Modelling the Financial Strength of a Reinsurance Company

Abstract

One of the more fruitful applications of computer simulation modelling is in the evaluation of the financial strength (or security) of insurance companies. The difficulty with conventional measures of solvency such as the solvency margin (as discussed in Section 18.5) is that they bear little relationship to the riskiness of the insurer’s activities. The model presented in this chapter therefore looks at the effect of possible variations on each of the main elements of an insurance company’s cash-flow (or emerging costs). An important feature of this technique is its stochastic nature: the effects of risk and uncertainty are built into the simulation, so that each time the model is ‘run’, slightly different answers are produced. By running the model a large number of times (normally many hundreds), the overall effect of the variation in each of the many components can be established. It is then possible to evaluate the strength and riskiness of the individual insurer or reinsurer which is being modelled. The model enables the user to quantify the probability that the assets will prove inadequate to meet the liabilities.