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

THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLES 315² The hurdle rate is 15% for calculating the cost of capital forthe EVA method and for determining the PV of 2012 andsubsequent value amounts.Both methods produce a valuation result of $88.03 million.DCF(1) Present value of free cash flow during the explicit forecastperiod(2) Terminal value (present value of free cash flow subsequent tothe explicit forecast period)$54.69$33.33Total $88.03EVA(1) Adjusted net worth (starting surplus) $42.13(2) Present value of value added amounts during the explicit$31.81forecast period(3) Present value of continuing value added subsequent to theexplicit forecast period$14.08Total $88.03A.2. Overview of the Financial ModelThe property/casualty insurer financial model for the PSICvaluation performs all of the necessary computations to produceprospective statutory and GAAP financial statements. The majorfunctions of the model are (i) runoff of loss and LAE reserves,(ii) payout of loss and loss adjustment expenses stemming fromthe earning of the unearned premium reserve, (iii) estimation ofthe level of future written premium and associated earned premiumand application of the loss and expense ratio assumptions,(iv) calculation of investment income, and (v) calculation of federalincome tax due.There are two items of note before discussing the details ofPSIC financial model projections. First, the model does not reflectall the changes resulting from the NAIC’s codification ofstatutory accounting principles. An example is the recognition