Ch 34: Further risk management

Question 1

What are some initial risk management methods we’ve covered so far in this course? (4)

What are the further risk management methods we cover in this chapter? (5)

Answer 1

So far, we’ve covered the following risk management methods

1. policy data checks
2. choice of with-profits bonus method
3. capital management
4. asset-liability matching

In addition to the above, we further cover the following risk management methods in this chapter

1. expense control
2. policy retention activities (managing persistency risk)
3. management of new business mix and volumes
4. management of options
5. systematic risk assessment and management strategies

Question 2

Expense control:

What is the main aim of expense control? (3)

What are the main pillars an insurer uses to achieve expense control? (4)

Answer 2

Main aim of expense control is that

• at a company level, and in the long term,…
• …the insurer should aim at least to contain expenses and commission
• …within policy loadings built into office premiums and charging rates

Insurer’s can achieve expense control by

• monitoring actual level of expenses incurred
• comparing expenses and expense ratios (the best ratio to use would be actual expenses over premiums to avoid LT insolvency)
• reducing current cost base
• monitoring commission procedures

Question 3

Expense control:

Discuss the various ways an insurer can control expenses:

monitoring actual level of expenses incurred (1)

comparing expenses and expense ratios (4)

Answer 3

Monitoring actual level of expenses incurred

• monitor actual expenses incurred, compare them to policy loadings

Comparing expenses and expense ratios where possible

• compare to competitors, especially for similar products
  
  • remain competitive
  • maintain adequate volume of sales
• compare actual expenses vs expense loadings

Question 4

Expense control:

Discuss the various ways an insurer can control expenses:

reducing current cost base (7)

Answer 4

Reducing current cost base to be within policy loadings

• active control of staffing levels to reflect volume of business and amount of work achieved (more business=> more staff, vice versa)
• budget contraints/targets within which individual departments must operate
• ensure staff not overqualified and overpaid for work they do
• salary increases which are not excessive, but consistent with price needed to retain necessary quality of staff
• sell greater volume of profitable business, without increasing cost base by as great a proportion (possible due to fixed expenses). Changes to product design and/or sales method may be required to achieve this.
• improve effeciency wherever possible
  
  • automation, computerisation => requiring less manpower
  • streamline underwriting process as much as possible without unreasonably compromising risk
  • doing tasks inhouse that were previously outsourced
  • cheaper distribution channels eg internet
  • sell simpler products=> sales and administration costs lower
• increase loadings in premiums to cover more expenses, if competitive position allows

Question 5

Expense control:

Discuss the various ways an insurer can control expenses:

monitoring commission procedures (6)

Answer 5

Monitoring commission procedures

• at level of
  
  • product line, or
  • distirbution channel, or
  • specific sales person/broker
    to ensure that commission increases do not start drifting upwards.
• consider acquisition costs
  
  • eg quotation systems, number of quotations should also be monitored and managed.

If the above was falling steadily:
- Improve info provided on quotation. Compare to competitors.
- Provide additional sales support services, if it would improve overall sales efficiency.
- Try a different sales method
- Try altering the product design and/or price of the product in case these are the cause of decline in popularity.

Question 6

State the main aim of managing persistency risk (2)

Outline the steps it might involve in practice (7)

Answer 6

Main aim of managing persistency risk is to

• minimise volume of lapses and surrenders

In practice, the steps involved include

• Distribution channel management
  
  • monitoring persistency rates by distribution channel + by specific salesperson/broker
  • design commission to encourage better persistency and/or penalise early lapses and surrenders eg
    
    • lower initial comm, higher renewal comm
    • using commission clawback (proportion repaid reducing the longer the policy is maintained)
  • identify systematic reasons for lapses/surrenders; invoke management strategies to avoid trend continuing
    
    • eg insurer providing misleading info about the policy leading to it being inappropriately sold thus targetting the wrong individuals and not fully meeting their needs.
• Customer relationship management
  
  • Through intermediary or salesperson see to the following:
  • encourage good persistency by ensuring that the product sold meets PH’s needs
  • maintain or improve quality of ongoing administration and contact with PH
  • by using types of pmt method with higher persistency (eg debit orders vs cash/cheque)

Question 7

Managing mix and volume of new business:

What is one of the insurer’s key areas of concern regarding management of new business mix and volumes? (2)

