Non Life Insurance risk management in the Insurance company : CSOB case studies

Non Life Insurance risk management in the Insurance company : CSOB case studies

Content Topics : case study Non Life Insurance risk management, 1. Non Life Insurance 2. Case study Example of non life insurance product MTPL, Domos and Business 3. Definition of Non Life insurance risks 4. Case study Health insurance as part of Non life risks 5. Non Life product Cash flows 6. Insurance Risk management process, Risk Limit definition 7. Case Study. Risk management for Non life insurance 2

Objectives Familiarize yourself with the basics of: Non Life insurance products Non Life insurance risk definition Non Life risk managements 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

Line of business for Non life insurance Liabilities of the insurance company must be segmented into homogenous risk groups and those are grouped into the classes of insurance. The classes are defined by Solvency II. LOB no. 4 MTPL Nonlife insurance classes 5 Other motor vehicles insurance 6 Marine, aviation transport 7 Property damage insurance 8 General liability insurance 9 Credit and Suretyship insurance 10 Legal assistance insurance 11 Assistance insurance 12 Miscellaneous financial loss insurance 5

Liability segmentation health insurance LOB no. Health insurance similar to nonlife insurance classes 1 Medical costs insurance 2 Income protection 3 Worker s compensation ins. 29 Health insurance similar to life insurance 33 Annuities arising from bodily injury Similar to non life insurance (non SLT) Similar to life insurance (SLT) Example: accident insurance Insurance is sold as a rider to Life product permanent disability, accidental death, riders to bank card insurance, permanent disability for children, daily compensation in case of injury, accident insurance with MTPL for free, etc. all of it is LOB 2. 6

Case Study 1 Examples of Non Life insurance product, categorisation to Line of Business 7 7

Liabilities segmentation nonlife Liabilities of the insurance company must be segmented into homogenous risk groups and those are grouped into the classes of insurance. The classes are defined by Solvency II. LOB no. 4 MTPL Nonlife insurance classes 5 Other motor vehicles insurance 6 Marine, aviation transport 7 Property damage insurance 8 General liability insurance 9 Credit and Suretyship insurance 10 Legal assistance insurance 11 Assistance insurance 12 Miscellaneous financial loss insurance Example: household insurance - Domos One policy often includes risk of property insurance as well as general liability. Liabilities that will occur from these insurance policies, must be allocated in the LOB 7 and LOB 8. 8

Examples of non life insurance product Motor Third Party Liability - MTPL (PZP) Insurance period: Insured event: Insurance benefit: Usually 1 year, but possible more Liability arising from use of motor vehicle Material damage: damage on other cars or property caused by insured car Health damage: health and annuity claims Car insurance - CASCO Insurance period: Insured event: Insurance benefit: Usually 1 year, but possible more Damage on insured car Repayment of repair cost of insured car 9

Examples of non life insurance product House/Flat and household insurance (Domos) Insurance period: Insured event: Insurance benefit: Usually 1 year, but possible more 1. Losses on insured house/flat and household 2. Liability arising from ownership of house/flat 1. Repayment of repair cost in case of natural catastrophe (e.g. flood, wind) or man-made catastrophe (e.g. fire, vandalism) depends on insured risks 2. Liability claim from house/household ownership e.g. losses caused to neighbors in case of water pipes damage Insurance for Small and medium enterprises (SME) Insurance period: Insured event: Usually 1 year, but possible more 1. Losses on insured property 2. Any third party liability 3. Business interruption insurance 4. Transport insurance 10

Liabilities estimates in nonlife insurance The best estimate liabilities The best liabilities estimate is the present value of future financial flows Post claim reserve Pre claim reserve Valuation day Post Claim Reserve Pre Claim Reserve (from premium) Reserve for losses that occurred before the valuation day. Reserve for losses that occurred after the valuation day and are related to the insurance policies that cannot be canceled anymore on the valuation date. 11

Post Claim reserve data history claim triangle Triangle of paid claims: paid claim in development year j for occurence year i Triangle of incurred claims: paid claims + all reserved claim Post claim cash-flows: project the future claim payments (green part) and claim settlement expanses Use actuarial techniques to create the model, that determined ultimate expected loss and also expencted spread over time - cashflows 12 12

