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Financial Analysis - The Old Fashioned Way

2014-Feb-12 - Pete Panno

As actuaries, there are many shiny new tools in our toolboxes when it comes to financial analysis. Technology and advances in computing power have expanded the horizon for advanced statistical modeling, stochastic analysis, and sophisticated regression and simulation. However, when taking stock of the tools in your box, it is often the old reliable tools that can get the job done in a cost effective way.

In 2013, Hause Monnin Consulting was contracted by 2 smaller insurance companies that were concerned about a decline in statutory earnings and the prospects for the future.

These would have been golden opportunities for a consultant to use scare tactics to sell a huge job using all of the latest and greatest analytical tools. But as consulting actuaries, it is important to scale the project to the needs of the client. In both cases, a several hundred page report with fancy charts and graphs outlining the results of millions of scenarios would be of little use to them. These companies just wanted answers, and wanted them communicated clearly and within an acceptable budget.

This is why Hause Monnin Consulting opened the toolbox and pulled out a tried and true Gains By Source analysis. In simplest terms, Gains by Source allocates the financial statement earnings into 4 categories: Gains from Loading, Gains from Mortality, Gains from Interest, and Gains from Terminations. The gains from these 4 categories will add up to the total gain from the financial statement. In the context of a company losing money, this is a great place to start because the analysis will highlight where to start digging. It can also be used to determine the short term outlook. Little time is wasted exploring things that aren't causing the problem.

This study, in conjunction with a high level review of pricing assumptions, can produce very meaningful management information. For example, if the Gains from Mortality component of the analysis highlights a mortality problem or a negative trend, it would indicate a more detailed review of pricing mortality assumptions may be in order. Similarly, if the Gains from Loading component of the analysis uncovers an expense problem, the next step would be to review expense assumptions to make sure pricing expenses are covering actual expenses. Further, performing this analysis over multiple years can uncover reporting problems, which could be masking true gains or losses.

Tailoring solutions to the needs and scale of a client can sometimes be challenging. The new wave of analytic technology is powerful and exciting. But powerful and exciting is not always what the client wants or needs. The most important criteria is still to get the right answer, and we must often remind ourselves that the older tools in the toolbox still work and still work well.