Life Insurance risk management in the Insurance company : CSOB case studies
Content Topics : case study Life Insurance risk management, 1. Life Insurance 2. Case study what is life insurance product and life insurance cash flows 3. Definition of Life insurance risks 4. Life Insurance Risk management process, 5. Risk Limit definition 6. Case Study. Risk management for life insurance 2
Objectives Familiarize yourself with the basics of Life insurance products Life insurance risk definition Get a view on the basics steps of assessment of Life risk Case studies 3
Insurance technical (underwriting) risk Insurance activities are split up into 3 main categories Life insurance Insured object is physical person life status. Non-life insurance Insured objects are property, cars, and liability ect. Health risks Covers common risk in Life and Non life insurance like insurance of accident or health of physical persons. But it is about the physical person health status. Health insurance is new arising from Solvency II regulation / new EU Insurance law valid since 1.1.2016. 4 4
Insurance line of business / product categories Based on current Slovak legislation: 1. Insurance in case of death, in case of survival or in case of death and survival 2. Insurance of dowry or children insurance ( obživa detí). 3. Insurance linked with capitalization - tontines. 4. Insurance based on points 1 to 3 linked with investment fund. 5. Pension insurance. 6. Insurance in case of accident or illness in case it is rider to points 1 to 5. 5
Case Study 1 Examples of Life insurance product and cashflows 6 6
Typical insurance product/ line of business Legislation line of business Product 1. Insurance in case of death, in case of survival or in case of death and survival 2. Insurance of dowry or children insurance ( obživa detí). 3. Insurance linked with capitalisation - tontines. 4. Insurance based on points 1 to 3 linked with investment fund. 5. Pension insurance. 6. Insurance in case of accident or illness in case it is rider to points 1 to 5 Term Insurance, Endowment, Pure Endowment Children Endowment, payment in case of parent Death Not in SK market Unit Linked products with main insurance cover Annuities ( not from pillar II. Critical illness, Permanent Accident Consequencies, Hospitalization, Sickness, ect 7
Examples of insurance product Insurance on death or survival Endowment for 5 year, insured risk death within period or surivor Insured: Insurance period: Sum insured: Jana 40 year old 5 Years 700 Eur Premium 200 EUR Expense 35 EUR Guaranteed interest 1,5% Insurance Death cover with investment insured risk death within period UL product Insured: Insurance period: Sum insured: Jana 40 year old 5 Years 700 Eur Premium 200 EUR Expense 35 EUR No Guarantee 8
Discounting of the cash flow life policy Year Premium Paid claims Costs Cash Flow 1 200 0-35 165 2 200-20 -35 145 3 200-35 -35 130 4 200-40 -35 125 5 200-700 -35-535 2,50% 2,00% 1,50% 1,00% 0,50% 0,00% Discount curve 1 2 3 4 5 Cash flow Discounting 1 2 3 4 Year 5 Total sum of Cash flows is 30 Eur profit. Taking into the account the time value of money expressed by the discount curve, then the expected value of future cash flows is the sum of discounted values in the year 0. Best estimate liability is 41 Eur higher profit. It is expected value. 9
Life policy one year later Year Premium Paid claims Costs Cash Flow 2,50% Discount curve 2,00% 2 200-20 -35 145 3 200-35 -35 130 4 200-40 -35 125 5 200-700 -35-535 1,50% 1,00% 0,50% 0,00% 1 2 3 4 5 Cash flow Discounting 1 2 3 4 Year 5 Total sum of Cash flows is -135 Eur reserve. Taking into the account the time value of money expressed by the discount curve, then the expected value of future cash flows is the sum of discounted values in the year 0. Best estimate liability is - 121 Eur reserve. It is expected value. 10
Unit Linked product Insurance Death cover with investment insured risk death within period Insured: Insurance period: Sum insured: Jana 40 year old 5 Years 700 Eur Difference: 1. Premium 200 Eur is first invested to client fund account 2. Fund units are bought, with the price 5 Eur, client has 40 Units 3. Insurance premium is not insurance company money 4. Premium for insurance risk is charged from fund account as well and charged for expenses. 5. There is as well fund management fee. 11
