International Association for the
Study of Insurance Economics
Extract from
7 th
Geneva Association
Health & Ageing Conference
18-19 November 2010
Paris
This document is free to download from The Geneva Association website, www.genevaassociation.org
January 2011
© Association Internationale pour l'Etude de l'Economie de l'Assurance
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The Geneva Association_________________________Etudes et Dossiers no. 368
• Today, LTC insurance market is becoming mature providing insurers with the possibility of efficient risk monitoring and measurement of profitability:
• Technical parameters are being estimated with better confidence levels
(mortality, disability rates, longevity, etc.) thus allowing for:
– Accurate pricing policies
– Sound reserving methodologies
• Models have been developed providing the possibility to implement effective asset-liability strategies as well as prospective measurement of profitability
• Yet many issues remain to be addressed:
– Definition of risks => still no normalization of risk among insurers and reinsurers
(based on GIR, usual actions, etc.)
– Challenges resulting from the development of partial disability contracts
– Impact of Solvency 2 on risks
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The Geneva Association_________________________Etudes et Dossiers no. 368
Objectives of Solvency 2 : definition of a standardized
European framework for the solvency of insurance companies;
Incitation for insurers to better manage and hedge their risks by adapting capital requirements to the real risks of insurance business
Timeframe of Solvency 2:
• January 2013 : enforcement of Solvency 2
• First reportings : April 2013
• Qualitative measures : January 2013
31/12/2009 31/12/2010 31/12/2011 31/12/2012
• Nov. 2009 : publication of the framework directive
Solvency 2
• defines main requirements
• Autumn 2010 : 5 e impact study (QIS)
• Level 2 measures under preparation
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2011 : publication of implementation measures (level
2)
• 2012 : transposition into domestic law
• publication of level 3 measures
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• No significant regulatory constraint from Solvency 1 prudential regime:
• Very simple capital requirements
– Capital requirement proportional to premiums (18%/16%) and payments
(23%/26%)
– Reinsurance acknowledged up to 50% only
• No real regulatory incentive
– to develop and manage risks properly either coming from assets (ALM risks) or from liabilities
– to implement economic capital models
• Under Solvency 2 regulation, risks related to LTC generate specific capital requirements. Two possibilities for insurers:
• Standard formula
• Internal model
But the first step is to estimate properly liabilities (best estimate + risk margin)
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The Geneva Association_________________________Etudes et Dossiers no. 368
• prospective methodology close to embedded value techniques premiums expenses fees payments
(renewals)
( taxes)
Impact of asset mix and reinsurance
Actualization & cost of capital
• Need for a good knowledge of risks
• Approach can be used to calculate the value of LTC portfolios (EV approach)
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• Many issues:
• Estimation of future premiums and subsequently of lapse rates and renewals
– Basic lapse rates (depending on relevant parameters: maturity of contracts, age d lth
– Use dynamic lapse policies?
• Stability of future payments: as mortality and disability rates for most aged insured people are still unknown, vision of profitability will only be known in the future…
• Estimation of expenses:
– Uncertainties linked to internal as well as external inflation rates
– Regulatory changes in LTC may as well impact expenses
• Estimation of cost of capital:
Solvency 1 ok
– Solvency 2 => what methodology?
 costly approximation of cost of capital risk margin
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“Truth is what stands the test
of experience“
Albert Einstein
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The Geneva Association_________________________Etudes et Dossiers no. 368
• Complexity associated with management rules and dynamic behavior of clients :
ALM risk
Increase of lapse/renewals
(less premiums)
S
Stress scenario
Increase of premiums
(when possible)
No increase in bonuses
• Would need stochastic modeling of liabilities
• Need to have data on past experience to calibrate
• Need to have written policies related to actions to be taken under stressed scenarios
• Need for complex models to take account basic effects as well as reinsurance and partial disability contracts
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Under Solvency 2 standard formula, LTC is considered the same way as life business
Requires ability to model deformations of net asset value of balance sheet
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The Geneva Association_________________________Etudes et Dossiers no. 368
• Issues related to Solvency 2:
• Standard formula not adapted to the specificities of LTC
– Longevity risk: a (permanent) 20% decrease in mortality rates for each age and each policy where the payment of benefits
(either lump sum or annuities) is contingent on longevity risk
 What treatment for LTC?
 Relevance of calibration?
– Disability: increase of 35% in disability rates for the next year, together with a (permanent) 25% increase in disability rates at g decrease of 20% in morbidity/disability recovery rates
 Relevance of calibration?
 Treatment of partial disability contracts?
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• Challenges of Solvency 2:
– expenses
 Need for refined modeling of expenses
– Interest rate risk
 Duration of liabilities generally exceeds duration of assets
 Costly risk module
– Complexity associated with the adjustment:
 Need the definition of a management rule
 What actions of an insurer in the context of a shock on the net asset value?
p probably better to use one at least partially for better calibration
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The Geneva Association_________________________Etudes et Dossiers no. 368
Combined with quantitative requirements, Solvency 2 regime will focus on both:
• data quality:
• Not an issue in itself for LTC
• Need for data of good quality arises from the need to have right parameters for risk monitoring (technical parameters, as well as efficient processes to update them)
• risk management with a specific issue, ORSA:
• standard formula based on all-business common assumptions (1-year 99.5%VaR)
• Yet obligation to have an own risk assessment
• For LTC, risk measure and time horizon might as well be different
– Operational risk
– Reputation risk (claims)
– Underwriting risk (reserving and pricing)
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• The third pillar of Solvency 2 remains a significant issue in LTC insurance management and risk monitoring
• Risk management under multiple reporting frameworks (some still under construction):
– IFRS 4 phase 2 => new calculations for insurance contracts reserves and recognition of profits
– MCEV => “natural” context for value and profitability measurement (IRR /
VNB/PVFP)
– Now Solvency 2
– And still fiscal and solo accounting rules…
Burdensome as those frameworks have to be reconciled to bring a unique risk monitoring to management and control bodies
Y t t ti f ti l implemented under those constraints:
– Expected profitability (self sustained growth + positive VNB)
– Specificity of AG2R LA MONDIALE
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The Geneva Association_________________________Etudes et Dossiers no. 368
• Solvency 2 will globally prove itself challenging for insurers:
• Increase in risk management rules
• Increase of reporting
• The burden may be twice as much for LTC insurers as the risk still is a ‘young’ risk under development
• Modeling
• Risk management
• But it represents a unique opportunity to match risk management and capital management.
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