Cash Flow Projection Models
The cash flow projection model is simulating the way the insurance undertaking is working and reflects it by generating run-off balance sheets and P&Ls. This simulation implies a very thorough and deep understanding of all dimensions: products, assets, risk factors, markets, environments, regulations, behaviors, accounting... The challenge for the model is then to look at the whole undertaking “through the eyes of the management” and to encapsulate it and how things interact into formulas. This could only be done with a certain level of shortcuts: granularity of projected portfolios, behavioral laws…, in order both to reach acceptable running time and to be sustained by the IT capabilities. However these shortcuts should be carefully tailored so as not to false the results. Difficulties addressed in the article cover: the simulation of French multi-funds savings contracts where cash dynamically flows from General Fund to Unit-Linked funds (and vice versa), the granularity of asset classes, the simulation of structural cash flows from liabilities and notably the estimation of expenses, the stochastic modeling of assets, the determination of behavioral laws: policyholders’ profit sharing, surrenders, fund shifting, investment policy, behavior in central scenarios versus behavior in extreme scenarios… Answers to these difficulties should take into account the requirements of consistency (backtesting), reality (how the model reflects the risk profile of the undertaking), rapidity (a model is designed to be used in production under deadline’s constraint).