Actuarial Practice 3 PDF

Assessment calculations V9R hedging Var CA + B) reinsurance  The UK’s European university Actuarial Practice Part L00: Introduction Vaishnavi Srinivasan 1 Introduction to Insurance Practice 2 Aims of...

Assessment calculations V9R hedging Var CA + B) reinsurance  The UK’s European university Actuarial Practice Part L00: Introduction Vaishnavi Srinivasan 1 Introduction to Insurance Practice 2 Aims of the insurance practice part of the module This module aims to give the student an introduction to the knowledge and skills that underpin the world of insurance: – Life – General Structure of this part Introduction – introduce the student to the key areas where actuaries work in a life insurance office and a general insurance office Practice areas– the teaching will then focus on a deeper dive into specific practice areas 2 1  Module Structure 3 Weeks 9-11 – aspects of the life office practice will be discussed though these lectures Part Life practice L00 Introduction L01 Life insurance risk cycle L02 Product development L03 Managing longevity L04 Life underwriting L05 Reserving, capital management and Solvency II L06 Reinsurance 3 THE UK’S EUROPEAN UNIVERSITY www.kent.ac.uk 4 2  27/09/2022 The UK’s European university Actuarial Practice Part L01: Life Insurance Risk Cycle Vaishnavi Srinivasan 1 Introduction to life practice 2 Aims of the life practice part of the module This module aims to give the student an introduction to the range of knowledge and skills that actuaries perform in roles inside life insurance. We will work through the product lifecycle of a typical life policy and as we progress along that lifecycle we will look more deeply at certain areas where actuaries work. 1 2  27/09/2022 Insurance Companies 5 Why do we care about insurance? Provides peace of mind to people. Reduces uncertainty for businesses. Insurance companies are big investors in the economy. Insurance companies pay taxes to the government. This money can be used to help pay for public services, such as education. Types of insurance: Life insurance General insurance There are around 500 insurance companies in the UK. Approximately 25% are life insurers, remaining are general insurers. 500 25 % life 75 % general Total approx. 3 5 Life insurance: Can pay a lump sum or regular payments to policyholder’s family, if policyholder dies Dduring the policy term. ~ epf Can sometimes provide pension schemes – a special kind of savings plan. You save a little of your income regularly whilst you are working, which can then be used as an income in later life when you want to work less or retire. - Day Premium Life insurers also sell an insurance policy called an annuity. This provides a guaranteed income for the life of the pensioner and stops the worry of using up all of their savings. General insurance: Protects ourselves and the things we care about, such as cars, homes and belongings – anything other than Life insurance. General Insurers are responsible for insuring against large catastrophes such as natural disasters and responding to emerging risks, such as cyber risks and climate change. General insurance policies are typically much shorter – many are renewed annually. 2 4  27/09/2022 what is default risk ? also conventional & unit linked Characteristics of life insurers 3 The primary purposes is to protect Two key & risk in investing : risks that the insurer takes: Purpose customers against the financial Insurance – probability of a claim occurring - reduce & strain caused by the risk of death, Investment – reducing market risk, interest rate risk, - liquidity risk, default risk - · market risk sickness and providing an income CProduct structures vary the risk sharingCbetween customers · interest rate risk in retirement. and insurer - conventional versus unit linked ?? · risk liquidity Insurers have been set up over time There are main corporate structures are: · default risk under various corporate Structure Friendly societies – these are mutually owned organisations structures. This represents the created to pool and share insurance risks. They are regulated main corporate structure diverse way that insurance has in a similar way to incorporated insurers. ?? Mutual insurer – again these have no shareholders but are · friendly societies grown to meet the needs of groups incorporated and are fully regulated. · mutual insurer of people through time. Proprietary insurer – shareholder owner incorporated office. · propriety insurer Most products can be traced back The main product structures are – conventional or into four main insurance type risks unit linked - that are insured. In terms of - Profit sharing between insurer and customer from products they are: investment, mortality (etc), and expenses can be either Products Life cover shared or not shared – non-profit or with-profits Zinsurance Critical illness Some of the above structures lend them more usefully to some types of products. Income protection For instance, products that are aimed at meeting Life annuities customers savings needs are likely to be more easily structured as unit linked. Business is marketed to individual Conventional products are simpler and often better customers and group clients aligned to protection products. 5 How has the life insurance market changed? 4 The past… Insurers Large number of insurers Mostly mutually owned Expensive Products Often overly complex and relies on using a with-profits approach Sales Own salesforce providing limited advice Remuneration structure often opaque ↳ benefits are vague For many years life insurance was provided directly by many insurers. They employed sales staff to sell policies directly to customers. Initially products were simple in a benefits sense but employed the concept of with-profits which is notoriously difficult for non- experts to understand. Over time the complexity of products increased to a level that meant customers found it difficult to understand how the product was structured, what the benefits were, the charges they are paying. Additionally the remuneration from selling policies to customers appeared to be influencing the behaviour of sales staff. 3 6  27/09/2022 &wa Quin How has the life insurance market changed? Now… 5 Small number of insurers Insurers Increasingly technology focused Mostly shareholder owned Lower cost products Products Simpler products that are better explained to customers Less with-profits Majority of insurers do not provide advice Most business is sourced through financial Sales advisors and no have no sales staff Remuneration structures have to be explained to the customer - In the late 1990s a number of scandals caused significant customer detriment. The Government decided that financial services in the UK required a significant increase in the amount of statutory regulation. The Financial Services and Markets 2000 Act (FSMA 2000) passed into law and the statutory regulators of the industry were established. This has ultimately led to the creation of: Financial Conduct Authority – focused on the advice and provision of insurance products Prudential Regulation Authority – focused predominantly on the solvency of insurers 7 The Regulators 5 4 8  27/09/2022 The Regulators 5 The role of the FCA: Ensure markets function well. Protect consumers of financial products. Protect and enhance the integrity of the UK financial system. Promote effective competition. The role of the PRA: The Bank of England prudentially regulates and supervises financial services firms through the Prudential Regulation Authority (PRA). Monitors the insurers’ financial safety and soundness, which also helps to support the wider stability of the UK financial system. Encourages firms to hold adequate financial resources – specifically capital and liquidity – to keep things ticking. 