Tag Archives: Bridget MacDonnell

New developments in the computation of mortality rates: An actuary’s bread and butter

The computation of mortality rates has traditionally been the bread and butter of actuaries. The first mathematicians to venture into the actuarial field most likely spent their days analysing mortality rates and conducting life valuations. Nowadays, the work of actuaries is much more varied—which is a welcome development for most—but are we sometimes neglecting this core skill?

Milliman researchers in Paris certainly aren’t and their new research, hot off the press, published on 22 February 2017, represents a significant development in mortality and longevity risk modelling. It is vital reading for anyone working in this sphere.

My colleagues have developed a robust statistical methodology to correct the implicit inaccuracies of national mortality tables which are used widely in sophisticated mortality and longevity risk modelling. The results are striking.

Here I take a closer look at the relevance of these national mortality tables, the problems with them, and the corrections available in order to enhance mortality and longevity risk models. I will touch on the key technical points behind these developments from an Irish/UK perspective, leaving the rigorous mathematical explanations to the underlying research publications—the 2017 publication can be found here and the 2016 publication can be found here.

The use of national mortality tables
In Ireland and the UK, to set basic mortality assumptions in our pricing and reserving work, we tend to use insured lives mortality tables, such as the Continuous Mortality Investigation (CMI) tables. However, national mortality tables based on the population as a whole are also used extensively in mortality and longevity risk modelling, where a greater quantity of data is required.

National mortality tables are used to calibrate stochastic mortality models, to derive mortality improvement assumptions, in sophisticated mortality risk management models, in Solvency II internal models, in pricing mortality/longevity securitisations, and in bulk annuity transactions.

Bulk annuity transactions are popular in the UK market, with a number of large deals executed during 2016, including the ICI Pension Fund’s two buy-in deals completed in the wake of Brexit, totalling £1.7 billion. Legal & General completed a £2.5 billion buyout agreement with the TRW Pension Scheme in 2014.

Longevity hedging (in particular, use of longevity swaps) is also an attractive approach to the de-risking of pension schemes, and would equally require the use of national mortality tables. Transactions range from the large-scale £5 billion Aviva longevity swap in 2014 to the recent, more modest, £300 million longevity swap completed between Zurich and SCOR in January 2017.

While the use of internal models to calculate mortality and longevity risk capital requirements under Solvency II is not prevalent in the Irish market, which is due to the size of companies and the amount of risk retained, it is likely that reinsurers are looking at such models. In the UK, larger companies may opt to use internal models if they are retaining large exposures.

Indeed, national mortality tables also typically inform mortality improvement assumptions for all companies, as the analysis of improvements requires large volumes of data. Therefore, even companies that do not use sophisticated mortality and longevity risk modelling techniques are implicitly impacted by the new developments in relation to the construction of national mortality tables.

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Recovery and resolution planning considerations

Recovery and resolution plans (RRPs) are receiving a lot of attention from regulators lately. In an InsuranceERM article, Milliman consultants Bridget MacDonnell, Eamonn Phelan, and Eoin King explore the Solvency II requirements related to RRPs for insurers and reinsurers.

The article is based on the authors’ paper “Recovery and Resolution Plans: Dealing with financial distress.”

A harmonized EIOPA Recovery and Resolution Framework discussion paper

king-eoinOn December 2, the European Insurance and Occupational Pensions Authority (EIOPA) issued a discussion paper on “Potential Harmonisation of Recovery and Resolution Frameworks for Insurers.” The paper sets out a number of considerations for the development of a harmonized European framework in the recovery and resolution planning space. It is open to comments from stakeholders until February 28, 2017.

