DFA Insurance Company Case Study, Part 2 Capital Adequacy and Capital Allocation

This paper has been submitted in response to the Committee on Dynamic Financial Analysis 2001 Call for Papers. The authors have applied dynamic financial analysis to DFA Insurance Company (DFAIC) to address capital adequacy and capital allocation issues. The DFA model used for this analysis was the Swiss Re Investors Financial TM Integrated Risk Management (FIRM) System. This paper is Part 2 of a two-part submission. Part 1 deals with using DFA to explore reinsurance efficiency and asset allocation issues. This paper explores different general risk measures used in the past to judge capital adequacy. This overview of various risk measures will incorporate the concept of coherent risk measures. It introduces a practical method for using Tail Conditional Expectation (TCE) as a measure of capital adequacy. We will look at the adequacy of DFAIC's capital position using the TCE risk measure along with other more widely accepted regulatory and rating agency capital adequacy measures for different reinsurance/asset allocation strategies. Additionally, we will discuss different risk measures associated with capital allocation, including TCE, along with different allocation procedures. This section will also explore the idea of allocating capital to assets. Different allocation methods will be discussed and the Shapley Value method, found in game theory, will be applied to two different risk measures to allocate DFAIC's current capital to line of business and to assets.