9 How has the life insurance market changed? 5 5 10  27/09/2022 Culture at life insurers now 6 The increase in regulation throughout the world has helped insurers become more customer centric organisations In many ways similar to many other industries In particular promoting the understanding that ‘corporate aims of the insurer can be best achieved if they are aligned to the needs of the customer’ Many of the principles that insurers now use to drive their behaviours are called the ‘treating customers fairly’ set of customer outcomes - Products Good No Post Good Appropriate Clear Suitable Customer Sale Culture for Information Advice Barriers to customers Service Exit 11 Our role as actuaries… 7 Actuaries have always been important in insurance. Traditionally focusing on reserving, pricing, product development. * - Now actuaries work in many roles of a life insurer – driving high performance in all areas. ~ ~ Actuaries must make sure that regulatory, public and professional responsibilities are considered alongside the Y corporate requirements of the insurer We shall now look at how new business is managed through an insurer, note where actuaries are involved, and how the process can be viewed as a lifecycle The forthcoming weeks will focus on diving deeper into aspects of this lifecycle 6 12  27/09/2022 &anncard a neraries The life insurance product lifecycle ( = actuaries involved) 8 Market testing ① Establish customer demand Business case Product build - Documentation O Product development - Systems (including reporting) Assumptions - Processes o Pricing Price product Customer mix Actuary Product Competitors Development Underwrite customers Actuary Aggregators ⑪ Write new business Distribution team focused ⑤ Invest premiums Asset-liability management Investment Actuary Ensure solvency and liquidity requirements Optimise reserves and capital are met ⑯ Utilise reinsurance and group structure Capital Assess, agree, and pay Performance feedback ① Pay claims claims Actuary Forecasting Underwriting profit/loss g Measure performance Customer performance Reporting Shareholder distribution Actuary Regulatory reporting 13 Deep dive 10 The areas of this lifecycle we shall look more deeply at during this part of the model are: Part Name Description L02 Product development Walk through the product development process that is often used to investigate and build new products by life insurers. L03 Managing longevity Description of how and why longevity is managed in a life insurer. L04 Life underwriting Explain the importance of medical underwriting and how actuaries interact with underwriters. L05 Reserving, capital Describe the key aspects of Solvency II and management & Solvency II give practical examples how is employed. L06 Reinsurance Walk through of how reinsurance works ans why it is important These represents areas of activity that you may be exposed to in your early career. 7 14  27/09/2022 THE UK’S EUROPEAN UNIVERSITY www.kent.ac.uk 15 8 Equitable Life Article BBC Website, 15 January 2009 Once upon a time, until the turn of the century, the Equitable Life was considered the most respectable pension company in the UK. Established in 1762, it eventually became one of the biggest mutually owned life insurers in the world, with around 1.5 million policyholders. Along the way it became the pension company of choice for the prosperous middle classes professions. People such as lawyers, accountants and anyone else who felt they needed to invest to provide themselves with a personal pension in retirement. The company had little trouble attracting savings and thrived in the 1980s and 1990s. For many years it appeared to provide a better return on its funds than most of its competitors. It claimed it did this, partly, by selling policies through its own sales force, thus cutting out commission to financial advisers. In the process its own salesmen gained a reputation for being among the highest earners in the financial services industry. As we now know, much of this was an illusion. Guarantees The two main reports on what went wrong at the Equitable were published by Lord Penrose in 2004 and by the Parliamentary Ombudsman, Ann Abraham, in 2008. Together they outlined a toxic mixture of financial exaggeration by the society's management, and a succession of government departments and regulators who were asleep on the job. It all came crashing to the ground in 2000. The society's own management had initiated a High Court test case to validate a policy they had been pursuing for a number of years - a policy of, in effect, reneging on a promise they had once made to certain policy holders over many years. - Known as the Guaranteed Annuity Rate (GAR) holders, these people had invested in policies that guaranteed a minimum rate of return on their investments once they got to retirement. The society had never really expected to make good on its promise and had not put enough money aside to do so. But once it became clear in the 1990s that these policyholders might be able to invoke the guarantee, the society tried to wriggle out of the commitment. Eventually the House of Lords ruled that the Equitable could not do this. = And this flushed out the astonishing revelation that it now needed to put aside an extra £1.5bn to make good the promise - money it did not have. Crisis All this triggered not only the closure of the society to new business by the end of 2000, but a financial crisis that almost caused it to collapse. It led directly to hundreds of thousands of savers having the value of their policies cut by the new management, for one very simple reason. The only way the society could survive was by paying investors in line with what the underlying funds were really worth, not with what they had been told they were worth before. = The available money simply had to be spread around more thinly. People who were still saving were told that their fund values were being slashed. But in addition, those who had already retired, but had still kept their funds invested in with- profits policies - the so- called "with profits annuitants" - suffered even more. - Their money was trapped in the society and their pensions payments were slashed too, partly as a result of the underlying funds being moved into much safer, but much lower yielding, bond funds. No reserves The position of