What actions might be taken in extreme cases regarding management of new business volumes and mix? (4)

What other important mismatch should be monitored regarding new business sold? (5)

Answer 7

Insurer will want to ensure that it can sustain writing of new business from

• sufficient capital, and
• sufficient administrative resources

In extreme cases, actuaries might recommend that

• directors withdraw from sale, for a suitable period, those products that are
  
  • the most capital intensive or
  • for which inadequate administrative resources are available

It is important to monitor the mismatch between

• actual new business volumes/mix sold vs assumptions used in original pricing
• control of new business volumes and mix largely comes down to
  
  • marketing
  • product design
  • pricing activities
  • could also encourage sales channel through rewards systems to achieve sales targets though care must be taken to not conflict with persistency targets or be unprofessional.

Question 8

Manage new bussiness mix + volume:

In the context of managing new bussiness, list items of information that need to be monitored by product line and distribution channel

Answer 8

1. New business valuation strain
2. Policy charges/loadings
3. Number of contracts
4. Amount of premium
5. Average case size (which can be determined from two points above)
6. Frequency of premium affects extent of new business strain:
   
   • least strain for single prem: full initial expense loadings are received on day 1
   • most strain for reg prem: only one month’s initial expense loadings in the first prem whereas almost all the initial expenses would’ve been incurred.
7. Actual expenses incurred

Question 9

Manage new bussiness mix + volume:

We previously listed ‘monitoring of valuation strain’ as one of the items of information to be considered regarding new business volumes and mix.

What does valuation strain relate to? (2)

How does valuation strain arise? (3)

Give examples of aspects of product design that will significantly influence valuation strain (for both unit linked and conventional business) (4)

Answer 9

Valuation strain relates to the impact of

• the supervisory reserves and solvency capital requirement on the company’s capital position.

Valuation strain arises when a policy is sold because

• the combination of supervisory reserves and solvency capital requirements tend to place a higher value on the net liabilities than the pricing basis.
• this results in the initial reserve and required solvency capital exceeding initial asset shares when the policy is issued, thus causing the strain

Key aspects of product design influencing valuation strain (unit linked + conventional business)

• premium frequency
  
  • single prem: least, full loadings for init expenses received at start
  • reg prem: most, only one month’s expense loading received at start
• presence of guarantees given
  
  • greater level of guarantee => greater valuation strain

Question 10

Manage new bussiness mix + volume:

We previously listed ‘monitoring of policy charges and loadings’ as one of the items of information to be considered regarding new business volumes and mix.

Give two ways in which the insurer could reduce the mismatch between actual expenses and policy charges/loadings and thereby reduce new business strain (11)

Answer 10

1. Restrict or encourage certain product lines and/or distribution channels
   
   • directly by structural change in product design eg
     
     • from non linked to unit linked
     • from regular to single premium
     • from guaranteed to reviewable premiums/charges
   • indirectly by
     
     • remuneration arrangements
     • by level of other support given to distribution channel (if diff channels have diff commission structures then the incidence of outgo will be altered high initial/low renewal -> not-so-high initial and renewal)
     • by literature used to market to PHs
2. Reprice and/or redesign contracts
   
   • ​​including possibility of an increased minimum premium

Question 11

Managing options:

Describe four ways for an insurer to manage the options present in its business (8)

Answer 11

1. Monitor charges/loadings included for options
   
   • in product pricing vs actual costs being experienced
   • look seperately at uptake rate and profit or loss once option exercised
2. If option appears unprofitable (even if we’ve allowed for increased marketability on a given product due to option), increase option’s pricing….
3. ….and/or reduce/remove option’s availability (allowing for the time lag between removal of option and the impact on experience emerging because the cost of an option is only incurred when it is exercised)
4. Following from 3. it is easier legally to amend the terms of the NB written
   
   • may also be possible to reduce option’s impact on existing business by strict interpretation of policy literature, subject to interpretation satisfying the need to treat customer fairly

If the options are serious to the company they may try to:
1. Set up appropriate prudent reserves for the future options cost thereby retaining current surplus and preventing future insolvency
2. Match the options by purchasing appropriate financial derivatives
3. Possibly buy them back from the ph but this may worsen the situation by making them aware that the company deems them valuable.

