Ah models, my old friends. You’re always wrong, but sometimes helpful. Often dangerous too.
A recent article in The Actuary magazine addressed whether “de-risking in members’ best interests?” I say “recent” even though it’s from August because I am a little behind on my The Actuary reading.
In the article, the authors demonstrate that by modelling the impact of covenant risk, optimal investment portfolios for Defined Benefit (DB) pensions actually have more risky assets than if this covenant risk is ignored.
The covenant they refer to is the obligation of the sponsor to make good deficits within the pension fund. Covenant risk then is the risk that the sponsor is unable (typically through its own insolvency) to make good on this promise.
On the surface it should seem counterintuitive that by modelling an additional risk to pensioners, the answer is to invest in riskier assets, thus increasing risk.
The explanation proffered by the authors is that the higher expected returns from riskier assets allow the fund to potentially build up surplus, thus reducing the risks of covenant failure.
Credit Life regulations have been live for long enough now that insurers are starting to feel the impact and the shake-up of amongst industry players is starting to emerge.
There have been plenty of debate around the regulations, in part because of the dramatic financial and operational impact they will have, and partly because of how imperfectly worded they are and the scope for interpretation.
I’ll be posting about this more in the coming days.
Basing the premium on initial or outstanding balance
First, a real anomaly is the ability for insurers to charge the capped premium rate either on initial loan balance or on the declining outstanding balance.
Insurance is misunderstood. Consumers ascribe malice where often practical restrictions are to blame.
Take deductibles for example. A deductible in an insurance claim decreases the number of claims an insurer has to deal with. More than that though, it reduces the claims where the administration costs of checking out the claim and paying it are large relative to the benefit to the policyholder. Sometimes these costs would have been larger than the claim itself.
In that case it does not make sense for the insurer to be processing and paying the claims – the increase in premiums required would be more than reasonable to policyholders.
Lemonade’s new “zero everything” removes the deductible and guarantees no premium increases for up to two claims per year. The reporting on this innovation has generally been silent on the practical reasons why this is hard for traditional insurers and easier for Lemonade.
Lemonade on the other hand explicitly recognise (or at least claim) that due to their AI-based claims underwriting process they can drive down costs and therefore manage small claims cost effectively.
This is important. Many complain about the lack of innovation in insurance. Removing deductibles isn’t innovation. Reducing costs to the extent it becomes viable is the step that enables differentiation and better value for customers.
Non-life claims reserves are regularly not discounted, for bad reasons and good. This part of the series looks at the related issue of inflation in claims reserving. (You’ll have to wait for part 3 for me to talk about the analysis that prompted this lengthy series.)
In many markets, inflation is low and stable. Until a decade ago, talk of inflation wouldn’t have raised much in the way of deflation either. That’s still sufficiently unusual to put to one side.
I’ve had the privilege to straddle life insurance and non-life insurance (P&C, general, short term insurance, take your pick of terms) in my career. On balance, I think having significant exposure to both has increased my knowledge in each rather than lessened the depth of my knowledge in either. I’ve been able to transport concepts and take learnings from one side to the other.
A recent example relates to the common non-life practice of not discounting claims reserves. Solvency II, SAM and IFRS17 moves to require discounting aside, it is still more a common GAAP approach to not discount than to discount claims reserves.
Discounting or fiddling with inflation has some obvious implications for analysing actual vs expected analysis, reserve run offs, and reserve adequacy analysis. That some non-life reserving actuaries trip over because it’s more natural in the life space.
If you haven’t heard about CRISPR and CAS9, you won’t understand why I say it seems likely that my children will be the last in my line that are “pure natural” descendants. My grandchildren will almost certainly be genetically altered in some direct way due to the explosion of genetic manipulation possibilities just beginning to open up.
Insurers have long worried about the costs and ethics of genetic testing. The time to start considering the impact of annuitant mortality is probably already in the past. The possible improvements in life expectancy are, according to some, literally unbounded. I don’t quite go that far yet, but the possibilities are provocative.
In another post, I’ll discuss my concerns around antibiotic resistance, and other risks to mortality, but for now, do yourself a favour and watch this crash course in the possibilities of cheap genetic editing.
In 2014, John Oliphant was fired from the Government Employees’ Pension Fund (GEPF) where he was principal executive officer. There were allegations, some details not disputed, that had Mr Oliphant accused of exceeding his powers and not following due process which amounted to, at the maximum, some hundreds of thousands of Rands.
That outcome, with those modest numbers, especially with the murk that surrounded the allegations, contrasts markedly with the hundreds of millions of Rands known to be deeply mired in scandal at the moment without consequence.
The GEPF and the Public Investment Corporation (the PIC, which investments money on behalf of many state entities) are proximate with huge amounts of money. It could be expected to be an attractive target for those with sticky fingers and connections. So when stories emerge of PIC directing GEPF investments towards SOEs or other private investments for merits other than the investment returns for the fund, nobody is surprised but plenty are concerned.
Most of the stories in the press on this matter are misinformed. The claims that pensioners’ money is at risk are misleading at best. One exception is the Daily Maverick article by Dirk De Vos. In this article, De Vos explains why tax payers rather than (only) government pensioners will bear the burden of failed investments for the GEPF. Continue reading “Who owns Defined Benefit holes?”
Aviva in France is still dealing with having written the worst insurance policy in the world. From the sounds of things, they weren’t alone in this foible. It’s also hard to say as an outsider what the right or reasonable resolution to their current problem is, but here is the policy that they wrote.
Buy a policy
Choose what funds you want to invest in
Unit prices calculated each Friday
Allow policyholders to switch funds on old prices until the next week
Hope like hell policyholders don’t switch out of poorly performing funds into well performing funds with perfect information based on backwards, stale prices.
Inconceivable – and since I don’t know more than I read on this blog post, maybe the reality and liability is really quite different.