UL life policy Year Risk Premium Paid claims Costs Cash Flow 1 40 0-35 5 2 60-20 -35 5 3 75-35 -35 5 4 80-40 -35 5 5 95-55 -35 5 2,50% 2,00% 1,50% 1,00% 0,50% 0,00% Discount curve 1 2 3 4 5 Cash flow Discounting 1 2 3 4 Year 5 Total sum of Cash flows is 30 Eur profit. Taking into the account the time value of money expressed by the discount curve, then the expected value of future cash flows is the sum of discounted values in the year 0. Best estimate liability is 24 Eur lower profit plus fund value at beginning of policy it is 0. 12
UL life policy one year later Year Risk Premium Paid claims Costs Cash Flow 2,50% Discount curve 2,00% 2 60-20 -35 5 3 75-35 -35 5 4 80-40 -35 5 5 95-55 -35 5 1,50% 1,00% 0,50% 0,00% 1 2 3 4 5 Cash flow Discounting 1 2 3 4 Year 5 Total sum of Cash flows is 25 Eur profit. Taking into the account the time value of money expressed by the discount curve, then the expected value of future cash flows is the sum of discounted values in the year 0. Best estimate liability is 19 Eur lower profit plus fund value at year 1. It is 167 Eur, so liability is 148 Eur. 13
UL life policy Conclusion: Sum Cash flow profit for insurance company is the same 30 EUR. PV of profit is not the same as profit signature is different. UL policy gives client possibility to earn more in case there are favorable conditions then guaranteed return. Insurance company in case of UL does not have direct market risk, recognized the clients cash flow like premium, surrender value or maturity value. does recognized only cash flow related directly to insurance cover death risk cover. Risk profile in case of Endowment and UL with death cover is different. 14
Definition of Life insurance risks Categorization of Life Insurance Risks 15 15
Positioning of Life Insurance risk within the risk universe CSOB INSURANCE RISK UNIVERSE Focus in the presentation is on Life Insurance risk which is part of Technical Insurance risk Do you know example of Life insurance product Example of Life risk? 16 16
Insurance company Life Insurance risk Life Insurance risk Mortality risk Longevity risk Morbidity risk Disability/ Morbidity risk KBC definition for Technical Insurance and Pension Claim risk: The potential negative deviation from the expected value of an insurance contract or pension claim (or a portfolio thereof). Lapse risk Reserve risk Catastrophe risk Premium risk Revision risk Expense risk 17 17
Insurance technical (underwriting) risk Insurance activities are split up into 3 main categories Life insurance risks cover the biometric risks (longevity, mortality and disabilitymorbidity risk), expense risk and lapse risk, also catastrophe related to life insurance contracts. Non-life insurance risks are further split up into catastrophe and non-catastrophe risks. Non-life, non-catastrophe risks cover premium risk, reserve risk and lapse risk related to non-life insurance contracts. Health risks are also split up into catastrophe risks and non-catastrophe risk. Covers common risk in Life and Non life insurance like insurance of accident or health of physical persons. further subdivided into health-similar to life techniques (HSLT) (includes longevity, mortality, disability-morbidity, expense risk and lapse risk) and health-non similar to life techniques (HNSLT) (premium and reserve risk, lapse risk). 18 18
Biometric risks typical for life insurance Biometric risk: The potential negative deviation from the expected value of an insurance contract or a portfolio thereof due to unexpected changes related to human life conditions. 1) Longevity risk: The potential negative deviation from the expected value due to a potential decrease in mortality rates. 2) Mortality risk: The potential negative deviation from the expected value due to a potential increase in mortality rates. 3) Disability-morbidity risk: The potential negative deviation from the expected value due to adverse changes in morbidity and/or disability rates (sometimes also referred to as health risk). 19
