There goes the long end

The Fed joins Bank of England and Bank of Japan in repurchasing government bonds.

Creative Commons License photo credit: amber.kennedy

This actions (quantitative easing) increases the prices of bonds (more demand, diminishing supply) pushing down long-term yields.

Great if you own bonds, not so great if you are an insurer with imperfectly matched long-term liabilities. Given how difficult it is to find assets of sufficiently long term to back long-dated annuities, many insurers may find themselves with assets of shorter duration than liabiltiies. More losses for insurers could follow.

Insurers have started using swaps to match their annuity portfolios, or to simply increase the duration of their assets such that the sensitivity of assets and liabilities to overall changes in the level of the yield curve has a limited effect. This solves part of the problem. When short term interest rates are affected  by desperate monetary policy and longer term yields are set by a perfect storm of future inflationary expectations, recession fears and now central bank intervention in the markets, matching key durations is a minimum requirement not to have large swings in surplus assets.

And this doesn’t even consinder the impact on Guaranteed Annuity Options and Variable Annuities in the US. More fun.

Insured against ranting and rambling

Moneyweb has an article describing the failure of the South African insurance industry to provide insurance to the wider population, including lower income markets such as the banking sector has done.

There are some interesting points to discuss here, and I’m certainly not saying the industry could not do more. However, there are some fairly fundamental social, pyschological and technical reasons that need to be overcome first. I’ve repeated some comments on the article below. I don’t claim this to be an exhaustive list, but I suggest that it lists some more likely suspects for the causes of imperfect penetration of the insurance market.

Sorry Felicity, but this article doesn’t even get into the details and shows a lack of understanding of the drivers of the need for insurance, and the perceived need for insurance.

Life Insurance
Comparing insurance to banking is disingenuous. Transactional banking makes your life easier, now. Basic savings account can work towards short-term goals. Life insurance will always seem less pressing.

1. Savings products will not work for lower income policyholders through an insurance policy because of the assumed average tax rate of 30%. It is a good deal for welathy investors in high marginal tax brackets, but awful for poor people. This is a function of the tax system not the insurers.
2. Life insurance requires payment of a premium now for a possible future benefit to dependents. There is no way this will ever be a priority need. This is human nature. Even if policies are sold, they will be lapsed very quickly and “better” uses are found for the premiums.
3. Lower income market segments typically have greater reliance on extended family for support. Thus, the need is lower for insurance. This is typical of developing countries, and declines as wealth and education increase (along with smaller families, later first children and less support from the extended family).

4. Funeral insurance may be sold through non-traditional outlets, but it is still exactly life insurance. Just that here the need is better appreciated and understood. Therefore it sells. Or do you want insurers to sell products for which there isn’t a need. (hey, easy on the comments that they already do… I don’t think insurers are angels!)
5. Credit life is required to protect the lenders from the death of the borrower. Again, there is a clear need and this form of insurance is quite widespread. Incidentally, funeral insurance and credit life are, unfortunately, typically quite profitable business lines. This might be a better line of attack against the insurance industry.
6. Insurance in South Africa has remarkably high penetration as measured by insurance premiums as a percentage of GDP and compared to other countries. This shows the succes of the industry, and also explains the limited growth prospects. Life insurance is typically less prevalent than short-term insurance in developing economies – if the problem isn’t restricted to South Africa maybe we should look for broader reasons?

7. I know several insurers who are targeting lower income markets with mixed success. The typical complaint against insurers is that they are overly profit-seeking. If (if!) this is true, then one can’t also complain that they aren’t following up on profitable opportunities? Again, maybe the reason is broader than you’ve implied.

Short-term insurance
Several other commentors have already described valid reasons for why short-term insurance take-up is lower than might be hoped. In many countries, third party liability cover is a legal requirement to drive a vehicle, and with good reason. This is the case in Lebanon, another country where I understand a bit about the insurance industry.

Losses on equity portfolios for our short-term insurers don’t really translate to a requirement to provide insurance to new markets. Maybe it suggests a requirement for less reliance on equity bull markets for performance in good years.

