Will Hurricane Matthew adversely affect the ILS market?

Hurricane Matthew was the most significant windstorm to affect the United States since Sandy in 2012. It is estimated to result in $4 to $7 billion in property insurance losses. In this article, Milliman actuary Aaron Koch considers the effect that Matthew may have on the insurance-linked securities (ILS) market and alternative capital investors. He also offers perspective on whether the storm will have any influence on United States property catastrophe reinsurance rates which have decreased in the last several years.

Here is an excerpt from the article:

Based on the impact profile of Matthew, we expect two sets of loss impacts to ILS fund valuations based on the storm:

1. Minor realized losses on collateralized reinsurance per-occurrence layers and sidecars

We might expect a minor to moderate amount of losses on the lowest layers of collateralized reinsurance programs. Key driving factors to consider include the proportion of economic loss that ends up being excluded by residential policies given the flood-heavy nature of the storm; a fund’s exposure to Florida-only writers versus those that are diversified across the Southeast (and thus potentially exposed to a larger proportion of the storm’s impact); and any limits that are written in the Caribbean, which suffered direct landfalls from Matthew across several countries, including Haiti and the Bahamas.

2. Minor writedowns on collateralized reinsurance aggregate layers and aggregate ILS deals

We expect that Matthew’s broader impact might be across the set of deals where Matthew will contribute towards an overall aggregated retention. Even if Matthew is not itself strong enough to trigger a loss to certain catastrophe bonds, ILWs, and collateralized reinsurance contracts with aggregates, we do expect that it will often exceed these contracts’ deductibles (in either standard or franchise form) to accrue a portion of the loss needed to erode the aggregate retention.

In these cases, the erosion of part of the aggregate retention makes the contract more susceptible to suffering loss over the remainder of the contract period (i.e., if future major loss events were to occur). As a result, the valuation of these contracts should see a slight negative impact from Matthew.

Fortunately, Matthew comes relatively late in the hurricane season. Thus – with the exception of multiple-year contracts – there is a correspondingly lower chance of additional U.S. wind events pushing the loss above the aggregate retention. As such, we can expect Matthew’s negative impacts on fair value estimates to be relatively small and to reverse quickly back up to full value assuming that no further events occur this year.

Indonesia Life Insurance Newsletter, October 2016

According to the Indonesia Life Insurance Association, the Indonesian life insurance industry experienced a year-on-year increase of 9.2% in total gross income over the first quarter of 2016. Total invested assets grew by 4.7% with a general growth across almost all asset classes except for a decline of 5.7% in equity investment. Total claims paid by the industry dropped by 4.8% compared with the first quarter of 2015. There were no new life insurance licenses in the four-month period ending 31 August 2016. Milliman’s Richard Holloway, Halim Gunawan, and Iwan Juwono offer more perspective in the latest Indonesia Life Insurance Newsletter.

Capital efficiency under Solvency II

Clarke_SinéadFollowing its implementation on 1 January 2016, Solvency II should now be “business as usual” for European (re)insurers. For years, (re)insurers were focused on understanding the Solvency II requirements and putting them into operation within their businesses. Now that this has largely been achieved, companies are beginning to really turn their attention to consider ways to better manage their capital in a Solvency II world. In a new series of blog posts, we will address some ways in which companies can achieve capital efficiency under Solvency II.

We have already seen some capital management techniques put into effect this year, most notably in the space of longevity risk transfer and corporate restructuring, including the use of internal reinsurance. These large scale projects are generally undertaken by sizeable European groups, but that’s not to say that they are not also relevant for smaller (re)insurers. This blog post will look at three techniques that companies may be able to use to improve capital efficiencies under Solvency II.

Contingent debt
In August, a Norwegian insurer, Gjensidige Forsikring, announced that it plans to become the first insurer to issue bonds that can be written down in the event of a breach of its Solvency II capital thresholds. The firm plans to sell approximately $120 million of these restricted tier 1 notes to enhance the structure of its own funds. The instrument is intended to aid insurers in times of stress. Bond holders will be the first to suffer any losses if the insurer breaches its capital thresholds through deferred coupon payments. Under Solvency II, up to 20% of the Solvency Capital Requirement (‘SCR’) can be covered by bonds with high loss absorbing capacity, which includes this type of contingent bond or “restricted tier 1 debt.” Similar instruments were issued by reinsurers in the past to provide capital in the event of a major catastrophe.

Operational risk bonds are another area for consideration. In May, Credit Suisse Group issued approximately $220 million in operational risk bonds to help insure against certain risks such as cyber risk, rogue trading, system failure and fraudulent behaviour. The bond is underwritten by Zurich Insurance Group and is designed to reduce the operational risk capital charges of the Swiss bank. The bond is similar in structure to a catastrophe bond with the principal being written down upon the occurrence of aggregate operational losses above a certain amount.

Longevity risk transfer
The longevity risk transfer market has been growing steadily as undertakings attempt to reduce capital requirements and technical provisions in respect of longevity risk. Such deals are particularly relevant to UK annuity providers. Legal and General recently completed another longevity reinsurance deal, a key outcome of which was to reduce the insurer’s risk margin. Rothesay Life has also hedged a significant amount of its longevity risk exposure through the use of reinsurance.

However, in the UK, the Prudential Regulation Authority (‘PRA’) is concerned about the additional risks involved in annuity risk transfer, particularly where these transactions are entered into solely to reduce the Solvency II risk margin and not to genuinely transfer risk. A key concern relates to increased counterparty risk where longevity risks are transferred to a small number of reinsurers. The PRA intends to closely monitor trends and developments in this space.