Question 12

Give an overview of the processes regarding systematic risk assessment and management strategies (3)

Answer 12

Main process of systematic risk assessment and management strategies

• Insurer should be aware and assess the overall risk profile to which it’s exposed..
• …based on an aggregation of the underlying risks which it faces…
• ….allowing for correlation effects

Question 13

How does the insurer achieve successful systematic risk assessmet and management strategies? (5)

Answer 13

Successful systematic risk assessment and management strategies can be achieved by

• advising directors regularly of the nature/size of risks faced, focusing especially on risks that are most material and/or the most sensitive to change
• the nature of risks should be explained, costed as far as possible and management strategies laid out to control main risks
• sensitive risks should have a range of long term scenarios modelled to show the impact on risk of variations to future experience + management strategies should be designed to protect those risks that the insurer is unable to control
• risks modelled deterministically or stochastically where appropriate
• documentation/implementation of risk management strategies where strategies consist of objective rules and procedures, which should then be monitored on an ongoing basis

Question 14

Systematic risk assessment and management strategies:

Describe the role of the actuary in managing a life insurer’s risks (5)

Answer 14

1. should regularly advise directors of nature and size of risks faced
2. should give particular attention to risks that are most material and/or most sensitive to change
3. risks should be controlled by analysing and explaining their nature, costing them as far as possible, and agreeing on management strategies
4. for sensitive risks (to which insurer results are most vulnerable) modelling should be done of a range of long-term scenarios to show impact of variations in future experience
5. management strategies should be designed and implemented to deal with main risks insurer is willing and able to control

Question 15

Systematic risk assessment and management strategies:

Define enterprise risk managment (ERM) (7)

Answer 15

• ERM is a risk management framework which considers the risks of the business as a whole, rather than considering individual risks in isolation.
• This allows the concentration of risk arising from a variety of sources within an organisation to be appreciated, and for diversifying effects of risks to be allowed for.
  This is the holistic, integrated approach to risk management.
  
  • insurer sees/considers overall level of risk exposure, which can be lowered if insurer is well diversified resulting in less capital required to be held against risks.
• ERM recognises that value can be added to a business through educated risk-taking
  
  • with a strong risk framework that better allows companies to identify and assess strategic opportunities eg
    
    • longevity risk on annuities offsets, to some extent, mortality risk on term assurances
    • so may be beneficial for an insurer writing lots of annuities to take on extra mortality risk by selling more term assurance

Question 16

What do we mean by the “benefits” and the “costs” of options

Answer 16

These actually have two possible interpretations, each of which is valid and useful.
(1) We should look at the benefits provided by the options to the policyholder, to see if they meet a useful policyholder need. The cost is then the price the policyholder has to pay for these benefits. So the question is whether the price the policyholder is paying for the option appears to be worth the benefits provided by the option. This then has implications for the company, which should be striving to have satisfied customers who feel they are getting something valuable for a fair price, and this should lead to successful sales and good persistency of its business.
(2) We should be considering whether it is worth the company’s while in offering the options (ie what is the “benefit” to the insurance company of providing options under its policies?). Even if the option benefits meet customer needs at a “fair” price, it may be doing little to attract or maintain business for the company and, worse, the options may be causing the company losses or be presenting an unacceptable risk of losses in the future. (So, the “cost” is here referring to how much it is actually costing the insurer to provide the options, not how much the policyholder is paying for them.)

Question 17

An option to increase benefits under a life assurance policy, without health evidence, has a low take-up rate. Even so, the company is losing money on this benefit.

Explain whether this indicates that the option should be dropped from future new business.

Answer 17

We have to consider whether the availability of the option is doing enough to enhance business volumes to more than compensate for the loss incurred by option take up. For example, it may be that policyholders really do appreciate the availability of the option (even if few end up using it) and as such may be a big factor in ensuring sales. What competitors offer, and what intermediaries consider important, would also be material factors here. So, it might well be that sales would suffer significantly if the option was withdrawn from new business, thereby causing significant loss of profit (and increased impact of overhead costs) from the loss of the normal premium income. The losses avoided by removing the option could be insignificant compared with this.
Also we would have to see whether it might be possible to increase charges levied for the option, so as to reduce the losses, without significantly impairing sales.
Therefore we do not have enough information (about the impact of the option on marketability and resulting profits) to say whether the option should be dropped or not.