the Equitable, as outlined by Lord Penrose, was startlingly clear, at least with the benefit of hindsight. He found that for many years the society's management had been telling its savers that their accumulated funds were, in fact, worth far more than was really the case. The society had simply failed to put enough money away in its reserves for a rainy day, allocating far too much of the return on its investment funds immediately to its members. O Lord Penrose estimated that the society had told its investors their policies were worth £3bn more than was actually the case. On top of that came the £1.5bn bill for the GAR fiasco. He also found that the society had used "dubious" actuarial techniques to make it seem it was profit- making when it was in fact losing money. Compensation Although the Penrose report pointed to failings at various regulators, like the Department for Trade and Industry and the Government Actuary's Department, it said the blame for the Equitable's problems lay principally with the society's management, who he accused of being the author of its downfall. However when Ann Abraham, the Parliamentary Ombudsman, published her second report on the saga last year, the regulatory failings were exposed glaringly. She found 10 examples of maladministration by the authorities and called for the government to establish a compensation scheme, an idea it had steadfastly rejected since 2000. She decided that the authorities had let the society continue trading "on an unsound basis" since 1990, thus letting the public be misled into thinking the society was solvent when it was not. All along the government has denied that it, and by extension the taxpayer, had any responsibility for the investment and managerial shortcomings of a commercial insurer. But the pressure on ministers since Ann Abraham's second report has been too great to resist completely any more. The Equitable is now much smaller than it was, as various parts of the business have been sold by the new management which was installed in 2001. But it has 200,000 individual policyholders, and 300,000 who are members of group pension schemes, who are still invested in its £6.5bn with- profits fund. Equitable Life Timeline 1999 15 January 1999 - Equitable Life launched court proceedings in order to gain approval for its plan to ask some policyholders to accept a cut in bonuses since it could no longer afford what it had once promised. But policyholders responded by taking legal action for alleged breach of contract. 5 July 1999 - The first court hearing took place. 9 September 1999 - Equitable won the first stage of the battle when the Court ruled that it acted lawfully in cutting bonuses. But the pension policyholders immediately decided to appeal. 2000 21 January 2000 - Equitable Life's confidence was shaken when the Court of Appeal reversed the decision, ruling that the Society must honour its original commitments. Equitable Life immediately decided to appeal against the decision to the House of Lords. 20 July 2000 - But the House of Lords upheld the Appeal Court's ruling. And the company - unable to pay the £1.5bn cost of losing - was forced to put itself up for sale. 27 July 2000 - Prudential, the UK's biggest life assurance company, mulled a £5bn bid for Equitable Life. About ten companies were thought to have considered a take- over, but no firm bids ever materialised. December 2000 - Policyholders are outraged to discover that no with- profits policies will receive any growth for the seven- month period from 1 January to 31 July 2000. Equitable Life had not allocated any growth to its with- profits policies in the first half of the year,D hoping that additional funds would emerge from a take- over. 8 December 2000 - Equitable Life closed its doors to new business, having failed to find a buyer. The society remains solvent and continues to pay out premiums on existing policies. 9 December 2000 - Policyholders are even more outraged and complain of being trapped when Equitable Life increased its penalty fee for withdrawing funds to 10%. 19 December 2000 - The Treasury announced that the Financial Services Authority (FSA) is to be probed, following criticism that the regulator should have acted faster in order to protect policyholders. 20 December 2000 - The president and seven non- executive directors of Equitable Life announced that they would& quit when replacements are found. 22 December 2000 - Equitable Life begins to sell- off its operations in order to generate cash to pay policyholders. 23 December 2000 - The Office of Fair Trading (OFT) wrote to the Equitable Life requesting information on the untimely rise in its penalty exit fee. Equitable's wholly- owned subsidiary Permanent Insurance Company Limited was sold off to Liverpool Victoria for £150m, payable in cash. 2001 9 January 2001 - The Equitable Life Guaranteed Annuity Action Group proposes a compromise to the Equitable, aimed at ending the dispute and capping the society's liability. 10 January 2001 - The part played by chartered accountants auditing Equitable Life is to be investigated by the Institute of Chartered Accountants. 3 February 2001 - After seven months of searching for a buyer, two bidders suddenly emerge: GE capital and Halifax. 5 February 2001 - Halifax clinches the deal. The Halifax agrees to pay £1bn to buy the Equitable's sales force and non- profits policies. The £1bn payment will allow the society more freedom to invest the funds of the with- profits policies. The deal is subject to policyholder approval. 23 May 2001 - Equitable Life's new management faces angry policyholders at its first annual general meeting since the crisis began. 16 July 2001 - With- profits policyholders are shocked and angry to learn that their savings will be slashed by 16%. But the board says desperate times require desperate measures. 22 August 2001 - The board meets with the action groups in order to thrash out a compromise deal in order to clinch the money promised by the Halifax. The details of the compromise are not yet made public. 31 August 2001 - The Government announces that it is to launch a full investigation into the circumstances leading up to the downfall of the assurer. Lord Penrose - an accountant and commercial judge - will head the inquiry. 20 September 2001 - Equitable publishes a compromise deal for policyholders. It proposes that 70,000 guaranteed policyholders (GARs) should get a 17.5% increase in the value of their plans and sign away their guaranteed pension rights. And the 415,000 policyholders, who are not GARs, are being offered a 2.5% increase on the value of their policies, but must sign away their rights to any legal claims. 17 October 2001 - Baird report published. Report by FSA director of internal audit Ronnie Baird wrote the report, which investigated the FSA, PIA and Treasury's handling of Equitable between January 1999 and December 2000. The report concluded that the FSA had failed to spot key problems and follow up issues that had been uncovered among other issues. However, Mr Baird also said that the "die was cast" before the FSA took over regulation. 