VIF monetisation
Value of in-force (VIF) is the term often given to the economic value of future profits associated with an in-force book of business. Under Solvency II, the VIF of profitable business can be recognised on the balance sheet through the calculation of the best estimate liability. VIF monetisation involves realising a portion of the value included in the best estimate liability by “selling” a share of the expected future profit stream to a third party in exchange for an upfront payment.

The main benefit of a VIF monetisation is to enhance liquidity and raise finance, and it is, therefore, a potentially attractive alternative to debt or equity issuance. It can also be used to significantly remove variability in the technical provisions over time, essentially via “hedging” a portion of the VIF asset by taking it off risk. This can protect the insurer from future variability in the risk drivers that affect future profits.

In recent years, there has been significant activity in Spain and Portugal in this space, primarily driven by the financial crisis. We have also seen transactions in other European jurisdictions, such as the UK and Ireland.

We have published a number of papers on this topic including Capital management in a Solvency II world (which focuses on life (re)insurance business), Capital Management in a Solvency II World: a non-life perspective (looking specifically at non-life or P&C issues) and Unit-linked matching considerations under Solvency II.

If you are interested in more information on capital management under Solvency II, please contact your usual Milliman consultant.

Big data, consumers and the FCA

Newton_DerekIn November 2015 the Financial Conduct Authority (FCA),1 a UK financial services regulator, announced that it intended to investigate the use of “big data”2 in retail general insurance in the UK. In September 2016, it announced that it was not, after all, going to pursue this investigation. Why this apparent turnaround?

The opportunities big data provides general insurers are widely acknowledged and the reason general insurers are investing heavily in this area. But with such opportunities come potential threats: big data could potentially lead to better service and outcomes for many consumers, but could it also lead to some consumers effectively being excluded from the market or to the exploitation of consumers who are less price-sensitive than others? Those are the concerns that the FCA sought to address when announcing its investigation in November 2015.

Since then, the FCA has been gathering and evaluating relevant information, mostly relating to private motor and home insurance. It has found a lot of evidence that the use of big data results in benefits to users of insurance, through products and services being better tailored for individual needs, through more focused marketing and better customer service, and through increasing feedback to consumers about the risks that they run and how to manage them effectively, most notably to those with telematics auto insurance.

While its concerns remain, the FCA concluded from this preliminary investigation that the increasing use of big data is “broadly having a positive impact on consumer outcomes, by transforming how consumers deal with retail GI firms, streamlining processes and encouraging more innovation in products and services.” As a result, it has decided that there is no immediate need either to push ahead with the full investigation that it had originally proposed or to change its regulatory framework in response to any issues raised. However, it will continue to look at big data, in particular looking for any related data protection risks and seeking to understand how big data is used in pricing.

Full details of the FCA’s views can be found in its Feedback Statement FS16/5.

1The FCA regulates the financial conduct of the financial services market within the UK and shares with the Prudential Regulation Authority the prudential regulation of the businesses within the UK financial services market.
2There is no universally accepted definition of “big data.” In the context of its investigation, the FCA considered big data very broadly, embracing data sets that are larger or more complex than have hitherto typically been used by the insurance industry, data sets derived from new sources such as social media, and the emerging technologies and techniques that are increasingly being adopted to generate, collect, and store the data sets, and then to process and analyse them.

CAS awards Milliman actuary honorarium

Milliman’s Mark Shapland received an honorarium from the Casualty Actuarial Society’s Monograph Editorial Board (MEB) for his paper on stochastic reserving entitled “Using the ODP bootstrap model: A practitioner’s guide.”

Mark’s paper explores practical issues and solutions for dealing with the limitations of over-dispersed Poisson (ODP) bootstrapping models, including practical considerations for selecting the best assumptions and the best model for individual situations. The paper illustrates the diagnostic tools that an actuary needs to assess whether a model is working well.

Life insurers and regulators prepping for principle-based reserving

The life insurance industry is preparing to implement a new reserving methodology, principle-based reserving (PBR), to help carriers produce better assumptions for the industry’s new range of products. “A customized approach,” an article in Best’s Review, quotes Milliman’s Karen Rudolph providing perspective on why PBR is needed.

“The evolution of PBR is a proactive response to the current statutory valuation design, which includes many regulatory guidelines meant to interpret the requirements. However, regulators find it difficult to stay in front of product design,” said Karen Rudolph, principal and consulting actuary at Milliman. “While it took a long time for PBR to come to fruition, it will provide a set of rules that accommodate future products.”

As with any change, insurers face several challenges related to PBR, like learning the new system and how to administer it. PBR will also push regulators to enhance their actuarial expertise. Karen and fellow Milliman consultant William Sayre discuss the steps insurers and regulators are taking in advance of PBR’s effective date of January 1, 2017.

The NAIC has launched a PBR Pilot Project with 12 companies, which will implement PBR in the same manner they would for actual PBR reporting and then submit their reports to regulators for review. The pilot is designed to shed light on the process for companies as well as regulators, Rudolph said.

“Companies were in a wait-and-see mode because there was skepticism that PBR would be adopted by the states,” said William Sayre, principal and consulting actuary at Milliman. “But now the industry is moving rapidly to get their ducks in a row. It is a resource-intensive exercise, but once they have those resources, it should become a routine exercise going forward.”