Implications of Variability in Timing of Cash Flows on Valuations

In valuing insurance companies, significant attention is paid to the adequacy of loss and loss adjustment expense reserves and loss and expense ratio assumptions. In most valuations, not only are the expected values of these variables reviewed, but also the impact on the value of variation from the stated expectations. A considerable volume of actuarial literature addresses the derivation of estimates of variability around expected losses. In addition, many actuaries have begun studying interest rate risk and its impact on the valuation of insurance companies. Less attention has been paid to the impact on valuations and the estimation of variability in the timing of payments. This paper begins with a review of the expected timing of each major item of cash flow. Variability around these expectations is also discussed. An illustration, for a sample company, of the impact of relatively small changes in loss payment patterns and delays in reinsurance recoveries on the value of the company is then presented. The paper concludes with some random thoughts on how to evaluate the variability in the timing of loss payments.