Dynamic Monitoring and Forecasting of the Soundness of U.S. Insurers in a Cyclical Environment

Abstract

Abstract This paper presents a model of dynamic monitoring and forecasting of key financial indices of U.S. insurers. The key financial indices are assumed to be cyclically time-varying correlated and are selected according to their impact on the soundness of the insurers. It also presents a new kind of control chart, {\mu _r} chart, based on the weighted average of standardized financial indices. Three kinds of objective functions are applied to determine the optimal weights: (1) minimizing the probability of a missed alarm; (2) minimizing the volatility of the weighted average of standardized financial indices; and (3) minimizing the expected shortfall of the weighted average of standardized financial indices. We note that the optimal weights are equal weights no matter which objective function is selected. The control technique presented in this paper can be extended to monitor the soundness of other insurance firms in a cyclical environment.