Reinsurers' investment and underwriting portfolios and the exchange rates risk

The traditional analysis of the performance of large international reinsurers typically concentrates on the effect of exchange rates on profitability of the firm (NRG [9]). The multi-index model enables us to capture and analyze two additional effects: According to the Interest Rates Parity Theorem, the expected rates of return on foreign investments already reflect the expected change in the exchange rate. Therefore, a firm operating in a perfect market would be indifferent to the currency denomination of its financial assets. The firm should consider only the unexpected element in the exchange rate movements, i.e., the exchange risk. The uncertainty in the exchange rate contributes to the variability of the return on each investment and underwriting project. The firm must consider this new element of risk while constructing its investment and insurance portfolios. p ]The model can be used to examine and analyze alternative policies of the firm operating in international markets. For example, the model can be used to examine the "full hedge" policy, in which the insurer has a zero net position in any non-reference currency, or the policy of isolating national insurance markets.