3. Emerging Risks for Insurers

swedishstreakMechanics

Feb 22, 2014 (3 years and 6 months ago)

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Andrea French

Technical
Specialist, Insurance Sector Team

3. Emerging
Risks for Insurers

3.1 Definition of an emerging risks


An

emerging

risk

can

be

defined

as
:


"an

issue

that

is

perceived

to

be

potentially

significant

but

which

may

not

be

fully

understood

or

allowed

for

in

insurance

terms

and

conditions,

pricing,

reserving

or

capital

setting"
.




(Source
:

Lloyd’s

of

London)




Emerging Risks

3.2 Key drivers of risk

The key drivers of risk include:



Economic, technological, environmental and socio
-
political
developments as well as the interdependencies between
them.


Other

risk

drivers

can

include
:



The changing business environment, such as liability
issues,
evolving
regulatory
regimes,
stakeholder
expectations,
and shifts in risk
perception.




Emerging Risks

3.3
Insurance
-
specific
r
isks

This presentation will concentrate on the insurable areas of risk for both life and general insurers.
These risks
include:



Life Products
Risk (credit & counterparties,
impact of the low interest rate
environment,
enhanced
annuities and r
etail distribution review & platforms)



General Insurance
(GI) Risk (impact
of the low interest rate environment, inadequate
reserving, UK
flooding
and
periodic payment
o
rders)



Technology Risk
(cyber
attacks
)



Stakeholder Risk
(shadow banking activities)



Black Swan Risks
(combined
e
ffect
of
financial
,
catastrophe
&
pandemic)

Emerging Risks

3.4 Life Emerging Risks

Emerging Risks

Financial
risks
-

Credit
and
counterparties

Risk

Impact

Risk

Mitigation

Growth of the annuity market posing
significant increase in risk to life
insurers.


Particular issue
-

backing annuities by
moving into alternative assets.


Number of annuity writers backing their
liabilities with equity
-
release mortgage
or other non
-
standard asset classes,
which may be unsustainable in the long

term.

Ensure asset classes being considered
are fully understood.


Seek permission from the regulator,

where necessary.


Actively monitor portfolios for different
and unexpected risks.


3.4 Life Emerging Risks

Emerging Risks

Financial risks
-

L
ow
interest rate environment impact

Risk

Impact

Risk Mitigation

Impact of low

interest rate
environment depends on the extent
to which life insurers are asset and
liability mismatched.


Margins for assets being managed
may be hit as investment returns
and profits are reduced.

Depends on the structure of the portfolio. Life
insurers typically have high bond allocations.


Interest

risk

hedging activities could put pressure
on bond yields causing:


reduction in firm’s solvency levels;


restricted investment policies;


restricted ability to write new business;


reduced new business profitability.


Future
-

may affect the availability of own funds
after the effect of subsidiaries to the group under
the Solvency II group solvency calculations
framework

Ensure there is


appropriate assessment of risk;
and


conduct stress testing exercises.


Strategy planning should assess
vulnerabilities including second order
and behavioural effects and
amplification issues.


3.4 Life Emerging Risks

Emerging Risks

Product
Risks


Enhanced
annuities

Risk

Impact

Risk

Mitigation

Enhanced annuities and
other non
-
standard annuities
offer higher annuity rates to
people whose lifestyle or
medical conditions cause
their life expectancy to fall
below the expected mortality
rates

Low yield environment and difficult
macroeconomic conditions mean people
are incentivised to derive more value
from their savings.


They may be more use of non
-
standard
products against a backdrop of falling
standard annuity rates


Monitor medical advancements affecting future
life
expectancy that annuities have been provided for.


Ensure books of business do not grow
unsustainably.


Ensure credible contingency plans are in place for
the treatment of assets for Solvency II.


Firms may wish to consider stress testing their
portfolios for scenarios such as withdrawal and/or
reduction of reinsurance covers or significant market
valuations changes in the future.

3.4 Life Emerging Risks

Emerging Risks

Product risk


Platforms and Retail Distribution Review

Risk

Impact

Risk

Mitigation

Retail Distribution Review implemented in
December 2012.


Fundamental change to distribution of retail
investments could affect consumer
behaviour, preference and changes of
products and markets attractive to firms.

Back books steadily declining as
maturities and surrenders exceed new
business premiums.


The key risk
-

life insurers’ existing books
of business decline significantly faster
than expected across the sector
before
new strategies are developed and
providing steady cash flow.

Immediate risk of failure is low.


Monitoring is required to ensure
sector trends of a persistent
decreasing back book do not
accelerate faster than expected
significantly increasing the impact.


3.4 GI Emerging Risks

Emerging Risks

Financial
risks
-

L
ow
interest rate environment impact

Risk

Impact

Risk

Mitigation

Slow economic recovery places pressure on
premiums, contracting market size, and
lowering investment returns which affects
profitability.


These factors combined with competition,
may result in general insurance firms to
seek out more reward for their risk.


Firms seeking to improve returns may
attract significant asset risks to their
balance sheet.


Unprofitable underwriting can result in
firms launching new products writing new
and/or growing the business in current
and new territories with a lack of data,
knowledge or experience.

Continue to focus on:



future underwriting strategies


pricing policies and


monitoring investment
strategies.


3.4 GI Emerging Risks

Emerging Risks

GI line of business risk


Inadequate reserving

Risk

Impact

Risk

Mitigation

Inadequate reserving by general
insurers can:


understate the costs of claims;


create premium rate pricing
adequacies; and


stress reserving risk capital
requirements.