Short-term insurance in South Africa would be considered competitive by most standards. If there were large, profitable, untapped markets out there (with sufficient volumes, limited fraud and low enough claims frequencies and severities to make the premiums affordable to the target market) I expect they would be aggressively pursued. The thing about third party liability cover is that it isn’t greatly a function of the value of your vehicle. That makes it relatively expensive compared with the value of a car typical of a lower income target market. Being insured against someone else’s costs, when you would have no way to pay them otherwise and therefore it would be pointless to be sued, doesn’t sound like a very likely expenditure item.

The expenses of adminstering a policy are also not related to the size of policy or the value of insured property. One can argue whether current efficiency levels are right, but that is a separate argument (and one likely to suggest job cuts…).

The propotion of South Africans with short-term insurance should also be compared against those with sufficient assets to make it sensible. Direct comparisons against the populatio as a whole are close to meaninless.

Ok, I think I have done more than enough rambling and ranting. However, let me conclude with one observation on a quote from the article:

“And the plain fact is that local insurers have done way too little to develop products that offer value for the vast majority of South Africans. This is self-evident; precious few South Africans use insurance products.”

Just saying something is a fact doesn’t make it a fact. And please don’t abuse “self-evident”. Just because one item could be a cause of something does not make it the cause, or the only cause, or the primary cause. Especially not when you have just laid out a few of the reasons I also covered as to why insurance is a hard sell.

I wonder whether I should have mentioned the bad debts on house and car loans that are stacking up based (only partially!!) on pressure to lend to households with little wealth for large deposits and strained financials?

Presentation to ACAL on GI Pricing

I gave a presentation on a holistic approach to ratemaking using predictive models yesterday to the Lebanese Insurance Association (ACAL, the acronym for the association in French). Over a hundred people attended, and there certainly seemed to be interest in the topic.

A common response though was that Lebanon isn’t yet ready for that, because rates are so low and nobody is prepared to change their approach. I accept that changing the “way things are done” in a fundamental way takes time and courage, but I expect that some players will start collecting the data, doing the analysis and improving their pricing in the next few years. By 2013, the market here will not be the same. The advantages across general insurance, banking, sales and cross-selling are simply too great. The techniques available are fantastic and can be implemented quite easily.

I’ve given the official press release below, and presentation ACAL GI Pricing 2008 (pdf version) is available under Resources on this site.

Insurance companies can generate a competitive advantage through accurate ratemaking, systematic risk-adjusted pricing, and careful analysis of policyholder price sensitivity at renewal dates. Single variable techniques can provide valuable insights into risk factors, but do not perform well in the presence of multiple drivers of risk.

Generalised Linear Modelling (GLM) is the preferred approach for robust, multivariate analysis of claim severity and frequency modelling. GLM can model several rating factors simultaneously, including interactions between different rating factors on risk. It is used extensively in the UK, the US and other highly competitive and developed insurance markets.

Judgement and experience are required when assessing different models and interpreting the diagnostic tests used to ensure accurate and robust results. A good model can make dramatic improvements in the separation of high and low risk policyholders.

These advanced approaches all have increased data requirements. Companies looking to reap the rewards of improved ratemaking will need to develop the databases and systems to store exposure, claims and rating factor data. There is a range of software available to perform the statistical analysis, from expensive purpose-built systems to freely available, open-source statistical platforms.

Successful implementation of an advanced rating system depends on commitment of key staff to the project and the inclusion of marketing, underwriting, legal, IT and actuarial skills in the project team. Market characteristics and reluctance to change are constraints to the adoption of advanced techniques. These have been faced and overcome in many other markets. It is only a matter of time before insurers must use these techniques even to maintain their competitive position.  Early movers will enjoy an improvement in their competitive position, market share and profitability.

Actuarial consulting career part 2 – system development

This is a continuation ofa post considering the relevance of an individual investment product development position to a career in actuarial consulting.

An old contact mailed me a couple of days ago asking my view on two possible actuarial positions. He was interested in whether either would be suitable preparation for a consulting or actuarial consulting role in future. I thought the answer might be of broader interest, so I’m copying it, with a little editing to protect the innocent into a couple of blog posts.

Please note this shouldn’t be taken as categorical always applicable advice – just some thoughts:

In-depth knowledge of policy systems and admin is a tremendously useful skill-set in its own right. Companies are always struggling with legacy systems, and the speed, efficiency and flexibility of current systems can generate a competitive advantage in getting new products to market, improving customer service and reducing costs. Although this role would introduce depth rather than breadth to your skills and experience, it could potentially be a stepping stone into a solo consulting career focussed on these areas. Alternatively, if you enjoy that sort of work, there is probably a long-term future for you at the potential employer moving up from coding to systems analysis and improvement.

