3. Emerging Risks for Insurers
Andrea French
Technical Specialist, Insurance Sector Team
3.1 Definition of an emerging risks
An emerging risk can be defined as:
"an issue that is perceived to be potentially significant but which may not be
fully understood or allowed for in insurance terms and conditions, pricing,
reserving or capital setting".
(Source: Lloyd’s of London)
Emerging Risks
3.2 Key drivers of risk
The key drivers of risk include:
•
Economic, technological, environmental and socio-political
developments as well as the interdependencies between them.
Other risk drivers can include:
•
The changing business environment, such as liability issues, evolving
regulatory regimes, stakeholder expectations, and shifts in risk
perception.
Emerging Risks
3.3 Insurance-specific risks
This presentation will concentrate on the insurable areas of risk for both life and general insurers.
These risks include:
•
Life Products Risk (credit & counterparties, impact of the low interest rate environment,
enhanced annuities and retail distribution review & platforms)
•
General Insurance (GI) Risk (impact of the low interest rate environment, inadequate
reserving, UK flooding and periodic payment orders)
•
Technology Risk (cyber attacks)
•
Stakeholder Risk (shadow banking activities)
•
Black Swan Risks (combined effect of financial, catastrophe & pandemic)
Emerging Risks
3.4 Life Emerging Risks
Financial risks - Credit and counterparties
Risk
Impact
Risk Mitigation
Growth of the annuity market posing
significant increase in risk to life
insurers.
Number of annuity writers backing their
liabilities with equity-release mortgage
or other non-standard asset classes,
which may be unsustainable in the long
term.
Ensure asset classes being considered
are fully understood.
Particular issue - backing annuities by
moving into alternative assets.
Seek permission from the regulator,
where necessary.
Actively monitor portfolios for different
and unexpected risks.
Emerging Risks
3.4 Life Emerging Risks
Financial risks - Low interest rate environment impact
Risk
Impact
Risk Mitigation
Impact of low interest rate
environment depends on the extent
to which life insurers are asset and
liability mismatched.
Depends on the structure of the portfolio. Life
insurers typically have high bond allocations.
Ensure there is
• appropriate assessment of risk;
and
• conduct stress testing exercises.
Margins for assets being managed
may be hit as investment returns
and profits are reduced.
Interest risk hedging activities could put pressure
on bond yields causing:
•
reduction in firm’s solvency levels;
•
restricted investment policies;
•
restricted ability to write new business;
•
reduced new business profitability.
Strategy planning should assess
vulnerabilities including second order
and behavioural effects and
amplification issues.
Future - may affect the availability of own funds
after the effect of subsidiaries to the group under
the Solvency II group solvency calculations
framework
Emerging Risks
3.4 Life Emerging Risks
Product Risks – Enhanced annuities
Risk
Impact
Risk Mitigation
Enhanced annuities and
other non-standard annuities
offer higher annuity rates to
people whose lifestyle or
medical conditions cause
their life expectancy to fall
below the expected mortality
rates
Low yield environment and difficult
macroeconomic conditions mean people
are incentivised to derive more value
from their savings.
Monitor medical advancements affecting future life
expectancy that annuities have been provided for.
They may be more use of non-standard
products against a backdrop of falling
standard annuity rates
Ensure books of business do not grow
unsustainably.
Ensure credible contingency plans are in place for
the treatment of assets for Solvency II.
Firms may wish to consider stress testing their
portfolios for scenarios such as withdrawal and/or
reduction of reinsurance covers or significant market
valuations changes in the future.
Emerging Risks
3.4 Life Emerging Risks
Product risk – Platforms and Retail Distribution Review
Risk
Impact
Risk Mitigation
Retail Distribution Review implemented in
December 2012.
Back books steadily declining as
maturities and surrenders exceed new
business premiums.
Immediate risk of failure is low.
Fundamental change to distribution of retail
investments could affect consumer
behaviour, preference and changes of
products and markets attractive to firms.
The key risk - life insurers’ existing books
of business decline significantly faster
than expected across the sector before
new strategies are developed and
providing steady cash flow.
Monitoring is required to ensure
sector trends of a persistent
decreasing back book do not
accelerate faster than expected
significantly increasing the impact.
Emerging Risks
3.4 GI Emerging Risks
Financial risks - Low interest rate environment impact
Risk
Impact
Risk Mitigation
Slow economic recovery places pressure on
premiums, contracting market size, and
lowering investment returns which affects
profitability.
Firms seeking to improve returns may
attract significant asset risks to their
balance sheet.
Continue to focus on:
These factors combined with competition,
may result in general insurance firms to
seek out more reward for their risk.
Unprofitable underwriting can result in
firms launching new products writing new
and/or growing the business in current
and new territories with a lack of data,
knowledge or experience.
• future underwriting strategies
• pricing policies and
• monitoring investment
strategies.
Emerging Risks
3.4 GI Emerging Risks
GI line of business risk – Inadequate reserving
Risk
Impact
Risk Mitigation
Inadequate reserving by general
insurers can:
•
understate the costs of claims;
•
create premium rate pricing
adequacies; and
•
stress reserving risk capital
requirements.
Inadequate reserving will strain business models
and affect solvency capital levels.