30 October 2001 - Treasury Select Committee. Sir Howard Davies and Ruth Kelly MP, economic secretary to the Treasury, were cross- examined by the Treasury select committee. Sir Howard admitted that there had been management failures, but it was Equitable Life which was "arrogant" and had blocked attempts by the FSA to investigate its troubles. Ms Kelly gave a glimmer of hope to policyholders by saying that the government might consider compensation for some victims if a "grave injustice" had occurred. 13 November 2001 - Sir Howard Davies to be questioned by Treasury Select Committee. 2002 11 January 2002 - Policyholders meeting to vote in person on the compromise deal, a last- ditch rescue package aim ed at salvaging t he com pany s finances and m eet ing it s liabilit ies. 28 January 2002 - Equitable announces that its policyholders voted overwhelmingly in favour of the rescue package. 98% of the company's guaranteed policyholders backed the - deal. - 8 February 2002 - The High Court approves the rescue package, paving the way for a £250m cash injection from the Halifax. 27 May 2002 - At the first annual general meeting since Equitable's compromise deal to end its £1bn pension liability was passed, members were told that the company was "solvent". 1 July 2002 - Members who move away& before their policy before it matures will face increased exit penalties and smaller surrender values. 29 September 2002 - Equitable denies a report that it is secretly planning for insolvency - a move that would put the savings of its 1.5 million members at& risk. 15 November 2002 - Equitable cuts income paid to 50,000 with- profit annuity holders by 20%. 22 November 2002 - The FSA say it is backing Equitable and it should not be wound up. 18 December 2002 - Equitable chairman Vanni Treves says that Equitable might consider suing the government if the Penrose report finds that governmental regulation was inadequate. 2003 14 February 2003 - The case for damages brought by the Equitable against its former auditors Ernst & Young for failing to offer proper advice in the 1990's is thrown out by the High Court. The judge in the case describes Equitable's claim for damages as "fanciful". The Equitable announces that it will appeal the decision. 23 May 2003 - The Financial Ombudsman tells Equitable that it must compensate GAR policyholders who were removed from the firm's with- profits fund before the compromise - scheme was agreed. 1 July 2003 - The Parliamentary Ombudsman, Ann Abraham, clears the Financial Services Authority of any wrong- doing. Report raises serious questions about public expectations of financial regulation. 25 July 2003 - Equitable wins its appeal and can now sue its former auditor Ernst and Young for £2.6bn 17 October 2003 - Equitable Life wins the right to sue nine former non- executive directors for £3.3bn. 12 November 2003 - In its interim accounts, the society says it is "solvent" but "challenges and uncertainties" lay ahead. 2004 24 November 2004 - In a letter to MPs Ann Abraham says she hopes to publish her report by the end of 2005. 19 July 2004 - Parliamentary Ombudsman Ann Abraham announces she will reopen her investigation into the life assurer. She will examine the government's role in the prudential regulation of Equitable Life in the period prior to 2 December 2001. 15 July 2004 - More than 700 pensioners, known as "trapped annuitants" lodge a multi- million pound claim against the society. 8 March 2004 - Lord Penrose's report is published, accusing the former Equitable management team of "dubious" practices and nurturing a "culture of manipulation and concealment". 23 January 2004 - Ruth Kelly, Financial Secretary to the Treasury, passes the soon to be published Penrose report to the Serious Fraud Office. 2005 21 March 2005 - The troubled mutual's chairman Vanni Treves says Equitable's finances are in a better state than at anytime since 2000. 11 April 2005 - Equitable sues former auditor Ernst & Young and 15 former directors for £4bn. The mutual claims that the directors failed in their duties to policyholders and the auditor signed off its accounts without warning of the problems that led to its collapse. 18 July 2005 - Equitable drops part of its claim for damages against Ernst & Young. 22 September 2005 - The case against Ernst & Young is dropped entirely at a cost of £30m. Ernst & Young chairman Nick Land described Equitable's decision to abandon the case as a "complete vindication" adding the case was "ill conceived" and should never have been launched. October 2005 - The Parliamentary Ombudsman Ann Abraham tells the Public Accounts Select Committee of MPs that the hopes to publish her report in the spring of 2006. 2 December 2005 - Equitable abandons its case against 15 former directors at a cost of £10m, groups representing members call for Vanni Treves resignation. 2006 18 January 2006 - The European Parliament announces an investigation into the Equitable scandal. The investigation will focus on whether the government failed in its regulatory duty and may call on UK Treasury officials to testify. 24 February 2006 - The Parliamentary Ombudsman Ann Abraham tells MPs she hopes to complete her investigation by the end of the year. 11 May 2006 - Equitable announces a deal to transfer £4.6 billion of non- profit pension annuities to Canada Life. This represents approximately 130,000 policies. Subject to approval from the High Court, this would be the largest transfer of a non- profit annuity portfolio in the UK. 16 October 2006 - The Parliamentary Ombudsman Ann Abraham warns of yet another delay in her investigation into the prudential regulation of Equitable. She now says the earliest she expects to publish is May 2007. 20 December 2006 - Equitable announces the sale of its wholly owned subsidiary University Life to Reliance Mutual for an undisclosed sum. University Life has £30 million of assets and fewer than 2,000 policyholders. 2007 12 February 2007 - The transfer of £4.6 billion of non- profit pension annuities to Canada Life is completed after approval is granted by the High Court and the Royal Court of Guernsey. 15 March 2007 - Equitable Life agrees to transfer £1.8 billion of with- profits annuity policies to Prudential. The deal involves the transfer of approximately 62,000 with- profits annuities (representing some 50,000 annuitants). It requires approval by members at an extraordinary general meeting and by the High Court. 22 May 2007 - Parliamentary Ombudsman Ann Abraham gives another progress update on her investigation. In a letter to MPs she says the draft report she sent to the Treasury, the Government Actuary's Department and the Financial Services Authority in January 2007 prompted a "substantial" joint response running to more than 500 pages. She says she will need "some time" to consider the response, and will therefore not publish her report before the summer recess as planned. She promises an update in October. 1 June 2007 - Equitable's sale of University Life to Reliance Mutual is completed. 