Dynamic Financial Analysis: Classification, Conception, and Implementation

Abstract

Dynamic financial analysis (DFA) models an insurance company's cash flow in order to forecast assets, liabilities, and ruin probabilities, as well as full balance sheets for different scenarios. In the past years DFA has become an important tool for the analysis of an insurance company's financial situation. In particular, it is a valuable instrument for solvency control, which is now becoming important as regulators encourage insurance companies to determine risk-based capital using internal risk management models. This article considers three aspects: First, we discuss the reasons why DFA is of special importance today. Second, we classify DFA in the context of asset liability management and analyze its fundamental concepts. As a result, we identify several implementation problems that have not yet been adequately considered in the literature, and therefore our third aspect is a discussion of these areas. In particular we consider the generation of random numbers and the modeling of nonlinear dependences in a DFA framework.

Failure Risks in the Insurance Industry: A Quantitative Systems Analysis

“…In addition, and unlike the classic financial theory perspective on corporate hazard rates, we adopt the point of view of the firm's managers (as opposed to the market's point of view). Overall, our model, which we named global financial analysis (GFA), represents an extension of dynamic financial analysis (DFA) models that have recently been introduced in the literature (see, e.g., Cummins et al, 1999;D'Arcy and Gorvett, 2004;Eling and Parnitzke, 2007). The GFA model, however, is focused on estimating insolvency risk and, unlike other DFA models, incorporates factors such as insurance ratings, social, and legal changes, as well as catastrophic failures at the industry level.…”

A systematic design for coping with model risk

“…In fact, Derman (1996) had listed numerous reasons to explain why the model has inadequacy based on the badly specified, incorrectly implemented, improper model parameters estimated and so on. For instance, in the case of Dynamic Financial Analysis (DFA) system (Berger & Madsen, 1999;Emma, 1999;Eling & Parnitzke, 2007) shown in Fig. 1, if the particular functional form or assumption chosen in models of risk factors for valuing an asset or a liability is incorrect, an incorrect surplus distribution will be generated; as a result, the insurer will be misled in risk management and strategy evaluation.…”