risk assessment in life insurance tel aviv, november 23rd, 2010 thorsten keil

Risk Assessment in Life Insurance

Tel Aviv, November 23rd, 2010Thorsten Keil

2Risk Assessment in Life InsuranceNovember 23rd, 2010, Thorsten Keil

Contents

Risks in Life Insurance

What is the Best Estimate?

Use of the Best Estimate under Solvency II

Requirements on Best Estimate calculation

How to derive Best Estimate assumptions

Personal risk factors

Product related risk factors

Calculation of Best Estimate

Obstacles on the way to Best Estimate

Diversification of life risks under Solvency II

Conclusion



Investment Risk

Mortality Risk

Longevity Risk

Morbidity Risk (e.g. Disability, Long-term Care)

Lapse Risk

Option and Guarantee Risk

Calculation Risk

Expense Risk

Counterparty Default Risk

Operational Risk



Results of QIS 4:According to QIS 4 technical specifications the market risk (resp. equity and interest risk) dominate by far the Basic Solvency Capital Required (BSCR) of European Life insurance companies

Source: CEIOPS


Risks in Life insurance

The Life Risk Module under QIS 4 showed the following composition of risks:

Source: CEIOPS


Scope of Risk Assessment

Better understanding of underwritten risks

Management of the undertaking

Reserving

Risk Management

Legal conditions

Solvency regulations

All this requires the calculation of the Best Estimate



Best estimation of an expected value

E.g. present value of future cash flows between policyholder and insurance company

The best estimate can be defined as an appropriate estimation of the expected value of a certain value excluding any margins – especially security margins – based on actual available information.



Projections of the cash flows without risk margin

Appropriate projection period

Use of known parameters and expected changes, e.g.

Contractual premiums and benefits of the current portfolio

Expenses

Mortality rates and trends


Provisions under IAS 37

Measurement of Provisions according to Best Estimate

IASB requires a prudent calculation of Provisions. An overestimation of provisions should be avoided since this is a contradiction to the market consistent evaluation (no security margins).

If the effect from interest rates is significant, IAS 37 also requires the calculation of the present value of Best Estimate.

Please note: There‘s a huge difference between Provisions (the insurer already has an obligation) and Contingent Liabilities (possible obligation) under IAS 37


Main focus of Best Estimate calculation

Property / Casualty Insurance

Main focus of calculation on reserves

Economic approach for IBNR calculation

Life insurance

Cash Flow Projections based on Best Estimate basis of calculation (e.g. qx, ix)

Use of Best Estimate under Solvency II


The use of Best Estimate under Solvency II

The Best Estimate is required under Solvency II in two different ways

Calculation of Available Solvency Margin (ASM)

Calculation of Solvency Capital Required (SCR)

Coverage Ratio = ASM / SCR


ResQ 3.4

ECONOMIC BALANCE SHEET

Assets Liabilities

Technical Provisions

Solvency Capital Requirement (SCR)

MCR

Free Surplus

Available Capital

Assets covering technical provisions

Risk Margin

Best Estimate

Minimum Capital Requirement

Other Liabilities

Tier 3

Tier 2

Tier 1

Ineligible capital

The use of Best Estimate under Solvency II


Available capitalResQ 3.4

Technical Provisions = Best Estimate + Risk Margin

Best Estimate = probability-weighted average of future cash flows

- Discounted with relevant risk free rate term structure.

- Use of entity-specific information (expenses, claims, mortality,…)

Risk Margin : Cost of Capital Approach with constant rate 6% (run-off after one-year perspective)

- Projection of future SCRs without simplification of the calculation

- Simplified methods proposed to derive future SCR and Risk Margin


Required capital

Calculation criteria (according to EU directive)Calculation criteria (according to EU directive) Should be calibrated to ensure all risk to which the company is

exposed are taken into account Cover existing business and new business to be written within

the 12 following months Correspond to a 99.5% VaR over one year period Cover at least:

Non Life underwriting risk Life underwriting risk Health risk Market risk Credit risk Operational risk

Shall take into account risk-mitigation techniques provided that all risks (e.g. credit risk) arising from these techniques are reflected in the SCR


Required capital - Structure

Basic Solvency Capital Required Operational RiskAdjustment for risk absorbing effects


Required capital – Life underwriting Risk


Best Estimate calculation for …

Balance sheet or P&L positions:

