Modeling and Management of Nonlinear Dependencies - Copulas in Dynamic Financial Analysis

The aim of this paper is to study the influence of nonlinear dependencies on a nonlife insurer's risk and return profile. To achieve this, we integrate several copula models in a dynamic financial analysis (DFA) framework and conduct numerical tests within a simulation study. We also test several management strategies in response to adverse outcomes generated by nonlinear dependencies. We find that nonlinear dependencies have a crucial influence on the insurer's risk profile that can hardly be affected by the analyzed management strategies. Depending on the copula concept employed, we find large differences in risk assessment for the ruin probability and for the expected policyholder deficit. This has important implications for regulators and rating agencies that use these risk measures as a foundation for capital standards and ratings