All insurers struggle with these issues, and I can’t see how this will ever change. As insurance takes off in other developing markets (rest of Africa, Middle East and so on) there will be a range of new companies selling new products to new customers with new designs and special features. This role will always be in demand.

Will an individual investment product development role help towards actuarial consulting career?

An old contact mailed me a couple of days ago asking my view on two possible actuarial positions. He was interested in whether either would be suitable preparation for a consulting or actuarial consulting role in future. I thought the answer might be of broader interest, so I’m copying it, with a little editing to protect the innocent into a couple of blog posts.

Please note this shouldn’t be taken as categorical always applicable advice – just some thoughts:

Insurers are facing stiff competition in the investment space, both on the individual and corporate side. Competing against investment banks and asset managers, often on more direct terms than in the past, and with the albatross of poor reputation, sluggish reaction to changing market conditions and often a higher cost base mean that insurers need plenty of help in this area. Depending on the specific role, you can get involved in anything from market research and customer needs analysis, creative product design, model coding, profit testing, distribution analysis, customer segmentation and analytics, financial reporting (IFRS, FSV/PGN104, EV, EEV, MCEV, Solvency II etc.), administration system design and implementation, liaison with distribution force, sales team training, product profitability monitoring, policy documentation wording etc.

There is plenty of scope to gain breadth of knowledge, but it is likely that you won’t be doing all of this. I’d check out what they envisage you actually doing, see what is in your “performance contract” if this exists and see whether it is a narrow or broad role, and whether it can become broader over time.

Aside from its relevance to an actuarial consulting career, this is an interesting space to be involved in at the moment. Around the world, insurers are only touching on possibilities of product design and customer information and analysis. South African insurers are probably a little further behind the curve.

Good luck!

Packing for Prague

Heading off to a Solvency II conference in Prague this evening. QIS 4 is hot news at the moment, and the conference is going to cover many of the details and requirements of the exercise.
Large European multinationals have spent enormous effort on the 4 QIS exercises. The data requirements alone are huge. Somehow CEIOPS has managed to keep the project more or less on track – the same can’t be said for the IFRS4 Phase 2 project. Given the intended consistency between IFRS and Sol2, I wonder whether this means IFRS will by default be more heavily influenced by Sol2 (and the recently published MCEV principles fomr the CFO Forum) than previously thought.
Will have some specifics from the course to blog about over the next week.

US CPAs to start speaking French

Until very recently, multinationals listed in the US but not resident in the US were required to show a reconciliaton of their local GAAP financial statements to the US GAAP equivalent. Many of these large companies (based in Europe and the Far East) incurred high costs in time, energy and hard cash in preparing US GAAP accounts for this purpose only.

As a result, listing on a US exchange started to appear less attractive to these and other new potential listings. The SEC had been mulling over how to deal with this for a while, and fairly suddenly has now announced that these companies do not need to provide the reconciliaton to US GAAP. As a result, many large companies have already opted not to produce the US GAAP figures.

The next major step would be if the SEC decides that US companies who decide to report under IFRS do not need to provide US GAAP figures. As IFRS gains traction around the rest of the world, nobody wants to be left behind as the special case. This is still a way off, and their is also plenty of trouble brewing with IFRS (Phase 2 Insurance Project particularly) but it does look like many US accountants will need to polish their European language skills.

Solvency II makes another milestone – QIS3 out

Apparently the results for QIS3 are now available.  QIS3 (“Quiz 3”) is the third Quantitative Impact Study along the path to rolling out Sovlency II for insurance companies between 2010 and 2012. It provides further light on what capital requirements will actually be when Sovlency II comes into effect.

Perhaps a warning is required for the overally optimistic. Basel II required 5 QISs before maturing to be ready for roll-out. Many acknowledge that Solvency II is more complicated, with a greater number of complex risks to consider so it could arguably take much longer. Also, Basel II had the framework of Basel I to start with, where many European insurers have had very simplistic capital requirements to date. Watch this space!

I’ll provide some more feedback on the actual results of Solvency II when I’ve had a look through the material.