Indonesia Life Insurance Newsletter, September 2015

In June, the Indonesian Life Insurance Association (AAJI) announced a 28.5% growth in gross premium for the first quarter of 2015 as compared with the first quarter of 2014. The AAJI also revised its growth forecast for the full year of 2015, revising it down to 20% from a previous range of 23% to 29%. Additionally, in August, the Financial Services Authority announced that, following recent developments in the capital markets, it is temporarily reducing the minimum solvency ratio to 50% from 100%, as calculated by the required risk-based capital norms, at least until the end of the year. Milliman’s Richard Holloway and Iwan Juwono provide more perspective in this newsletter.

Milliman Risk Talks: Cyber risk challenges

Many organizations have recently become interested in cyber risk. In this Milliman Risk Talk, consultants Mark Stephens and Vikas Shah provide market observations based on their project experiences. They discuss cyber risk challenges and risk management priorities that organizations must consider. They also offer tips for organizations struggling to quantify their financial exposures related to cyber risk.

To watch our Milliman Risk Talks series, click here.

Using the right volatility quote in times of low interest rates for Solvency II risk factor modelling

Typically many insurance companies have been using the Black model as a benchmark pricing model to derive the implied volatility quote, often referred to as Black volatility. The interest rate movements for the euro in the past six to nine months, however, have unveiled a major drawback of the Black volatility quote, which can affect current best practice approaches of insured companies’ risk and valuation models in a significant way. Milliman consultants provide perspective in this research report.

Stepping stones to ORSA: Looking beyond the preparatory phase of Solvency II

The Solvency II preparatory guidelines require undertakings to prepare a Forward Looking Assessment of Own Risk (FLAOR), which is based on the Own Risk and Solvency Assessment (ORSA) principles. While the FLAOR can be prepared on a “best efforts” basis, it is undoubtedly a useful first step toward full implementation of the ORSA. In this research report, Milliman’s Eamonn Phelan and Sinead Clarke explore the progress that undertakings have made toward meeting the preparatory guidelines in a number of different European countries. They also outline the feedback provided by various European supervisory authorities and discuss the steps that can be taken to build upon what has been achieved during the preparatory phase in order to meet the full requirements of the ORSA from 2016 onward.

Swap out longevity risk

Life insurers in South Africa are now translating statistically significant risk factors into their pricing models and are grappling with producing a credible expectation of future increases in longevity. One product that can help insurers reduce their longevity risk exposure is the longevity swap. In this article, Milliman’s Peter Carswell discusses how various longevity swaps work. Here’s an excerpt:

Longevity Swap
An alternative risk transfer mechanism is the longevity swap, which sees the insurer make a series of pre-agreed fixed payments to the reinsurer (the ‘fixed leg’) in return for the reinsurer making payments to the insurer based on actual longevity experience (the ‘floating leg’). The payments made under each of the legs are typically netted off with only the difference transferred.

Longevity swaps come in two major classes: indemnity swaps and index-based swaps. Indemnity swaps see the floating leg payment being linked directly to the insurer’s portfolio. Index-based swaps see the floating leg payments being linked to a predefined objectively calculated index, for example a specific national population metric.

The term of the longevity swap is also something that can vary, with short-term swaps being made available in the market (so called ‘shortevity’ swaps) with a term of around five to seven years, swaps with a term that is expected to cover the bulk of the benefits covered around 25 years, and terms that provide cover until complete runoff of the reinsured portfolio.

In addition to the fixed leg, the insurer will typically pay a regular fee to cover the reinsurer’s expenses, profit margin, and cost of capital. The separate fixed leg and fee structure has the advantage of promoting transparency in that it allows the parties to hold a technical discussion around the expected longevity rates for the fixed leg while holding a parallel commercial discussion around the level of the fees. The resulting rates used for the longevity swap typically reflect a commonly held best estimate view of mortality, which provides a useful reference point for the actuary when setting a basis for valuation work. This same structure also allows for a better matching of cash flows to profit recognition for the reinsurer. The alternative approach is to build the profit loading into the base longevity rates, but this results in the reinsurer receiving cash from fees at a much later date in the lifetime of the contract.

Assessing the appropriateness of the Standard Formula

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 Probability Risk and and Impact SysteM (PRISM) rating system, which are not in either the preapplication or application process for an internal model, are required from 2015 onward to perform an assessment of whether their risk profiles significantly deviate 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 FLAORs. To read the entire analysis, click here.

Learning the competition’s pricing structure

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

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 Award

Milliman has received a 2015 US Captive Services Award, presented by Captive Review magazine. The awards recognize excellence and innovation in the U.S. 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.).