Other Life Insurance risks related to long term nature Lapse risk: The potential negative deviation from the expected value due to unexpected changes in policy lapses. It covers premature termination of both contracts with and without surrender value and hence also includes surrender risk, policy lapses, paid up, ect. (premature termination). Note that the term surrender risk refers surrender value. specifically to contracts with Expense risk: The potential negative deviation from the expected value of due to a potential increase in expenses (sometimes also referred to as cost-related risk), the risk that assumptions about acquisition and administration costs turn out to be too optimistic, Revision risk: The potential negative deviation from the expected value of due to unexpected revisions of claims. Only to be applied on annuities where the amount of the annuity may be revised during the next year. 20 20
Other Life Insurance risks common for all insurance Premium risk :the risk that the premium that will be earned will not suffice to cover liabilities and expenses resulting from claims Reserve risk: the risk that liabilities stemming from claims that have occurred in the past, but that are not yet fully settled, will turn out to be higher than expected. Catastrophe risk: The risk that a single damaging event, or series of correlated events, of major magnitude, usually over a well-defined shorttime period leads to a significant deviation in actual claims from the total expected claims Examples: Birds Flu, Spanish Flu, Ebola, accidents on big sports events 21 21
Insurance company simplified balance sheet ASSETS Balance sheet LIABILITIES Cash Government bonds Slovak Government German Government Other EU governments Corporate bonds Financial insitutions EU Other companies EU, outside EU... Unit Linked investments divided per UL asset fund Shares and participations Property Capital Shareholders capital Reserve fund Asset revaluation reserve Revaluation of AFS portfolios Life traditional reserves Life insurance reserves Claim reserves RBNS, IBNR Unused premium reserves Life Unit Linked reserves Number of unit x value of units Value of other parts of reserves Non Life reserves Claim reserves RBNS, IBNR Unused premium reserves Other 22 22
Case Study 2 Limit definition for life insurance risk 23 23
Key risk indicators 1. Capital Adequacy achieve the adequate available capital 2. Performance maximalisation of return within risk playing field, avoid risk concentration in profit generation and dependency on one product or distribution channel 3. Liquidity and Concentration risk hold sufficiently liquid assets with aim to be able to pay unexpected shock in portfolio 4. Asset And Liability Management Risk (ALM) - create sufficient matching of asset and liability cash-flow with aim to minimize the capital 5. Insurance underwriting and reserving risk generate sufficient profit by selling profitable products and adequate underwriting of insurance risks 24 24
Key risk indicators 1. Capital Adequacy achieve the adequate available capital = solvency ratio 2. Performance maximalisation of return within risk playing field, avoid risk concentration in profit generation and dependency on one product or distribution channel = ROE 3. Liquidity and Concentration risk hold sufficiently liquid assets with aim to be able to pay unexpected shock in portfolio = investment limits, concentration limits 4. Asset And Liability Management Risk (ALM) - create sufficient matching of asset and liability cash-flow with aim to minimize the capital = Liability coverage ratio, BPV 5. Insurance underwriting and reserving risk generate sufficient profit by selling profitable products and adequate underwriting of insurance risks = postive profit margin for new business Value New Business (VNB)/ PV Premium 25 25
Risk limit Allocation of aggregated risk appetite to Business line (life, non-life, retail,...) product (MTPL, Unit Linked,...) Specific risk category( market risk, operational risk,..) Risk concentration In order to achieve efficient monitoring and reporting the limits has to be specific, sensitive towards the portfolio movements, measurable, regularly reported and based on forward looking assumptions = Stress test = Measuring of actual position Stress test should be done on company level, Take into account the diversification amongst risk type, business lines and risk specifics Number of risk limits cannot be large, to achieve the balanced message for management, costs and efficiency of reporting 26
