Qs on Chapter 8: Return on Capital

[Bill SD]

Hi,
Would greatly appreciate answers to the following 5 queries on SA3 Chapter 8: Return on Capital:

pg 4: "The capital allocation method should:

• be consistent with the modelled capital for the whole business…
• be justifiable and consistent. "

Q1- What does 'consistent' mean in these 2 bullets? Presume the first bullet really means compatible with the business' risk measure; while last bullet means compliant with reg requirements or applied equally to each risk/business class? (Either way seems an inconsistent use of the word

Pg 10: "Expected policyholder default – this is a variant of the above measures that gives the expected loss beyond a threshold, set as the company’s surplus capital. It is not a coherent measure of risk as it does not satisfy the linear homogeneity axiom.
Transformed loss measures – these apply a transformation to the loss distribution to give more weight to the key focus areas of the loss distribution for the decision maker. They are generally coherent."

Q2: What/How are these 2 measures calculated?

Pg 11
"If you are interested in exploring these concepts in more detail, you may like to look at the following papers:
Denault, M. (2001) Coherent allocation of risk capital ; Kaye, P. (2005) A guide to risk measurement, capital allocation and related decision support issues
Myers, S. & Read, J. (2001) Capital allocation for insurance companies ; Venter, G. (2004) A survey of capital allocation methods with commentary."

Q3: Where can I access these 4 referenced academic papers? Similar question for many papers mentioned in the Further Reading chapter since the IFoA Library (https://actuaries.cirqahosting.com/HeritageScripts/Hapi.dll/search1?SearchPage=srchgen.htm or https://research.ebsco.com/c/34b3ls/search)‎ doesn’t offer access.

pg 13: Proportional (spread) method

Q4: Is this method equivalent to the pro-rata or Euler approaches from SP9 Chapter 30? If not, please explain this method since I don't follow the Core Reading.

Pg 16 "Helping underwriters appreciate the gearing of returns on capital and hence the significance of pricing terms and conditions"
Q5: Does this basically mean convincing UWs to care that the incurred risk (from weak T&Cs, policy wording) will lead to a capital requirement.
Thanks very much in advance!

 

[Aman Sehra]

Hi Bill,

Responses have been put below:

pg 4: "The capital allocation method should:

• be consistent with the modelled capital for the whole business…
• be justifiable and consistent. "

Q1- What does 'consistent' mean in these 2 bullets? Presume the first bullet really means compatible with the business' risk measure; while last bullet means compliant with reg requirements or applied equally to each risk/business class? (Either way seems an inconsistent use of the word

I think you've got it, but for the second point, this is all about compliance ie the company is comfortable with the method and it can justified to the regulator; but more importantly, we are using the method consistently across the business (eg you can't use marginal last in for a new line of business, where the rest of the business is using a proportional method)

Pg 10: "Expected policyholder default – this is a variant of the above measures that gives the expected loss beyond a threshold, set as the company’s surplus capital. It is not a coherent measure of risk as it does not satisfy the linear homogeneity axiom.
Transformed loss measures – these apply a transformation to the loss distribution to give more weight to the key focus areas of the loss distribution for the decision maker. They are generally coherent."

Q2: What/How are these 2 measures calculated?

This isn't part of the core reading, however there are some links on the top of page 11, which you can refer to in order to learn more.

Pg 11
"If you are interested in exploring these concepts in more detail, you may like to look at the following papers:
Denault, M. (2001) Coherent allocation of risk capital ; Kaye, P. (2005) A guide to risk measurement, capital allocation and related decision support issues
Myers, S. & Read, J. (2001) Capital allocation for insurance companies ; Venter, G. (2004) A survey of capital allocation methods with commentary."

Q3: Where can I access these 4 referenced academic papers? Similar question for many papers mentioned in the Further Reading chapter since the IFoA Library (https://actuaries.cirqahosting.com/HeritageScripts/Hapi.dll/search1?SearchPage=srchgen.htm or https://research.ebsco.com/c/34b3ls/search)‎ doesn’t offer access.

Using a popular search engine can yield you results and you can find versions to look at online

pg 13: Proportional (spread) method

Q4: Is this method equivalent to the pro-rata or Euler approaches from SP9 Chapter 30? If not, please explain this method since I don't follow the Core Reading.

Looking at the SP9 course notes, this is closest to the 'pro-rata' from SP9

Pg 16 "Helping underwriters appreciate the gearing of returns on capital and hence the significance of pricing terms and conditions"
Q5: Does this basically mean convincing UWs to care that the incurred risk (from weak T&Cs, policy wording) will lead to a capital requirement.

This is saying that the returns on capital are quite sensitive to risk taken on, so ensuring adequate prices for policy terms and conditions is rather important.

Thanks
Aman
ActEd Tutor

 

[Bill SD]

Thanks very much for your helpful answers to this and other threads. Search engine didn't provide the papers but will try again looking online.