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

322 THE APPLICATION OF FUNDAMENTAL VALUATION PRINCIPLESTABLE 8Changes From Base Case in Valuation EstimatesDCF ModelEVA Model2001— 2012 2001— 20122011 to 1 Total 2011 to 1 TotalSurplus/RBC ratio = 2:5 (11.6) 1.3 (10.3) (6.7) (3.7) (10.3)Base loss ratios +2% points (8.7) (2.9) (11.7) (8.0) (3.7) (11.7)Base loss ratios ¡2% points 8.6 2.9 11.5 7.9 3.6 11.5Investment yield +100 basis pts 12.9 6.5 19.4 12.9 6.5 19.4Investment yield ¡100 basis pts (13.1) (6.6) (19.6) (13.1) (6.6) (19.6)Premium growth = 0% 3.4 (7.0) (3.6) (1.4) (2.2) (3.6)Premium growth = 6% (2.3) 4.0 1.7 0.7 1.1 1.7Hurdle rate +3% points (6.4) (12.4) (18.8) (10.7) (8.0) (18.8)Hurdle rate ¡3% points 7.8 23.1 30.9 13.6 17.3 30.9its of the insurance company are modest. This is apparent inExhibit 9, which shows the underwriting income contribution topretax operating income for 2002 through 2011.The hurdle rate for the entire valuation period is also a keyassumption. Decreasing the hurdle rate from 15% to 12% for allprojection periods increases value by 35%.An increase in the required surplus (raising the surplus-to-RBC ratio from 2.0 to 2.5) lowers value. This result is logical inthat the higher the capital required, the lower the free cash flowsfor DCF and the higher the cost of capital for EVA.Value is also very sensitive to changes in the investment yieldfor the asset portfolio. This result is logical for this companysince over 95% of the pretax operating income is related to investmentincome (as shown in Exhibit 9).Valuation results will always be sensitive to small changes inloss ratios as shown in Tables 7 and 8. A reduction in loss ratio