Applying a DFA Model to Improve Strategic Business Decisions

Until recently, insurance companies were forced to evaluate business decisions at the functional level. With the advancement in computing power and understanding of advanced financial mathematics, company's are now able to integrate all of the various operational functions into a total company model, and evaluate the impact of various business decisions on the total company's risk/reward profile. This paper describes an approach for using "decomposition of risk" as part of a comprehensive ALM analysis for an insurance company. The objective is to identify and quantify the major factors that contribute to a company's total risk. Isolating each component of risk allows a company to better understand its total risk and thus develop strategies to improve its risk/reward profile. As a result, management can assimilate the relative and combined risk of assets, liabilities, and capital markets into a set of stochastic financial statements, thereby providing the information necessary to improve strategic investment, operating and capital allocation decisions.