Assessing the appropriateness of the Standard Formula

September 1st, 2015 No comments

Under the Central Bank of Ireland’s Guidelines on Preparing for Solvency II, all insurance and reinsurance undertakings are required to prepare a Forward Looking Assessment of Own Risks (“FLAOR”) in 2014 and 2015. Those companies rated as high or medium-high impact under the Central Bank’s PRISM rating system, which are not in either the pre-application or application process for an internal model, are required from 2015 to perform an assessment of whether their risk profile significantly deviates from the assumptions underlying the standard formula Solvency Capital Requirement (“SCR”). This requirement will apply to all companies from 2016 onward.

Milliman’s Andrew Kay and I conducted a survey analysis of 27 companies in Ireland to gain perspective on the appropriateness of the standard formula for the risk profile of these companies in their 2015 FLAOR. To read the entire analysis, click here.

Learning the competition’s pricing structure

August 26th, 2015 No comments

In his article “Analysing competitor tariffs with machine learning,” Milliman consultant Bernhard Konig provides a sample analysis demonstrating how machine learning can help insurers better understand their competitors’ tariffs and premium rates. The excerpt below explains some advantages of the machine learning technique.

Machine learning techniques provide a flexible tool set to derive accurate estimates of competitor premiums without any knowledge about the underlying tariff structure. The machine learning approach we developed as part of our research is faster and much less expensive than exhaustive web scraping or mystery shopping. It [enables] insurance executives to make better informed decisions about not only tariff changes, but also marketing campaigns and commercial discounts for certain customer segments. The impact of a tariff change on profitability and business volume can certainly be much better assessed in the presence of competitor premiums. In an ideal scenario, a company has an estimate of the competitor premiums at the point of sale. This allows adjusting one’s own quote to increase either the probability of conversion (by lowering the quote) or the profitability (by increasing the quote).

Adequate pricing for captive insurance takes communication

August 18th, 2015 No comments

Actuaries and risk managers must communicate effectively when pricing captive insurance. Changes in coverage, operations and exposures, and loss control initiatives may require adjustments in premiums. Milliman consultant Mike Meehan provides some perspective in his article “Pricing for captives: Communication is key to getting it right.”

From an actuarial perspective, pricing a coverage for a captive often involves looking at the past experience of that coverage and adjusting the results to reflect inflation (for both losses and exposures), legislative changes, updated expense forecasts, etc. When a captive has been in business for a number of years, has a statistically credible history of losses, and is keeping the terms of the coverage consistent from year to year, this is a reasonable approach. Challenges arise when the captive has no credible loss history, when the risks that a captive is insuring are different or altogether new, or when the terms of the policy are different from what had been covered previously. In situations such as these, good communication becomes critical between the risk manager and the actuary that is involved in the pricing. This ensures that the pricing exercise is done correctly.

For example, consider a “Firm ABC” that had been purchasing professional liability coverage from the commercial market for a number of years. The terms of the policy have historically excluded coverage for asbestos-related claims. Firm ABC is now going to insure its professional liability claims through a newly established, wholly owned captive insurance company. The actuary pricing this coverage would typically rely on the historical loss experience of Firm ABC, assuming it has credible experience, or perhaps on industry loss costs used to price this type of coverage. If the actuary is not aware that there has been an expansion in coverage, namely the inclusion of asbestos coverage, the resulting premium could be inadequate.

This situation can work in reverse as well. Consider the same example, except now Firm ABC had been purchasing professional liability insurance that did include coverage for asbestos-related claims. If that same Firm ABC were to decide that it was now going to insure that coverage through a captive, however, and exclude the asbestos-related claims from coverage, then adjustments would need to be made during the rating process. Otherwise the premiums, based on loss experience or loss costs with provisions for asbestos-related claims, could be excessive. The risk manager, the underwriter, and the broker typically have the in-depth knowledge related to the subtle differences in coverages that aren’t necessarily identifiable by an actuary reviewing only loss runs. Communicating this information will help the actuary make sure that the necessary adjustments in the calculation of premiums are being made.

Meehan also participated in a recent panel discussion held by A.M. Best during the Vermont Captive Insurance Association’s annual conference. The discussion focused on some considerations that potential sponsors should think about if they decide to form a captive.