Value of New business How to estimate the Value new business? The cash flow is estimated sequence of incomes or costs from the insurance policy since coming in force. It is based on the expected present value of future cash flows. It represents the probability-weighted average of all expected incomes and outcomes with including the time value of money. It contains the pricing of traded options (lapse) and guaranties (interest rate).. An example of cash flows: Incomes : + future premium + recourses from claims + reinsurer payments Costs: - expected claims - expected costs - commissions Actuary model: Model Policy data (premium, risk, age, sum insured...) Parameters for the model (cancellation rate, costs, inflation...) 27
Value of New business vs solvency of insurance company How is related VNB and Solvency position of insurance company? On Solvency I ratio? On value for shareholders? What risk does ot present? 28
When is the insurance company solvent? In insurance business, the required amount of own resources is defined by the law and it is called capital requirement. Balance sheet Account ing value of assets Free resources resources Own Capital requirement Technical reserves The insurance company is solvent, if its own resources achieve the amount of the capital requirement. The insurance company is able to cover the loss that equals the amount of this capital requirement without threatening its stability. If the amount of own resources drops below the value of the capital requirement, it is in danger of receivership, eventually loss of the insurance license. Solvency rate of the insurance company = Own resources / Capital requirement Return on Capital = Profit / Capital requirement Assets Liabilities 29
VNB life policy Year Premium Paid claims Costs Cash Flow 1 200 0-35 165 2 200-20 -35 145 3 200-35 -35 130 4 200-40 -35 125 5 200-700 -35-535 4,00% 2,00% 0,00% Discount curve 1 2 3 4 5 Here is missing commission and acquisition expenses Total sum of Cash flows is 30 Eur profit, discounted value 41. This is Value of New Business. In case of profitable product VNB is positive In case of loss making product VNB is negative Profit margin = VNB/ PV premium Represent the average profit to be earned during the insurance peridod expressed as % from expected premium. 5 30
Calculate profit margin? Task: Profit margin = 39/949 = 4.1% Is it OK or NOT OK? How will be defined the risk limit? It should be known that based on actual and also new Insurance ACT selling of life insurance products with negative profit margin is not compliant with regulation. Negative profit margin expressed this way means inadequacy of the life insurance premium. Current legislation requires to have adequate premium per Line of business - 6 +2 categories. 31
Insurance risk identification Mortality risk real mortality will be higher then expected mortality tables used in product pricing Expense Risk expenses overtime will increase with inflation, not all expanses were included into product pricing Lapse Risk contract terminates sooner and company will loose th future profits Market risk interest rates decrease below the guarantee Reserve risk reserves are not adequate and need to be increased as future assumption need to be changed / reality is different Catastrophic risk Ebola might be spread to Slovakia 32
Case study 3 33
Case study 3 Assets Liabilities property 5 000 Own equity 20 000 Cash at bank 9 000 revaluation 9 670 Fixed income (Life insurance) 59 493 Life insurance reserves 45 000 Fixed income (non life insurance 6 177 Non life insurance reserves 5 000 Total 79 670 Total 79 670 3. Kapitálové požiadavky (Capital requirements) Solvency I required capital Solventnosť 2 Life insurance 6 800 Riziko životného error poistenia and that Life insurance 3 000 Non Life insurance 3 900 Riziko neživotného poistenia 2 000 Trhové riziko 0 z toho Koncentračné riziko 0 z toho Kreditné decreasing. riziko 0 Solvency I required capital 10700 Kapitálová požiadavka S2 3 606 Solvency I ratio 277% liability coverage ratio life 132% Return on Capital What S2 shall be done???? liability coverage ratio non life 124% 34 Chief Actuary find out that there is reserves were not properly valued. There are 2 errors Mortality in Slovak population is - lapse rate is higher in portfolio 34
What we will do? 1. Up date new expense assumtion 2. Product new cash flows 3. Discount 4. Calculate the market value of liabilities on portfolio and sum it up 35
