Insurance Loss Modeling Using Simulation
With the dramatic increase in the speed of personal computers and steep decline in the cost of computing, simulation has become one of the standard tools in the risk manager’s toolbox and should now become one of the standard tools in the risk management and insurance student’s toolbox. This teaching note aims to facilitate this process by showing how to create and run a simulation in a spreadsheet environment, and interpret simulation results to gain insight and understanding about a real-world problem. Specifically, this teaching note provides step-by-step instruction for simulating the present value of payments for losses occurring within a one-year policy period. Losses are covered by an aggregate excess of loss treaty. The uncertainty lies in the frequency and severity of losses, as well as in claim processing time; and also in the discount rate for calculating the present value of loss payments.