Premium income

Reserves

Claims

Lapses

Guarantees

Options

Target: Calculation of future profits resp. losses



(If possible) for each basis of calculation a best estimate is necessary

The calculation should always be based on company specific estimations

The actuary has to use common and accepted actuarial methods

The appropriateness of the assumption has to be provable

The underlying data have to be checked and adjusted regularly


2nd order basis of calculation for Best Estimate

Age

Gender

Socio-economic factors, such as

Profession / Education

Smoking habits

Product features

Options and guarantees

Lapse and surrender rules

Distribution channel


Evaluation of options and guarantees

Contractual client‘s options

Lapse with or without surrender value

Waiver of Premium

Lump sum payment for deferred annuities

How to derive Best Estimate How to derive Best Estimate assumptionsassumptions


How to derive Best Estimate assumptions

In order to derive appropriate basis of calculation the following steps are required:

1. Comprehensive portfolio analysis for achieving detailed company specific data

2. Segmentation of portfolio into homogenous groups of risks

3. Definition of determining risk factors

4. Calculation of raw probabilities

5. Deriving of Best Estimate rates from raw data


Portfolio structure / Distribution of

Tariffs

Insurance periods

Age and gender of insured persons

Sum insured

Contractual guarantees

Option for lump sum payments (deferred annuities)

Cancellation rights

Indexations (risk increase)

Portfolio Analysis


Segmentation of portfolio into homogenous groups of risks / groups of tariffs (depending on size of portfolio)

Tariff / Type of cover, e.g.

Policies with guaranteed interest rates

Unit linked policies

Policies without profit participation

Group life business

Groups of risks


Choice of potential types of risk:

Mortality Risk

Disability Risk

Longevity Risk

Lapse Risk

Option Risk

Expense Risk

Types of risk / Risk classes

Personal risk factorsPersonal risk factors


Choice of potential risk factors:

Gender

Age

Smoking habits

Profession / Education

Family state

Place of residence

Personal risk factors


Impact of Education on Mortality:

Age standardised mortality rates in Austria (1981 and 1991)

Male Female

Age, Education level

1981/82

1991/92

Change 1981/82

1991/92

Change

30-59

Low 6,9 5,9 -15% 2,8 2,4 -14%

Medium 5,7 4,5 -22% 2,3 1,9 -17%

High 3,4 2,5 -26% 2,1 1,7 -21%

60-74

Low 36,0 31,7 -12% 18,5 15,4 -17%

Medium 32,5 26,9 -17% 16,5 13,0 -22%

High 25,0 18,7 -25% 14,2 10,5 -26%

Source: Max-Planck-Institut

Example: Personal risk factors


Relative mortality compared with married people

Male Female

Age Single Widower Divorced Single Widow Divorced

35-39 3,4 4,9 1,9 2,3 3,4 1,4

40-44 3,1 3,4 1,9 2,3 2,3 1,5

45-49 2,6 2,2 1,8 2,1 1,9 1,4

50-54 2,3 2,2 1,8 1,7 1,6 1,4

55-59 2,1 1,9 1,7 1,7 1,5 1,4

60-64 1,7 1,8 1,7 1,3 1,4 1,3

65-69 1,6 1,6 1,6 1,3 1,3 1,3

Source: 1992 Mortality Statistics, OPCS Serie DHI

Example: Personal risk factors


Mortality in men aged 16 to 64 according to SPC

Socio-professional category Mortality Ratio

Self-employed 58 %

Senior executives 77 %

Middle management 93 %

Qualified personnel 107 %

Skilled workers 130 %

No qualification 204 %

All men 100 %

Source: Mortality Statistics by Social Class, 1971-85- OPCS Population Trends

Example: Socio-professional category (SPC)

Product related risk factorsProduct related risk factors


Choice of potential risk factors:

Agent / Distribution channel

Underwriting

Level of the sum insured

Embedded guarantees

Product related risk factors


Agent / Distribution channel:

Analysis from several markets show an increased lapse rate from life insurance policies that were sold via brokers or pyramid sales forces

Reduced lapse risk for policies that were sold by direct selling companies or bankassurance

Lapse rate increases within policy period (early lapses)

Example: Product related risk factors


Medical underwriting:

Significant selection effect by medical underwriting within first years of policy period

Decreasing effect within first five years – afterwards average mortality rate



Level of sum insured:

In many portfolios a lower mortality rate for people with higher sums assured can be recognized

Positive effect on term insurances

Negative effect on annuity portfolios

Negative effect on disability insurances with a high sum insured compared with net income



The impact of sum insured

Relation between mortality and level of annuity (private annuities)

0%

20%

40%

60%

80%

100%

120%

0 - 600 601 - 1.200 1.201 - 2.000 2.001 - 3.500 3.501 - 6.000 > 6.000

Contractual annuity in EUR

Mo

rta

lity

in %

of

qx

re

sp

. q

y

Female MaleSource: German Actuaries Society


Disability rates in relation to level of sum insured

0%

50%

100%

150%

40% 50% 60% 70% 80%

Relation: Contractual Annuity to Gross income

Re

lati

on

: R

ep

ort

ed

cla

ims

to

e

xp

ec

ted

cla

ims

Source: Gerald S. Parker, Juni 1976

Subjective Risk / Moral Hazard


Embedded guarantees:

Indexation option (e.g. in case of marriage, birth of a child,…)

Up to now rarely taken

Option for lump sum payment (instead of an annuity)

Depends on legal and fiscal environment

Cancellation right (Surrender)

Lapse rate depends strongly on economic environment



Calculation of raw Best Estimate data

Mortality

Mortality trends

Annuities

Term insurances

Morbidity

Surrender behaviour (company specific)

Surrender

Waiver of Premium

Opting for annuity or lump sum payment

Raw Best Estimate Rates


Key question: Which length the observation period should have?

The observation period should not be too long since changes in legislation, taxation or policy conditions might lead to distortions

According to experience a period of up to 5 years is reasonable

But: In order to evaluate mortality trends a longer period should be considered (e. g. 20 years)

Raw Best Estimate Rates


The derivation of Best Estimate Rates from raw data should be done by actuarial processes, e.g.

Smoothing

Extrapolation

Benchmarking with reference tables

Best Estimate Rates

Calculation of Best EstimateCalculation of Best Estimate


Performance of Cash Flow Projections

Policy by policy

Very extensive and comprehensive calculation

Model Points

Building blocks of business, if risks and results don‘t get falsified.

Loss ratio models

In case of weak portfolio information also a loss ratio model can be considered

Separated calculation for profit participation and reinsurance

Buffer effect of profit participation

Risk mitigation by reinsurance


Example: Model points


Example: Loss ratio model


Performance of Cash Flow Projections

In order to calculate the Best Estimate both, a deterministic or a stochastic approach is possible, but

Evaluation of options and guarantees only possible with stochastic simulations

Basic idea: The difference between stochastic and deterministic calculation shows the value of options and guarantees

Life insurers seem to prefer deterministic calculations since also the basic idea of life insurance techniques is deterministic


Calculation of Present Value

Once all Best Estimate values of future years are available, one has to discount them

Which yield curve should be used?

Risk free interest rate, since Best Estimate does not allow for additional margins

Based on government bonds

Swap curve

If available: same period for both, interests and Best Estimate values

Congruency of currencies

Obstacles on the way to Obstacles on the way to best estimatebest estimate



Inadequate data quality

Missing company specific 2nd order basis of calculation due to

Small sub-portfolios

Poor historical data

Public available basis of calculation can only be used under certain circumstances

Proof of adequacy of basis of calculation



Time and effort of the calculations should be in a reasonable relation to the portfolio size

If necessary refer to available data from insurance associations, actuarial societies or reinsurers

Diversification of life risks Diversification of life risks under Solvency IIunder Solvency II


Diversification of risks under Solvency II

Mortality and longevity


13

15

17

19

21

23

1950 1960 1970 1980 1990 2000

Netherlands

England and Wales

France

Germany (West)

Japan

USA

Switzerland

Female life expectancy at age 65

Source : Analysis based on data from the Human Mortality Database. University of California, Berkeley (USA), and Max Planck Institute for Demographic Research (Germany). Available at www.mortality.org

USA

France

Japan

England and Wales

Germany

Switzerland

Netherlands

The length of the blending period and the final weighting depend on the mortality history of the country


Is there a maximum life expectancy?

Source: Max Planck Institute

The highest life expectancy (worldwide)


Does it really diversify?

Development of the average life expectancy (Female, Germany)

0102030405060708090

100

0 6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96

1871/81 1901/10 1924/26 1932/34 1949/51 1960/62 1970/72 1986/88 2000/02 2004/06


The impact of increasing life expectancy

-70

-60

-50

-40

-30

-20

-10

0

65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 101 103 105 107 109 111

Age of Portfolio

Te

ch

nic

al L

os

se

s

Additional Reserves

Additional Annuities

The consequences of a mortality improvement of 1% p.a.

ConclusionConclusion


Conclusion

The new solvency rules and accounting standards require a market consistent view of insurance portfolios

Best Estimate is a key component of actuarial valuation under the new regime and requires a new approach since additional security margins are not allowed

In future times a better knowledge of underwritten risks is required

Beside the current actuarial evaluation of balance sheet positions the best estimate calculation will be one of the most important actuarial tasks

Thank you for your Thank you for your attention!attention!

risk assessment in life insurance tel aviv, november 23rd, 2010 thorsten keil

Documents

life risk module

life insurance slide

market risk

best estimate slide

best estimate calculation

thorsten keil slide

best estimate iasb

life insurance results