Post claim non life reserves Year Premium Paid claims Costs Cash Flow 1 0-200 -35-235 2 0-100 -16-116 3 0-35 -3-33 4 0-10 -1-11 5 0-1 -1 2,50% 2,00% 1,50% 1,00% 0,50% 0,00% Discount curve 1 2 3 4 5 Cash flow Discounting Total sum of Cash flows is -396 Eur reserve. 1 2 3 4 5 Year 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 - 380 Eur reserve. It is expected value. 13

Post claim NL reserves 1 year later Year Premium Paid claims Costs Cash Flow 2,50% Discount curve 2,00% 2 0-110 -20-130 3 0-47 -3-50 4 0-10 -1-11 5 0-1 -1 1,50% 1,00% 0,50% 0,00% 1 2 3 4 5 Cash flow Real 1 Origi nally exp. 1 2 3 4 Discounting 5 5 Year 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. 14

Preclaim reserves Is defined as present value of expected probability weighted average of future cashflows Expected future claims Expected future expenses Expected future commission Minus expected premium It includes the laspe ratio 15 15

Market value of liabilities How to estimate the Market Value of liabilities? 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...) 16

Definition of Non Life insurance risks Categorization of Non Life Insurance Risks 17 17

Positioning of Non Life Insurance risk within the risk universe CSOB INSURANCE RISK UNIVERSE Focus in the presentation is on Non Life Insurance risk which is part of Technical Insurance risk Do you know example example of Non Life risk in products? 18 18

Influence of risk on Solvency low tariffs Example no. 1: The insurance company A and B have the same portfolio of insurance policies 100 ths. vehicles. The insurance company A offers very low tariffs that are its competitive advantage. The insurance company B makes business with higher prudence therefore has higher tariffs. How will the strategies of both companies be reflected in the capital requirements in solvency I regime and in risk profile? Note: The example is simplified, as it does not reflect possible differences in the policy of creation of technical reserves, amount of costs and the way of underwriting the risk. 19

Influence of risk on Solvency low tariffs Insurance co. A Insurance co. B Total premium 10 000 000 (5% profitability) Capital requirement Solvency I 18% * 10 000 000 = 1 800 000 12 000 000 (21% profitability) 18% * 12 000 000 = 2 160 000 Capital requirement Solvency II 4 100 000 4 100 000 Created own resources / Profit 500 000 2 500 000 Return of Capital SI 27,7% 115,7% Return of Capital SII (RoC) 12,1% 60,9% Under Solvency I, the company A has the lower capital requirement. It creates less own resources (profit) and therefore has lower ability to survive unexpected negative events (e.g. worse loss ratio). Under Solvency II, the capital req. of both companies are the same. The company A doesn't have an advantage towards the company B. The company B creates more own resources and has higher return of capital. It has higher ability to survive unexpected events. 20

Risk categories Non Life Insurance risk 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 21 21

Non 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 22 22

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. 23 23

24

Overview of catastrophe risks natural catastrophe risks windstorm flood earthquake hail man made catastrophe risks MTPL (Motor Third Party Liability) Marine Aviation Fire Liability Credit & Surety ship 25 25

Need to introduce a common risk language 26 26 26

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 27 27

Case Study 2 Limit definition for non life insurance risk 28 28

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 29 29

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 - Combined ratio 30 30

Definition of combined ratio Combined ratio measures the technical profitability of product. It indicates how well the company is performing in its operations. A ratio below 100% indicates that the company is making profit while a ratio above 100% means that we are paying out more (losses, expenses) than we are receiving from premiums. Combined ratio = Loss ratio + Commission ratio + Expense ratio Parts of combined ratio: 1. Loss ratio measures the paid claims against earned premium 2. Commission ratio measures the amount of commissions against earned premium 3. Expense ratio measures the company expenses against earned premium. 31