19 June 2007 - The European Parliament calls on the UK government to compensate Equitable policyholders after MEPs vote overwhelmingly in support of a highly critical report from a committee of enquiry set up to examine the crisis. The report blames the UK government for failing to ensure that EU legislation on insurance had been implemented properly, and said the UK's financial regulators had been "excessively lenient" in failing to ensure that Equitable was solvent. The MEPs acknowledge that they have no power to enforce their recommendations. 26 October 2007 - At Equitable's extraordinary general meeting, more than 98% of voting members support the transfer of £1.8 billion with- profits annuity policies to Prudential. Subject to approval from the High Court, the transfer is expected to take effect on 31 December 2007. 30 November 2007 - The High Court approves the Prudential deal. 4 December 2007 - The Royal Courts of Guernsey and Jersey approve the transfer of with- profits annuitants based in the Channel Islands to the Prudential. 10 December 2007 - Parliamentary Ombudsman Ann Abraham finally gives MPs the progress update she promised for October. She proposes circulating her revised draft to the government and other interested parties, and advises MPs she will not now publish her report before April 2008. Policyholder groups condemn the continuing delay. 2008 2 January 2008 - The transfer of all of Equitable's with- profits annuity polices to Prudential is completed. 10 January 2008 - The law firm Clarke Willmott announces it has reached a settlement with Equitable Life on behalf of 407 with- profits annuitants. Equitable agrees to pay an undisclosed sum to the policyholders. The annuitants launched proceedings against Equitable in the High Court in 2004, alleging that their annuity policies had been mis- sold by the society between 1990 and 2000. 17 July 2008 - Parliamentary Ombudsman publishes a major report saying ministers should set up a compensation fund for policyholders in the Equitable Life. 15 December 2008 - MPs on the Public Administration Select Committee call on the government to comply with the Ombudsman's recommendations and to apologise to the Equitable's savers. 2009 15 January 2009 - The government announces that it will compensate those policyholders "hardest hit" by the collapse. Former appeal court judge Sir John Chadwick will advise the government on who will receive payment and how much. Opposition MPs and campaigners, however, say the scheme does not go far enough. 29 January 2009 - Parliamentary Ombudsman Ann Abraham says she is "astonished" at the government's "unsatisfactory" response to her report. 19 March 2009 - The public administration committee says it is "deeply disappointed" with the government's limited remedy scheme. 21 July 2009 - The Equitable Members Action Group goes to the High Court to call for a judicial review over the government's decision not to follow recommendations to offer full compensation to victims. Where Equitable Life went wrong ANALYSIS By Andrew Verity BBC News personal finance correspondent The near-collapse of Equitable Life shocked not just the firm's policy holders, but the whole life insurance industry. Now the report of Lord Penrose has laid open what went wrong. Equitable Life was promising its policyholders more money than it actually had for more than a decade, according to one of the most striking findings in the Penrose report. For years, Equitable had claimed to be more transparent than other life insurers, allowing its customers to work out what the value of a policy was in pounds and pence. But from the late 1980s, the society was telling policyholders their investments were worth substantially more than Equitable actually had in its coffers. By the year 2000, the stated value of By the year 2000, the stated value its customers' policies was £3bn of its customers' policies was £3bn more more than the assets actually held by than the assets actually held by the D the company. company That was before the House of Lords handed Equitable a bill of more than £1.5bn to pay for annuity guarantees in full. By 2001, that gap had reached £4.4bn - forcing the new board led by Vanni Treves and Charles Thompson to slash policy values by 16%. Smoothing out in the wrong direction It was that policy of consistently allocating to policyholders & more than it actually held in assets which led to the society's financial troubles. Annuity guarantees only precipitated its decision to sell - itself. From one perspective, there would The society did not believe in be nothing wrong with Equitable keeping money from current investors in allocating more to policyholders than order to build up a reserve for the it had in its coffers - for a short time. future. In "with-profits" funds life insurers hold some money back in reserve during years when their investments on the stock market do well. That way they can still afford to make good payouts in years when their investments do poorly - an approach known as "smoothing". Because of smoothing, a life insurer may at times allocate more value (in the form of bonuses) to its customers policies than it holds in underlying assets. However, that should, in theory, be a temporary state of affairs. When markets are booming, the[value of the underlying assets should exceed the value allocated to policyholders.. 7 Another way of looking at this is the "peaks and troughs" diagrams adopted by sales people. These show the effect of smoothing: although in the good years the investor may not do as well as he would in a fund that tracked the stock market, in the bad years the investor should do better, "smoothing" out returns - steering a middle course between the peaks and troughs. Equitable's appointed actuary in the 1990s, Chris Headdon, told Lord Penrose Equitable was "smoothing across the peaks" - not a credible approach, according to the judge. Maximum bonus, maximum shortfall Equitable explicitly adopted a controversial policy, known as "maximum distribution". Its chief executive from 1992 to 1997, Roy Ranson, said this was based on a belief that the society belonged to the current generation of policyholders - not future generations. The society did not believe in keeping money from current investors in order to build up a reserve for the future. Because the maximum money was Equitable used a range of distributed to policyholders in good "dubious" actuarial techniques - also years, very little was held back for a employed by other life insurers - to make rainy day. it look like it had made a surplus when in fact it had made a loss In theory, this should have meant that in bad years, the stated value of customers policies would go down. Penrose Report However, instead of cutting them, Equitable used a range of devices to keep them up - allowing a growing gap to open up between what it was promising policyholders and what it could actually deliver. Dubious practices One device - used by all life insurers to varying degrees - was to stop allocating bonuses to customers policies in the form of "reversionary bonuses". These were guaranteed and had to be counted on the life insurers' accounts as a liability.  