Milliman wins a 2015 US Captive Services Awards

August 14th, 2015 No comments

Milliman has received a 2015 US Captive Services Awards presented by Captive Review magazine. The awards recognize excellence and innovation in the United States’ marketplace. This article provides some coverage of the awards ceremony.

Here is an excerpt:

Milliman was able to demonstrate its leading position and experience in serving a broad captive marketplace. They have a large and strong captive practice allowing them to meet the demands of a significant client base. The Milliman submission pointed to specific examples of serving the wider captive industry in both educational and legislative activities.


Captive Review’s Lucy Kingston presents a US Captive Services award to Milliman consultants Mike Meehan (l.) and Joel Chansky (r.).

Milliman Risk Talks: Integration of ERM into capital and strategy decisions

August 13th, 2015 No comments

In this episode of Milliman Risk Talks, Mark Stephens and Vikas Shah discuss key takeaways from their article, “Integration of ERM in Capital & Strategy Decisions.” In particular, organizations can improve capital strategies and decision-making processes by implementing an enterprise risk management program throughout the organization. Mark and Vikas also share ideas on how to improve the role of ERM in decision-making.

To watch our Milliman Risk Talks series, click here.

A casual approach to risk-based capital requirements

August 12th, 2015 No comments

Cantle-NeilDiversification benefits, and the associated correlation parameters, are critical in determining risk-based capital requirements for many companies. Under Solvency II, firms will be required to justify the use of the standard formula parameters, or else derive their own if those prescribed are deemed to be inappropriate. However, setting and validating correlation parameters can be challenging, with reliance often placed upon high-level discussions and expert judgment.

Historically, the degree of dependency between risks has always been difficult to quantify. Where data is reliable and plentiful, regression analysis can be carried out between risks, and results can be derived and validated. But for risks with insufficient or flawed data (operational risks, for example), it is very difficult to derive meaningful correlations. Consequently, models are often built with the end result already in mind, influenced by the expert’s view of the correlations, with little justification as to how the estimate was derived. This can lead to an incomplete view of how the risks behave, and can be difficult to justify and validate.

One possible solution is to use knowledge from business experts to build up a complete picture of each risk, and then build a causal model to derive correlations between them. This approach allows information already within the business to be extracted and provides a multitude of options for sensitivity analysis and stress testing. Furthermore, by documenting the initial discussions and model build, the process provides a clear audit trail for validation.

The article “Correlation from cause” in the latest edition of Milliman’s Issues in brief looks at how this approach works and how it can help firms satisfy the use test, a particularly challenging requirement for those intending to use an internal model. The information contained within the model can help to identify the drivers and signals that would lead to a change in the correlation between risks. These can be monitored and used in the day-to-day decision-making process of the firm. This will lead to enhanced communication among the risk owners, board members, and staff working in the business, and is a big step toward satisfying some of the modeling requirements of Solvency II.

This article was first published on LinkedIn.

Enhancing ERM processes improve capital decision-making

August 7th, 2015 No comments

Some organizations view their enterprise risk management (ERM) program as a rote process to identify and assess risk. However, those that align their ERM processes across departments and management can improve capital strategies and decisions. In this article, four Milliman consultants provide perspective on how organizations can improve the initial implementation of a program, establish ERM leadership, and enhance risk quantification. The following excerpt highlights the benefits of these developments.

Integrating a fuller spectrum of risk exposures into capital and strategic decision-making offers many competitive advantages. Organizations become better equipped to answer questions regarding capital adequacy, working capital strategies, capital investment alternatives, and additional mitigation or controls.

Capital planning is an integral part of board, CEO and CFO decision-making. With all organizations, a key uncertainty exists in determining the amount of capital or working capital necessary to protect against performance variation or risk. Regulatory capital assessment frameworks struggle to identify and capture the idiosyncratic operational or strategic risks that would require an additional capital buffer. Integrating ERM into capital decision-making can help resolve this critical uncertainty, and many organizations benefiting from this capability find the capital conversation much more tangible.

At the capital committee, hundreds, if not thousands, of requests for funding come in during a given year. Many times, the requests are submitted in an ad hoc fashion and lack a presentation of risk exposures. Without a standardized approach to the assessment of the opportunity and risk, normalizing the investment candidates becomes impossible. By introducing risk exposures into a capital investment analysis, organizations can be much better equipped to evaluate investment alternatives and optimize capital expenditures.