Recovery and resolution planning is a very topical subject at present and there are numerous examples of requirements for financial services companies and regulatory authorities to develop recovery and resolution plans and frameworks. For example, larger financial institutions that are classified as globally systemically important financial institutions (G-SIFIs) and globally systemically important insurers (G-SIIs) are required to undertake recovery and resolution planning under the Financial Stability Board’s “Key Attributes of Effective Resolution Regimes for Financial Institutions” and similar requirements adopted by the International Association of Insurance Supervisors. This is also an area of focus for European regulators. In Ireland, for example, Sylvia Cronin, Director of Insurance Supervision at the Central Bank, noted at the European Insurance Forum in March that recovery and resolution for insurers is an area of particular interest for the Central Bank.

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Spotlight on operational and reputational risk

macdonnell-bridgetOperational and reputational risks have become areas of greater focus in recent times. There have been so many high-profile operational risk events that it is clear how important operational risk management is for all companies—Anthem, Volkswagen, and UBS are just a few examples of companies that have suffered significant losses because of operational risk events. In addition, for every publicly reported incident there are sure to be a host of smaller cases, which have not been large enough to hit the headlines, and which, of course, can have a cumulative detrimental effect over time. There is also a somewhat invisible aspect to operational risk, given that the damage does not always affect physical assets. Information can be stolen through a cyber breach, agents can act in their own interests, fraudulent activity can happen, and all of these events can go undetected.

Operational risk can also contribute to other risks that undertakings face, particularly reputational risk—a risk we don’t always fully appreciate until the damage is done. There are many strategies and marketing campaigns aimed at ‘one brand’ and ‘one vision’ which show the value organisations place on their reputations. Yet reputational risk management is not always given the attention it deserves. It’s worth pausing for a moment to take a closer look at operational and reputational risk management.

Operational risk
The challenges of quantifying operational risk are numerous—they include the lack of data to properly calibrate models and there are also challenges in relation to the models themselves. For example, the major shortcomings of the Solvency II standard formula calculation of operational risk capital are highly topical at the moment. Under Solvency II, operational risk capital must be held as part of the company’s Pillar 1 capital requirements. Criticism of this factor-based calculation includes its failure to capture many relevant elements of a company’s risk profile, such as the operating model and the specific processes within the company.

Interestingly, the solvency regime in Switzerland (known as the ‘Swiss Solvency Test’) does not require operational risk capital to be held. Rather, operational risk is considered as part of the company’s risk management, therefore treating it as a Pillar 2, as opposed to a Pillar 1, issue. Earlier this year, the Basel Committee on Banking Supervision imposed an outright ban on operational risk internal models for banks, acknowledging the widely differing approaches and complex modelling of this risk within the industry. Whether or not such developments will flow over to the EU (re)insurance solvency regime remains to be seen, but regardless of where operational risk sits from a regulatory perspective it is nonetheless an area where there are increasingly sophisticated methods being used in companies’ own risk assessments, such as, for example, Bayesian Network modelling.

For those who may be unfamiliar with Bayesian Network modelling, it is a technique that is gaining more and more traction as companies continue to develop their understanding of their operational risk exposures. This technique aids the understanding of operational risk exposures through workshops with various experts within the business, in order to establish the key underlying drivers of operational exposure and the relationships between these drivers. They are often not obvious at first glance and tend to involve quite nonlinear relationships. Once these exposures are well understood, the company can focus its attention on managing and mitigating the risks.

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Recovery and Resolution Plans: Dealing with financial distress

Recovery and Resolution Plans (RRPs) have been attracting a lot of regulatory attention of late in the reinsurance industry. Globally, we have seen requirements for RRPs come into force for Global Systemically Important Insurers (G-SIIs) as well as across many parts of the banking industry.

In Europe, the European Insurance and Occupational Pensions Authority (EIOPA) has included an operational objective in relation to its focus on RRPs in its Annual Work Programme for 2016. In the United States, a small number of insurers designated by the Financial Stability Oversight Council (FSOC) for supervision by the Federal Reserve are required to periodically submit resolution plans.

In this paper, Milliman’s Eoin King and Bridget MacDonnell discuss the latest developments in relation to RRPs, explore the available toolkit, and provide insight into real-life situations through the use of colorful case studies involving different strategies that have been implemented in practice around the world.