Eliminating proxy errors from capital estimates by targeted exact computation

Abstract

AbstractDetermining accurate capital requirements is a central activity across the life insurance industry. This is computationally challenging and often involves the acceptance of proxy errors that directly impact capital requirements. Within simulation-based capital models, where proxies are being used, capital estimates are approximations that contain both statistical and proxy errors. Here, we show how basic error analysis combined with targeted exact computation can entirely eliminate proxy errors from the capital estimate. Consideration of the possible ordering of losses, combined with knowledge of their error bounds, identifies an important subset of scenarios. When these scenarios are calculated exactly, the resulting capital estimate can be made devoid of proxy errors. Advances in the handling of proxy errors improve the accuracy of capital requirements.