Finally, organizations struggle to compare between capital requests for maintenance, investments, research, and additional mitigation and controls. Identifying risk exposures and translating them through an economic capital model can provide a framework for these types of considerations. Introducing different types of capital expenditures into an economic capital model allows for a better understanding of the effect of each on the mean value or on variation for a key performance metric.

Milliman studies implications of the ASEAN Economic Community for the life insurance industry

Milliman today announced the availability of new research into the implications of the transition toward the Association of Southeast Asian Nations (ASEAN) Economic Community (AEC). With the AEC commencement quickly approaching at the end of this year, Milliman has examined the market characteristics and regulatory environments in each ASEAN country and has launched the Milliman ASEAN Liberalisation Index (MALI), a tool that characterises each member-state’s progress toward the more harmonised regime envisioned when AEC was originally conceived.

MALI is intended to provide a holistic and relative view of each ASEAN life insurance market, covering aspects such as regulatory openness, alignment to international standards, ease of doing business and adequacy of policyholder protection. The higher the MALI score, the greater the state of liberalisation. As may be expected, Singapore has the highest MALI score, confirming the view that it has the most advanced life insurance industry in ASEAN.

“Many insurance executives in the region view the move toward the AEC as advantageous for the industry in the long run, presenting more opportunities for cross-border sales and better exchange of talent,” said Richard Holloway, Milliman’s Managing Director of South East Asia and India Life. “However, each member country faces unique challenges. We are introducing MALI to help the life insurance industry across the region better understand commonalities and differences between the markets and develop appropriate strategies as we advance toward a more unified regime.”

“The requirements and deadlines of AEC as originally conceived may not be attainable short-term,” said Michael Daly, principal and consulting actuary in Milliman’s Hong Kong office. “We may see the emergence of a slimmed-down framework, leaving room for current differences while paving the way to greater integration in the long term. This report details those challenges and helps to identify a way forward.”

To see the full report, click here.

Global trends in derivatives

August 5th, 2015 No comments

Cantle-NeilTo explore trends in risk management practices and derivative usage within the insurance industry, Milliman has been conducting an annual global survey of life insurance companies. The 2014 survey report has recently been released and gives an overview of current usage and practices, as well as a perspective on how derivative usage is likely to change in the future. This year’s survey received responses from 66 insurance companies, with a spread of responses from North America, Europe, Asia, and other territories, including many of the largest companies in the industry.

The two dominant market risk factors faced by respondents of the survey are interest rate risk and equity risk, with 98% and 85% respectively of survey respondents having exposures to these risk factors. Currency, credit, and longevity were also important risk factors, with at least two-thirds of respondents exposed to each of them. Inflation risk was less prevalent among survey respondents globally, with only 39% materially exposed to this risk factor.

Some of the key findings of the survey results include:

• The split between static hedging and dynamic hedging among survey respondents is fairly even, with 70% of global respondents using some form of static hedging and 68% using some form of dynamic hedging. Many respondents use both forms combined.
• Managing economic profit and loss (P&L) volatility is the top reason chosen by our respondents for using derivatives in all territories except the UK, where managing regulatory capital was considered slightly more important.
• With Dodd-Frank now implemented and EMIR central clearing expected to go live later this year, we are seeing a sharp reduction in the number of insurers relying solely on non-cleared interest rate swaps, as may be expected. In North America, only a quarter of respondents do not use cleared swaps, compared with two-thirds last year. In the UK 43%, and in Europe (excluding the UK) two-thirds of respondents, do not use cleared swaps. In Japan, however—where it is expected that some of the largest insurers may be subject to mandatory central clearing of swaps in the near future—not a single survey respondent stated that it currently uses cleared interest rate swaps.

The article “Milliman global derivatives survey” in the latest edition of Milliman’s Issues in Brief highlights more key findings from the survey.

This article was first published on LinkedIn.

Milliman coauthored paper wins ERM Research Excellence Award

August 3rd, 2015 No comments

The Actuarial Foundation recently presented its ERM Research Excellence Award in Memory of Hubert Mueller to Milliman’s Neil Cantle and Systemic Consult’s Neil Allen and Christos Ellinas. The award recognizes their significant contributions to the growing body of enterprise risk management (ERM) knowledge and research. The award is given annually to the author(s) of the best overall paper at the ERM Symposium. The recipients received the award for their paper entitled “How Resilient is Your Organisation? From Local Failures to Systemic Risk.”