Perform regular deep-dive reserve
exercises to ensure that they
understand their claim exposure
fully.
Coupled with:
•
competitive market pricing pressure;
•
changing supply and demand trends;
•
increased claims inflation costs; and
•
current low interest rate environment
can result in pressure to alter an insurers
behaviour in the current phase of the
underwriting cycle.
Effective reserve governance is
essential.
Ensure reserves are adequate by
using correct booking of reserves
with appropriate challenge.
Emerging Risks
3.4 GI Emerging Risks
GI line of business risk - UK flooding
Risk
Impact
Risk Mitigation
More than 30 major rivers in the UK that
have extensive reach and are currently
or were historically, multi-channelled.
More flooding is predicted in the UK and
rates of river bed, bank erosion and
floodplain sedimentation are also likely to
accelerate.
Identify vulnerable points within
their insured portfolio of household
properties and maintain adequate
reserves to manage these
exposures.
These rivers represent significant points
of increased vulnerability in the river
network to increase flooding.
Historic underinvestment in flood
defenses and changing weather patterns
have increased the risk.
There remains the possibility that certain
households will not be able to afford flood
insurance as it becomes too costly.
A new regime coming in mid 2015
is intended to ensure the continued
widespread availability of flood
insurance to high-risk households.
Follows the expiry of the Statement
of Principles.
Emerging Risks
3.4 GI Emerging Risks
GI line of business risk - Periodic Payment Orders (PPOs)
Risk
Impact
Risk Mitigation
Since their introduction through the 2003
Courts Act, PPOs have begun to change
the landscape of how large bodily injury
(BI) claims are paid in the UK.
This payment method transfers to the insurer
risks such as longevity, investment and
inflation. PPOs now pose a material current
and future risk for motor insurers.
It is essential for:
•
Firms to actively track and
monitor potential PPO claims.
PPOs are an alternative to lump sum
payments. Under a PPO settlement an
insurer pays a semi-annual amount to the
claimant for the remainder of their life,
like an annuity.
It is estimated that, within a decade, 25% of
general insurer motor reserves could be
formed of PPO commitments.
•
Have specific reserving,
modelling and methodology in
place to minimise the longevity,
investment and inflation risk.
Emerging Risks
3.4 Life and GI Emerging Risks
Technology risk - Cyber attacks
Risk
Impact
Risk Mitigation
Many firms are leaner so are opting to use
cloud computing, offshoring data and
processes to third party firms.
A cyber attack could affect a firm’s
ability to process premiums and issue
insurance contracts affecting
cashflows and covers – particularly an
issue for compulsory insurances.
Ensure and monitor that third party
firms provide the security and service
that they are contracted to deliver.
A cloud service provider concentration
could become a second order risk if
such providers were subject to
multiple cyber-attacks causing a
failure of services.
Rectify breaches immediately to
minimise security risks is paramount.
Critical functions outsourced include
catastrophe modelling, actuarial analysis
and compliance functions.
Constantly monitor firewalls.
Limit staff use of mobile devices to
minimise damage to high risk critical
areas of the infrastructure.
Emerging Risks
3.4 Life and GI Emerging Risks
Stakeholder risk - Shadow banking activities
Risk
Impact
Risk Mitigation
Shadow banking activities can cover nonbanking financial firms that provide services
similar to traditional commercial banks
where there is a maturity transformation.
Non-traded assets are highly risky and
volatile and may cause significant
losses in a short timeframe. They may
also be less liquid in times of stress
and valuations may be difficult to
quantify.
Firms engage with the regulator to
ensure products are appropriate.
Such activities could include credit
investment vehicles (e.g. investment funds,
mutual funds and trusts) that have a cash
management or very low risk investment
objective.
Once deemed appropriate firms may
require expert advise when
transacting in these products.
Firms should regularly monitor asset
exposures to minimise risk and
volatility.
Investments may also occur in unregulated
markets, so are not visible in conventional
balance sheets, making it difficult to assess
exposures.
Emerging Risks
3.4 Life and GI Emerging Risks
Black Swan - Combined effect of a financial, catastrophe & pandemic events
Risk
Impact
Risk Mitigation
Simultaneous shocks to the:
Certain scenarios could lead to loss in a
large number of life products and GI lines
of business.
Some policies may be hit unexpectedly by
claims, the insurance industry should clarify
coverage intentions sooner rather than later to
ensure contract certainty.
• global economic system
• natural catastrophes
• pandemics
could trigger insured loss
events which could test the
resilience of insurers.
Life and health assurers will be adversely
affected in a pandemic event and GI
insurers could experience unprecedented
liability claims and an accumulation or
large value claims following a catastrophe
event.
Claims could also come from secondary
impacts to society.
A firms solvency capital could be
adversely affected if there is a “flight to
quality” at the same time due to investor
unpredictability.
Firms ensure they have an understanding of the
financial markets second order, behavioural and
amplification issues affecting their investments
Firms ensure they understand their concentration
of exposures for natural catastrophe (for
modelled and unmodelled perils)
Pandemic contingency plans should aim to
ensure continuity of essential operations during
an extended period of high illness rates in the
workforce, suppliers, and customers.
Emerging Risks