ActionLevel (100% of the RBC calculation) [11].3. A hurdle rate of 15% per annum for all future years.4. After the explicit forecast period ending December 31,2011, we assume the surplus and total company incomewill increase at 2% per annum indefinitely.For each valuation methodology, future valuation amounts aremodeled in two distinct time periods: the explicit forecast period(10 years for the example, 2002 through 2011), and all subsequentyears (2012 and later). For our sample company valuation,the explicit forecast period income and surplus estimates (via theRBC calculation) rely on financial modeling procedures. Valu-