Example of combined ratio Example of company s combined ratio report 32 32

Premium adequacy of nonlife contract Contract duration 1.1 31.12 Valuation date Contract boundary When calculating premium adequacy of nonlife portfolio at the valuation date for year Y : 1. Post claim cash flows - Present value of cash flows of paid claims and claim handling expenses for claim which incurred up to valuation date 2. Pre claim cash flows - Present value of cash flows of claims which will incur on insurance contracts after valuation date up to contract boundary. 3. Expenses which will incur from valuation date up to contract boundary If sum of these three components > unearned premium than premium is inadequate. If sum of these three components < unearned premium than premium is Adequate. Solid estimation of premium adequacy is combined ratio. 33

Premium adequacy of nonlife contract Mon th Premium Future claims Future Costs Post claim CF 1 316-90 -250-235 2 316-90 -200-116 3 316-90 -150-33 4 316-90 -100-11 5 316-90 -1 We are 7th months of the contract Monthly paid contract. Monthly premium 316 Eur Reserve for incurred claims (post claim) = 396 Eur. Company expects it will pay 396 euro for already incurred claims. Future claims = 450 Eur Company expects they will pay 450 Eur on claims which will incure in the future Future costs = 700 Eur Company expects they will further 700 Eur on their own expense 37 Eur left from last 5 months + 52 Eur from past months. Company profit is 52 + 37 = 89 Eur. 34

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. 35

Non Life Insurance risk identification Premium risk higher large claims might occur in future, premium is Reserve risk reserves are not adequate and need to be increased as future claims are higher then expected/ reality is different 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 the future profits, but also is not able to cover fixed costs Market risk interest rates decrease not sufficient PL contribution Credit risk our major reinsurer will get bankrupt, Catastrophic risk floods in to Slovakia, dam of river Vah is broken - earthquake in Komarno - explosion in Slovnaft 36

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 37

Capital tree in Solvency II Capital requirement SCR =>SCR: P&L impact of new business and portfolio with 99.5% probability level 38

Capital tree in Solvency II SCR NON-LIFE SCR PREM & RES SCR CAT SCR MTPL SCR CASCO SCR FIRE SCR GTPL SCR MAN MADE CAT SCR NATCAT SCR MTPL RES SCR CASCO RES SCR FIRE RES SCR GTPL RES SCR MM MTPL SCR WINDSTORM SCR MTPL PREM SCR CASCO PREM SCR FIRE PREM SCR GTPL PREM SCR MM FIRE SCR FLOOD SCR MM LIABILITY SCR EARTHQUAKE SCR HAIL 39 39

Zoom in for SCR reserve risk SCR NON-LIFE SCR PREM & RES SCR CAT SCR MTPL SCR CASCO SCR FIRE SCR GTPL SCR ASSISTANCE SCR MAN MADE CAT SCR NATCAT SCR MTPL RES SCR CASCO RES SCR FIRE RES SCR GTPL RES SCR ASSISTANCE RES SCR MM MTPL SCR WINDSTORM SCR MTPL PREM SCR CASCO PREM SCR FIRE PREM SCR GTPL PREM SCR ASSISTANCE PREM SCR MM MARINE SCR FLOOD SCR Reserve risk= Reserve risk Sigma res Motor vehicle liability 9,5% SCR MM AVIATION SCR EARTHQUAKE 3 * sigma * BE reserva (LoB) Plus diversification Motor, other classes 10,0% Marine, aviation, transport (MAT) 14,0% Fire and other property damage 11,0% SCR MM FIRE SCR HAIL Third-party liability 11,0% Credit and suretyship 19,0% Legal expenses 9,0% SCR MM LIABILITY Assistance 11,0% SCR MM CREDIT & SURETTYSHIP 40 40

Úvod do Solventnosti II EIOPA požaduje celistvý systém, ktorý transformuje vstupné dáta o poistných zmluvách na predpokladaný vývoj zisku poisťovne a jeho distribučnej funkcie - aktuársky model. Interný model je viac ako mechanický proces. Musí mať v sebe zahrnutý spôsob, ktorým je aktuársky model integrovaný so interného systému riadenia rizík poisťovne. Aktuársky model môže byť použitý na odvodenie kapitálových požiadaviek 04 December 41 Slovenská 41spoločnosť aktuárov ČSOB poisťovňa 41

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 42 42