Risk Assessment in Life
Insurance
Tel Aviv, November 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
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November 23rd, 2010, Thorsten Keil
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Risks in Life Insurance
Risks in Life Insurance
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
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Risks in Life Insurance
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
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Risks in Life insurance
The Life Risk Module under QIS 4 showed the
following composition of risks:
Source: CEIOPS
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What is the Best Estimate?
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
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What is 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.
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What is the Best Estimate?
 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
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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
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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)
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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
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ResQ 3.4
The use of Best Estimate under Solvency II
ECONOMIC BALANCE SHEET
Assets
Liabilities
Ineligible capital
Tier 3
Available Capital
Free Surplus
Tier 2
Solvency Capital
Requirement (SCR)
Tier 1
MCR
Minimum Capital Requirement
Risk Margin
Assets covering
technical
provisions
Technical
Provisions
Best Estimate
Other Liabilities
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ResQ 3.4
Available capital
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% (runoff after one-year perspective)
- Projection of future SCRs without simplification of the calculation
- Simplified methods proposed to derive future SCR and Risk Margin
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Required capital
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
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Required capital - Structure
Adjustment for risk absorbing effects
Basic Solvency Capital Required
Operational Risk
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Required capital – Life underwriting Risk
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Requirements on Best
Estimate calculation
Best Estimate calculation for …
Balance sheet or P&L positions:
 Premium income
 Reserves
 Claims
 Lapses
 Guarantees
 Options
Target: Calculation of future profits resp. losses
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Requirements on Best Estimate calculation
 (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
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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
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Evaluation of options and guarantees
 Contractual client‘s options
Lapse with or without surrender value
Waiver of Premium
Lump sum payment for deferred annuities
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How to derive Best Estimate
assumptions
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
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Portfolio Analysis
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)
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Groups of risks
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
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Types of risk / Risk classes
Choice of potential types of risk:






Mortality Risk
Disability Risk
Longevity Risk
Lapse Risk
Option Risk
Expense Risk
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Personal risk factors
Personal risk factors
Choice of potential risk factors:






Gender
Age
Smoking habits
Profession / Education
Family state
Place of residence
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Example: Personal risk factors
Impact of Education on Mortality:
Age standardised mortality rates in Austria (1981 and 1991)
Male
Age, Education
level
Female
1981/
82
1991/
92
Change
1981/
82
1991/
92
Change
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%
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%
30-59
60-74
Source: Max-Planck-Institut
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Example: Personal risk factors
Relative mortality compared with married people
Male
Age
Single Widower
Female
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
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Example: Socio-professional category (SPC)
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
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Product related risk factors
Product related risk factors
Choice of potential risk factors:




Agent / Distribution channel
Underwriting
Level of the sum insured
Embedded guarantees
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Example: 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)
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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
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Example: Product related risk factors
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
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The impact of sum insured
Relation between mortality and level of
annuity (private annuities)
Mortality in % of qx resp.
qy
120%
100%
80%
60%
40%
20%
0%
0 - 600
601 - 1.200
1.201 - 2.000 2.001 - 3.500 3.501 - 6.000
> 6.000
Contractual annuity in EUR
Source: German Actuaries Society
Female
Male
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Subjective Risk / Moral Hazard
Relation: Reported claims to
expected claims
Disability rates in relation to level of sum insured
150%
100%
50%
0%
40%
50%
60%
70%
80%
Relation: Contractual Annuity to Gross income
Source: Gerald S. Parker, Juni 1976
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Example: Product related risk factors
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)

Cancellation right (Surrender)
 Depends on legal and fiscal environment
 Lapse rate depends strongly on economic
environment
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Raw Best Estimate Rates
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
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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)
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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
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Calculation 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
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Example: Model points
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Example: Loss ratio model
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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
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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
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Obstacles on the way to
best estimate
Obstacles on the way to Best 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
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Obstacles on the way to Best Estimate
 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
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Diversification of life risks
under Solvency II
Diversification of risks under Solvency II
Mortality and longevity
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Female life expectancy at age 65
23
The length of the blending period
and the final weighting depend on
the mortality history of the country
Japan
France
21
Switzerland
Netherlands
19
USA
17
Netherlands
England and Wales
France
Germany (West)
Japan
USA
Switzerland
15
England and
Wales
Germany
13
1950
1960
1970
1980
1990
2000
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
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in Life
Insurance
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Is there a maximum life expectancy?
The highest life expectancy
(worldwide)
Source: Max Planck Institute
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Does it really diversify?
Development of the average life expectancy (Female,
Germany)
100
90
80
70
60
50
40
30
20
10
0
0
1871/81
6 12 18 24 30 36 42 48 54 60 66 72 78 84 90 96
1901/10
1924/26
1932/34
1949/51
1960/62
1970/72
1986/88
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2000/02
2004/06
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The impact of increasing life expectancy
The consequences of a mortality improvement of 1% p.a.
0
-10
Technical Losses
-20
-30
-40
-50
Additional Reserves
-60
Additional Annuities
-70
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
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Conclusion
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
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Thank you for your
attention!