Inadequate reserving will strain business models
and affect solvency capital levels.


Coupled with:


competitive market pricing pressure;


changing supply and demand trends;


increased claims inflation costs; and


current low interest rate environment


can result in pressure to alter an insurers
behaviour in the current phase of the
underwriting cycle.

Perform regular deep
-
dive reserve
exercises to ensure that they
understand their claim exposure
fully.


Effective reserve governance is
essential.


Ensure reserves are adequate by
using correct booking of reserves
with appropriate challenge.


3.4 GI Emerging Risks

Emerging Risks

GI line of business risk
-

UK flooding

Risk

Impact

Risk

Mitigation

M
ore than 30 major rivers in the UK that
have extensive reach and are currently
or were historically, multi
-
channelled.


These rivers represent significant points
of increased vulnerability in the river
network to increase flooding.


Historic underinvestment in flood
defenses and changing weather patterns
have increased the risk.


More flooding is predicted

in the UK and
rates of river bed, bank erosion and
floodplain sedimentation are also likely to
accelerate.


There remains the possibility that certain
households will not be able to afford flood
insurance as it becomes too costly.


Identify vulnerable points within
their insured portfolio of household
properties and maintain adequate
reserves to manage these
exposures.


A new regime coming in mid 2015

is intended to ensure the continued
widespread availability of flood
insurance to high
-
risk households.

Follows

the expiry of the Statement
of Principles.


3.4 GI Emerging Risks

Emerging Risks

GI line of business risk
-

Periodic
Payment Orders (PPOs)

Risk

Impact

Risk

Mitigation

Since their introduction through the 2003
Courts Act, PPOs have begun to change
the landscape of how large bodily injury
(BI) claims are paid in the UK.


PPOs are an alternative to lump sum
payments. Under a PPO settlement an
insurer pays a semi
-
annual amount to the
claimant for the remainder of their life,
like an annuity.

This payment method transfers to the insurer
risks such as longevity, investment and
inflation. PPOs now pose a material current
and future risk for motor insurers.


It is estimated that, within a decade, 25% of
general insurer motor reserves could be
formed of PPO commitments.


I
t

i
s essential for:



Firms to actively track and
monitor potential PPO claims.



Have specific reserving,
modelling and methodology in
place to minimise the longevity,
investment and inflation risk.

3.4 Life and GI Emerging Risks

Emerging Risks

Technology
risk
-

C
yber attacks

Risk

Impact

Risk

Mitigation

Many firms are leaner so are opting to use
cloud computing, offshoring data and
processes to third party firms.


Critical functions outsourced include

catastrophe modelling, actuarial analysis
and compliance functions.

A cyber attack could affect a firm’s
ability to process premiums and issue
insurance contracts affecting
cashflows and covers


particularly an
issue for compulsory insurances.


A cloud service provider concentration
could become a second order risk if
such providers were subject to
multiple cyber
-
attacks causing a
failure of services.



Ensure and monitor that third party
firms provide the security and service
that they are contracted to deliver.


Constantly monitor firewalls.


Rectify breaches immediately to
minimise security risks is paramount.


Limit staff use of mobile devices to
minimise damage to high risk critical
areas of the infrastructure.


3.4
Life and GI Emerging
Risks

Emerging Risks

Stakeholder
risk
-

Shadow banking activities

Risk

Impact

Risk

Mitigation

Shadow banking activities can cover non
-
banking financial firms that provide services
similar to traditional commercial banks
where there is a maturity transformation.


Such activities could include credit
investment vehicles (e.g. investment funds,
mutual funds and trusts) that have a cash
management or very low risk investment
objective.


Investments may also occur in unregulated
markets, so are not visible in conventional
balance sheets, making it difficult to assess
exposures.


Non
-
traded assets are highly risky and
volatile and may cause significant
losses in a short timeframe. They may
also be less liquid in times of stress
and valuations may be difficult to
quantify.



Firms engage with the regulator to
ensure products are appropriate.


Once deemed appropriate firms may
require expert advise when
transacting in these products.


Firms should regularly monitor asset
exposures to minimise risk and
volatility.

3.4
Life and GI Emerging
Risks

Emerging Risks

Black
Swan
-

Combined
effect of a financial, catastrophe &
pandemic events

Risk

Impact

Risk

Mitigation

Simultaneous shocks to the:



global economic system


natural catastrophes


pandemics


could trigger insured loss
events which could test the
resilience of insurers.


Certain scenarios could lead to loss in a
large number of life products and GI lines
of business.


Life and health assurers will be adversely
affected in a pandemic event and GI
insurers could experience unprecedented
liability claims and an accumulation or
large value claims following a catastrophe
event.


Claims could also come from secondary
impacts to society.


A firms solvency capital could be
adversely affected if there is a “flight to
quality” at the same time due to investor
unpredictability.


Some policies may be hit unexpectedly by
claims, the insurance industry should clarify
coverage intentions sooner rather than later to
ensure contract

certainty.


Firms ensure they have an understanding of the
financial markets second order, behavioural and
amplification issues affecting their investments


Firms ensure they understand their concentration
of exposures for natural catastrophe (for
modelled and unmodelled perils)


Pandemic contingency plans should aim to
ensure continuity of essential operations during
an extended period of high illness rates in the
workforce, suppliers, and customers.