Instead, an increasingly large chunk of the bonuses allocated to policyholders took the shape of "terminal" or "final" bonuses. These could be added or cut with impunity and without affecting the company's solvency - even if they did affect the value the customer expected. Equitable never even counted part of these final bonuses as a liability. And it used a range of "dubious" actuarial techniques - also employed by other life insurers - to make it look like it had made a surplus when in fact it had made a loss (Penrose report, p. 689 para 41) These included devices such as counting future profits - which might never be generated - as an asset in the accounts. Another was to use financial reinsurance to get a liability off its balance sheet. In fact the reinsurance provided only a very limited amount of cover. Yet more surprises And the report yields yet more startling findings. The Government Actuary's Department (GAD) is supposed to monitor life insurance companies through the voluminous "returns submitted" every year by every life insurer. "It is clear that Equitable's returns were not understood by GAD actuaries throughout the 1990s," Lord Penrose writes (p 744 para 75). The board of non-executive directors were so dependent on input from executives, in particular the chief executive and appointed actuary, that they were "largely incapable of exercising any influence" (p. 739, para 51). Regulators (ie the Department of Trade and Industry and GAD) allowed Ranson to become chief executive and appointed actuary * (normally separate roles to avoid conflicts of interest) in spite of the "obvious dangers inherent in such a concentration of authority and influence". Appointed actuaries have special statutory duties to look after the interests of policyholders and challenge management decisions if necessary. (Despite) "officials' clear understanding of the unsatisfactory aspects of the situation, no steps were taken effectively to prevent it coming about." Don't ask, don't tell Roy Ranson, the "idiosyncratic and autocratic" actuary and later chief executive, formulated Equitable Life's policy on guaranteed -  D annuities, ruled illegal by the House of Lords in July 2000, as far back as 1983. He did not tell the rest of the board about it until 1993. Policyholders were not told about it until 1995 at the earliest. Roy Ranson ran a large with-profits fund worth £30bn "without- significant control by his colleagues, his board, the auditor or the regulator". Regulatory failings There was an "unacceptable" lack of co-ordination between the two branches of regulation - the DTI, responsible for "prudential regulation" of the company's solvency - and other regulators (eg the Securities and Investments Board, later the FSA) checking on whether it followed strict rules on selling process (p 742 para 64). Regulators assumed no-one would be disadvantaged when Equitable continued selling policies after 1999, when it became clear Equitable might have a problem. Regulators simply assumed there would be compensation if something went wrong. There was no recognition that other policyholders would have to pay the compensation; no attempt to quantify the risks of Equitable continuing to do business; and no attempt to mitigate the possibility that policyholders might in future claim misrepresentation. In the words of Lord Penrose: There was a "general failure on the part of regulators and GAD to mount effective challenge of the management".  The UK’s European university Actuarial practice Part L02: Product development Vaishnavi Srinivasan 1 The steps involved with building a new product and writing new We will focus business ( = actuaries involved) 2 on product development Establish customer demand Market testing Business case Product build - Documentation Product development - Systems (including reporting) Assumptions - Processes Pricing Price product Customer mix Actuary Product Competitors Development Underwrite customers Actuary Write new business Live on aggregators Distribution team focused Invest premiums Asset-liability management Investment Actuary Ensure solvency and liquidity requirements Optimise reserves and capital are met Utilise reinsurance and group structure Capital Pay claims Assess, agree, and pay Performance feedback Actuary claims Forecasting Underwriting profit/loss Measure performance Customer performance Reporting Shareholder distribution Actuary Regulatory reporting 2 1  Background 3 * Product development has been part of writing insurance right since the foundations of insurance. card It can mean: fash Invention – bringing something new to the market Innovation – enhancing an existing product Updating/modernising an existing product Building a proposition for a particular group Insurance started due to society need for financial protection but over time that focus became clouded by: complex products, even more complex structures – unit linked initial and accumulation units for example and the financial advice given was often not of good quality The FCA decided that they would prescribe requirements as to how product development should take place in an insurer. It is covered in their PROD handbook. Section PROD 4.2 is especially important 3 Product development process 4 Concept document Bann Concept A fully defined product customer insight - development process Gate 1 strategy alignment - (PDP) governs how product development is market opportunity - - done in an insurer Proceed The PDP is considered Business case and authorised by the Viability business case CManagement CommitteeC Gate 2 (or the Board directly) inc product design A more recent approach Proceed is for the Board to allow the Management Committee to establish a Functional design Design Product & Customer Sub- function design Gate 3 Committee to focus on updated business such matters. case with buildP costs The PDP has various Proceed ‘gates’ where the management committee Delivery plan Delivery agrees to proceed or project plan & costs stop development. including launch planning 4 2  Customer insight 5 onot Customer insight can be in several forms. This should drive virtually all possible developments. Examples include: Market research - establishing customer need - - customer satisfaction - - customer sentiment - Customer analytics - lapses - - - number & type of complaints - review against TCF outcomes - Market intelligence - competitor pricing - - macro aspects – regulation etc - - future changes that will impact market - Staff feedback - conversations with customers - - highlighting issues - - presenting ideas - 5 Market research – testing a concept 6 One aspect of customer insight that is very important is performing market research (aka customer research). It involves interviewing potential customers to ascertain insight whether the proposed development is attractive. You must plan very carefully what aspects of the proposed development you want researched else the customer feedback may