Case study 3 results Book Value of liabilities Assets Book value of Liabilities property 5 000 Own equity 20 000 Cash at bank 9 000 revaluation 9 670 Market value of Fixed income (Life insurance) 59 493 Life insurance reserves 45 000 Fixed income (non life insurance 6 177 Non life insurance reserves 5 000 Total 79 670 Total 79 670 3. Kapitálové požiadavky (Capital requirements) Change: Solvency I required capital Solventnosť 2 Life insurance 6 800 Riziko životného poistenia 3 000 Non Life insurance 3 900 Riziko neživotného poistenia 2 000 Trhové riziko 0 z toho Koncentračné riziko 0 z toho Kreditné riziko 0 Solvency I required capital 10700 Kapitálová požiadavka S2 3 606 Solvency I ratio 277% liability coverage ratio life 132% Return on Capital S2??? liability coverage ratio non life 124% Book value of liabilities is unchanged in both cases, Lapse risk is not recognized, and changes in mortality cannot be used in change in book value of reserves. only in case Liability adequacy test will show. Book value of liabilities is inadequate. Solvency I ratio did not change. Book value reserves did not change no negative PL effect. 36 36
Insurance risk committee to oversight the Life insurance policies portfolios of insurance company, to oversight the profitability of the new life insurance products and their risk profile to be in line with company risk strategy, to take decision to change product parameters for new products or mitigate appearing risks, to optimize the effective risk management per portfolio 37 37
Case study 3 results Market Value of liabilities Assets Liabilities property 5 000 Own equity 20 000 Cash at bank 9 000 revaluation 9 670 Fixed income (Life insurance) 59 493 Life insurance reserves 45 000 Fixed income (non life insurance 6 177 Non life insurance reserves 5 000 Total 79 670 Total 79 670 Assets Market Value of Liabilities property 5 000 Own funds 29 833 Bonds (life) 9 000 Bonds (Nlife) Best Estimate 59 493 life liabilities 44 905 Cash Best estimate Nl 6 177 liabilities 4 932 Total 79 670 79 670 3. Kapitálové požiadavky (Capital requirements) Solvency I required capital Solventnosť 2 Life insurance 6 800 Riziko životného poistenia 3 000 Non Life insurance 3 900 Riziko neživotného poistenia 2 000 Trhové riziko 0 z toho Koncentračné riziko 0 z toho Kreditné riziko 0 Solvency I required capital 10700 Kapitálová požiadavka S2 3 606 Solvency I ratio 277% liability coverage ratio life 132% Return on Capital S2??? liability coverage ratio non life 124% Comparison of Book value to Market value of balance sheet: Book value of liabilities are higher as expected profits are recognized. Insurance company was prudent enough in the past. Market value of balance sheet is must to have for Solvency II regulation. 38 38
Case study 3 results Market Value of liabilities Assets Market Value of Liabilities property 5 000 5 000 Own Own equityfunds 29 20 000 833 Cash Bonds at bank (life) 9 000 9 000 revaluation 9 670 Best Estimate Fixed Bonds income (Nlife) (Life insurance) 59 59 493 493 Life insurance life liabilities reserves 44 45 000 905 Fixed income (non life insurance Cash Best estimate Nl 6 177 6 177 Non liabilities life insurance reserves 45 000 932 Total 79 79 670 670 Total 79 670 Assets Market Value of Liabilities property 5 000 Own funds 28 833 Bonds (life) 9 000 Bonds (Nlife) Best Estimate 59 493 life liabilities 45 905 Cash Best estimate Nl 6 177 liabilities 4 932 Total 79 670 79 670 3. Kapitálové požiadavky (Capital requirements) Solvency I required capital Solventnosť 2 Life insurance 6 800 Riziko životného poistenia 3 000 Non Life insurance 3 900 Riziko neživotného poistenia 2 000 Trhové riziko 0 z toho Koncentračné riziko 0 z toho Kreditné riziko 0 Solvency I required capital 10700 Kapitálová požiadavka S2 3 606 Solvency I ratio 277% liability coverage ratio life 132% Return on Capital S2??? liability coverage ratio non life 124% New assumptions changes Market Value of balance sheet by 1 Mio Eur: This brings volatility of equity, capital and liabilities 39 39
conclusion Insurance risks are very complex Influences many items in balance sheet of insurance company Due to long term nature of liabilities pricing assumption will change on 100% There is difficult to satisfy all criteria, many of them are in conflict Choices need to be made by management 40 40