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Until recently, the actuary's role in maintaining the financial health of an insurer was largely related to setting rates which were adequate to pay future losses and expenses, as well as assessing the value of future liabilities for business currently on the books. Now the actuary is increasingly being asked to opine on the adequacy of the capital and surplus accounts of a company to cover these projected future payments, a process formally known as Dynamic Financial Analysis (DFA). The Casualty Actuarial Society's efforts to define the actuary's role and responsibilities in the DFA process, have culminated in a draft version of the DFA Handbook (Draft Release 1.0). While this Handbook does not yet rise to the level of a standard of practice for actuaries, it does codify the essential considerations in the DFA process.
Dynamic Financial Analysis, as defined by the DFA Handbook "is the process by which an actuary analyzes the financial condition of an insurance company. Financial condition refers to the ability of the company's capital and surplus to adequately support the company's future operations through a currently unknown future environment." In the past, financial analysis of an insurer's operations was generally carried out in a one dimensional fashion, whereby each aspect of the operation was evaluated separately, with little evaluation as to how the pieces interrelated. The DFA process is concerned with evaluating how adverse deviations in one or more areas of an insurer's operations interrelate and affect the total financial condition of the enterprise.
Areas identified as crucial to the DFA process are the appropriateness of the prices charged, the business plan, the reserving practices, the reinsurance program and the investment portfolio. Although each area is separately addressed in the Handbook, much effort is made to show how these considerations are all intimately related. An appropriate business plan demands appropriate pricing, investments and reinsurance. All of these rely heavily on the reserving function, which should help define the investment portfolio and so on and so forth. It is impossible to adequately analyze any one of these areas independently of the others without critical input from several staff functions within the insurance enterprise. The dynamic aspect of the analysis is essentially that repercussions of a change in any one, or...