well come back bland and not usable. The key objectives are to understand: Whether there is a need for the proposed product Identify groups of target customers The barriers to the product The research method to obtain this can be: Face-to-face questioning Telephone based Internet based Insight can be either quantitative and qualitative. & Typically internet based is the cheapest and may lead to a much wider interview base reached (and faster). It is imperative that the actuary is involved in this process, as they are likely to be responsible for ownership of the business case 6 3  Market research - an example 7 Qualitative Referring to the questions asked Quantitative 7 Business case & wo Once Gate 1 has been passed, then the proposed development moves onto a formal investigation into 8 zant whether the insurer should progress with the opportunity. The writing of the business case draws skills and experience from all the business and externally too. In extreme circumstances the business can take months to sign off and goes through several committees (often including the Board) Strategic fit ~   Initial product pricing Product profitability - - Product description  Project build cost ↑ -  Company impact - Distribution  P&L ~ - > Administration  Solvency Financial aspects >  Risks to product profitability M - Risks  Risk to the insurer as a V result of the development Build & launch plan ↑ 8 4  Financial aspects The actuary often builds the models behind the financial 9 modelling. Typically this involves the following steps: noncaro & cash flow model build - assumption set - Per policy profitability cost of risk capital included - f - market opportunity Sales customer mix - volumes - cost of build ↑ Development additional entity costs costs profitability - - capital impact - including new business Final product profitability strain > ↑ P&L Insurer Solvency - impact 9 Build & launch plan 10 Functional areas that may be required to support development: IT systems - Underwriting ~ Actuarial pricing - Pricing ~ Customer - Actuarial - services reporting Marketing - Financial - control Sales support - Financial > Management - reporting information Investment - management Compliance > Risk management - Claims - - Launch plan Functional areas may require development and also ongoing changes 10 5  Build & launch plan 11 QUESTION - How do we build the product successfully in an insurer ANSWER – The business has an area that with many area? leads ‘change’ in a business - named Change Management - The build process is managed by the project delivery process inside the Change Management area. A project manager runs the build on a day-to-day basis. A project plan is formed outlining: - What needs to be built - When it needs to be done - Who needs to build it Much resource is used in building the project plan. Weekly project meetings will track progress against plan Formal reporting will be through to the Management Committee also 11 Summary 12 Product development is an exciting and demanding area of work where actuaries are key. In particular an actuary may have the responsibility to understand the financial costs and implications of implementing the proposed development The process from concept to launch can take months (or even years), hence careful determination is important. 12 6  THE UK’S EUROPEAN UNIVERSITY www.kent.ac.uk 13 7  - - ↑ 1 ↑ - ~ - - ~ - - and - ul has ↑ - - ~  - - - - - ~ - - - - - ↑  - - - - ~ - - -  The UK’s European university Actuarial practice Part L03: Managing longevity risk Vaishnavi Srinivasan 1 t The product cycle (✔ = actuaries involved) 2 We willMarket focus testing on Establish customer demand longevity risk Business case ✔ Product build Product development management - Documentation - Systems (including reporting) Price product Assumptions Customer mix Pricing Actuary - Processes ✔ ✔ Product Competitors Development Underwrite customers Actuary Write new business Live on aggregators Distribution team focused Invest premiums ✔ Asset-liability management Investment Actuary Ensure solvency and liquidity requirements Optimise reserves and capital are met Utilise reinsurance and group structure ✔ Capital Pay claims Assess, agree, and pay Performance feedback Actuary claims Forecasting Underwriting profit/loss Measure performance Customer performance Reporting Shareholder distribution Actuary Regulatory reporting ✔ 2 1 * Insurance: Customer point of view 3 na ① Choose an insurance policy: & Depending on – Needs: savings, protection, etc. – Money available for paying premiums. – Availability of insurance products, regulations, tax, etc. O Pays premiums: Single or regular premiums. Premium amount depends on risk and value of what is being insured. & Make a claim: If the insured event occurs during the policy term. Insurer may or may not honour the claim. 3 Insurance: Insurer point of view 4 Maancard Insurance policies are inherently risky. Managing this skill is key to the insurer’s success. Can you name the name ’product’ related risks? Claim – amounts and/or frequency – higher than expected Expenses – higher than expected Investment returns – lower than expected There are other risks too: Business risk – the operational risk that the business is not sustainable Customer risk – the risk customers do not require insurance We will focus on claims risks here. usi D For life insurance there are two types: Mortality ↓ Yongenits Longevity mortality We will now discuss longevity risk 4 2  5 Longevity and longevity risk In 1965, André-François Raffray, a lawyer in the southern French city of Arles, made a deal with a ninety-year-old local woman. In a contract relatively common in France, he agreed to pay her an income for the rest of her life in exchange for inheriting her house upon her death. Unfortunately for M. Raffray, the woman was Mme. Jeanne Calment, who went on to be the longest-lived person in the world at 122 years. She outlived the luckless M. Raffray, who paid more than the value of the house before pre-deceasing her. “In life, one sometimes makes bad deals”, said Mme. Calment of M. Raffray. 