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

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 313selected capitalization standard result of 2:0 £ $21:07 million(the RBC indication at December 31, 2001) or $42.13 million.The “excess” surplus is recognized as free cash flow/value addedfor both DCF and EVA at December 31, 2001 (time 0), and ourvaluation models begin with a statutory surplus of $42.13 million.For the EVA model, the surplus of $42.13 million is recognizedimmediately as value. It is also the basis of the cost ofcapital calculation in the first period. For the DCF model, thesurplus of $42.13 million contributes to value only through theinvestment income it earns in subsequent periods.No other adjustments were made to the starting surplus forvaluation. Carried reserves were assumed to be at the actuariallyindicated amount. There was no difference between market valueand book value of investments and no other adjustments weredeemed warranted.After establishing PSIC’s adjusted net worth, the valuationprocess requires the total statutory income and RBC amountsfor the first future projection year, 2002, from the financialmodel constructed for PSIC. Exhibit 8, Changes in Statutory Surplus,shows the estimated future income for PSIC during 2002to be $10.44 million. The PSIC valuation model includes incomefrom two categories: statutory net income and changesin unrealized capital gains. Exhibit 9 shows the computationof statutory net income. Unrealized capital gains stem from increasesin market value for preferred and common stock investments.The projected RBC for year-end 2002 is $23.25 million, leadingto a December 31, 2002, required surplus of $46.50 million.Exhibit 12 shows PSIC’s RBC calculation. During 2002, the requiredsurplus increases by $4.37 million, from $42.13 millionto $46.51 million.The DCF methodology determines value from free cash flowestimates; for 2002 free cash equals $10.44 million of income