5 6 Longevity and longevity risk Longevity = individuals living longer than expected. & avo Longevity is the result of a complex interaction of factors: Increased prosperity - nat Healthier lifestyle - Better education - Progress in disease diagnostics and medical treatment, etc. - LongevityD risk: Individuals living longer than expected, creates challenges for: – Individuals (risk that they run out of income) – Government – Defined benefit pension funds – Life insurers who sell retirement-related insurance products, whose ↑ liabilities increase as life expectancy improves. Has two components: - – Individual longevity risk (can be diversified away) – Collective longevity risk (no easy way to reduce/remove this) 6 3  7 Longevity and longevity risk Factors which could increase longevity Factors which could reduce longevity Fewer smokers - Lifestyle Improved diets > More stress - Rise in obesity Regular exercise - Less physical activity > Medicine Development of drugs tackling life- Viruses and bacteria develop resistance to threatening conditions (e.g., statins) Y available drugs - Lower accident mortality - Discovery of an effective gene therapy ~ Disease Improved survival rates of, for example, New diseases/viruses evolve - cancer or heart disease ~ Pandemics - Diabetes - 7 8 Longevity and longevity risk - 1 - - ~ ↓ M 8 4  9 Longevity Risk Examples – Pensions e Defined Benefit fund An employer, via a retirement fund, promises the employee a formula‐based benefit in retirement. The longevity and investment risk and reward reside with the employer/retirement fund. e Defined Contribution fund An employer, via a retirement fund, promises to make contributions on behalf of the employee and the employee receives whatever this “pot of money” has grown to at retirement. The longevity and investment risk and reward reside with the employee. ③ Income Drawdown Income drawdown is a way of getting pension income when you retire while allowing your pension fund to keep on growing. Instead of using all the money in your pension fund to buy an annuity, you leave your money invested and take a regular income direct from the fund. The investment and longevity risk and reward reside with the annuitant. 9 Longevity Risk Examples – Life Business 10 · Guaranteed Annuities A purchased annuity providing a guaranteed monthly benefit for the lifetime of the annuitant, with the investment and longevity risk residing with the life insurer. - With‐Profit Annuities A purchased annuity providing a non‐guaranteed monthly benefit for the lifetime of the annuitant. It features an annual increase in income that is dependent on a future declared bonus rate, which is related to the performance of the underlying assets. longevity risk resides with the life insurer, while the[ The[ 3] investment risk mostly resides with the annuitant. 10 5  and inc Why do we need to model longevity? 11 Longevity risk can impact life insurers in the following areas: Pricing – we need to understand the likely cost of policy benefits for each customer Reserving – once a policy is written a estimate of the expected future claims is required Measure performance – to understand the source of profits/losses All of the above should source the longevity assumptions from an actuarial team that monitors longevity. 11 Longevity – a recap 12 Actuaries have built mortality tables over many years. These list annual mortality rates for individuals by age, sex and various other factors. & They are denoted by qx for a particular group at a particular calendar year There are some aspects for us to note: qx represents the average value. The variance of qx will change as sample size increase The values of each qx are calculated using the experience from a group of lives. You may remember the crude death rates are found using 𝑞. Graduation of the crude rates is then applied to produce the final rates. Examples of the methods of graduation are: – Least squares fitting – P-spline regression modelling – Lee-Carter (1992) modelling 12 6 Longevity – a recap 13 The profession produces a range of standard tables through the CMI bureau. The website is here: https://www.actuaries.org.uk/learn-and-develop/continuous-mortality- investigation/cmi-mortality-and-morbidity-tables/00-series-tables An example is: PMA92 (C=2010) This represents male pensioners weighted by amounts from data collected in 1992 and updated to include mortality improvements to calendar year 2010. Improvement factors are applied to tables to attempt to keep the values of qx in the table updated for the current calendar year Longevity is found from px = 1 – qx Ultimately, it is used to estimate how long people will live. The skill of the longevity actuary is to consider how the individual values then translate into a portfolio of policies 13 Modelling longevity 14 As mentioned earlier the key purposes as to why we need to model longevity are as follows: T Pricing new business – we considered this in Part L02 Reserving – we will see more of this in Part L05 Performance analysis In a modern insurance this modelling is usually performed centrally by a specialised team They develop sophisticated models to analyse data from various sources: I Standard tables from CMI Models from actuarial consultants Data from national bodies – such as the Office of National Statistics I Reinsurer data Own policies They often suggest mortality/longevity rates by several additional factors, as well as modelling future mortality 14 7  & 15 Hedging longevity risk flashcard Reinsurance Longevity Bonds Other options for pension schemes 15 THE UK’S EUROPEAN UNIVERSITY www.kent.ac.uk 16 8  The UK’s European university Actuarial Practice Part L04: Life underwriting Vaishnavi Srinivasan 1 The steps involved with building a new product and writing new 2 business (✔ = actuaries involved) Market testing Establish customer demand We will ✔ focus Business case Product build Product development on underwriting - Documentation - Systems (including reporting) Price product Assumptions Customer mix Pricing Actuary - Processes ✔ ✔ Product Competitors Development Underwrite customers Actuary Write new business Live on aggregators Distribution team focused Invest premiums ✔ Asset-liability management Investment Actuary Ensure solvency and liquidity requirements Optimise reserves and capital are met Utilise reinsurance and group structure ✔ Capital Pay claims Assess, agree, and pay Performance feedback Actuary claims Forecasting Underwriting profit/loss Measure performance Customer performance Reporting Shareholder distribution Actuary Regulatory reporting ✔ 2 1  What is underwriting? 3 Risk assessment process to check: – Applicant’s eligibility for cover - – The premium to be paid - This is performed as part of the new business application process. It is - carried out by skilled administrators called medical underwriters. Personal information from the applicant is used to allow underwriting to take place. This includes medical/health, lifestyle and financial information. Automated systems are commonly used to provide underwriting decisions with very little or no human interaction. Automated systems: -– Are faster – Have lower costs of processing & na and T– Help make more consistent decisions – Generate useful management information has 3 What is underwriting? 4 Medical consent will be taken from policyholders: – AMRA: Access to Medical Reports Act consent form – Information on policyholder’s GP will also need to be provided. For complex cases: trained underwriters. Typical risk assessment factors: - – Age and gender - 1 – Health conditions – Build (using body mass index: BMI) > – Family History - – Occupation and hobbies ↑ – Smoking, alcohol and drugs usage V – Residence and travel ~ – Financial situation ↑ – Driving records ↑ 4 2  Background 5 Purpose of underwriting in life insurance – To ensure that the premium charged is appropriate for the level of risk - - – To reduce anti-selection against the insurer - – ToD reduce fraud - - – To ensure over insurance is not taking place - 5 Purpose of Underwriting