Tag Archives: dynamic management actions

Lack of management action plans may leave European insurers exposed

This Risk.net article (subscription required) highlights Milliman’s “Dynamic policyholder behavior and management actions survey report”. In the article, Ed Morgan discusses how the absence of management action plans by European insurance firms can lead to shortcomings in governance. Here is an excerpt:

The majority of European insurers are not formally documenting how management teams plan to respond to changing economic conditions and are not modelling the impact of such management behaviour in stress scenarios, a survey has found.

Only five out of 20 European firms currently possess an official plan listing the actions management will take in certain economic scenarios, according to the survey by actuarial consultancy Milliman.

This is despite such plans being a requirement for European insurers under the Solvency II directive.

Ed Morgan, managing director of Milliman’s operations in Italy and Central Eastern Europe, says not having well-documented management actions is a governance issue, as well as being an issue for modelling and financial reporting.

“The absence of management action documents and model functionality can sometimes be because firms haven’t fully appreciated their importance,” says Morgan. “But you could also argue that sometimes management themselves might prefer not to be subject to this high spotlight governance in case it makes it harder to justify the actions they take in real life after the event.”

… The reason why some European firms have to do model management actions, despite regulatory pressure, is unclear, says Morgan.

“One thing may be lack of awareness of how modelling management actions can materially improve results. If you model management actions in an overly simplistic way, then they’re very likely to be suboptimal under various stress scenarios, and likely to overstate required risk capital,” he says.

The way companies are organised may also play a part in how management actions are modelled, says Morgan. For example, the actuaries that are building the model may not be close to the personnel setting investment decisions. “So when it comes to modelling management actions in regards to investment decisions, one set of people have one view on what they’re doing, another set of people are doing the modelling, and potentially a lack of communication and of understanding prevents a proper linkage being made between the two,” Morgan adds.

Dynamic policyholder behaviour, management actions, and life insurance

D Clark - J  Kent - E  MorganMilliman has just published a new report summarizing the results of a recent survey of current practice in the modelling of dynamic policyholder behaviour (DPB) and management actions (MA) for life insurance business.

There are 56 companies represented in the survey, across Europe, the United States, and Japan.

The survey revealed some interesting results. For instance:

• For variable annuities/unit-linked with guarantees, only around 50% of respondents model at least one type of DPB. This increases to 85% for other types of products (what we have termed “traditional” products).
• Of respondents offering guaranteed annuity options (GAOs) on traditional products, only around 16% of respondents were modelling them with dynamic take-up rates.
• Around 60% of companies have monitored DPB experience against that predicted by their models; of these, almost half say their models predicted experience well.
• Most companies in the United States and Europe model assets and liabilities, the interactions between them, and some type of future investment strategies (a form of MA) for certain classes of business. However, future investment strategies modelled are often oversimplistic, for instance being invariant to economic conditions.
• Only a minority of companies hold a formal documented plan for management actions. Most companies also don’t monitor actual management actions against those predicted by their models.
• Actuaries were the most prominent group involved in setting modelled MA rules, followed by investment and risk management professionals. Other professionals were more rarely involved.

DPB and MA are becoming increasingly important aspects of modelling as more focus is placed on stochastic calculations and the tails of distributions. In particular, Solvency II in Europe specifies requirements for both DPB and MA, so we expect significant work will be required of companies in these areas, particularly as they should form a key component of a company’s risk management.

Market turmoil in recent years across various regions highlights the importance of working to understand and model how management may react to such scenarios. However, the survey results show that many companies are failing to model DPB for some key options. Modelling of MA is also underdeveloped in many cases, with some key actions not being modelled at all, or in an oversimplistic way that doesn’t appropriately reflect reality.

DPB and MA predicted by models should also be monitored against actual experience as it emerges, with models being refined over time.

To download a copy of the DPB and MA study, click here. For further information email Jeremy Kent.

Solvency II presents challenges on management actions

Milliman’s Elliot Varnell, Jeremy Kent, Russell Ward, Russell Osman, and Andrew Gilchrist published a new paper on InsuranceERM.com assessing the implementation of management actions (subscription) to reduce technical provisions and capital charges by firms as well as their desire to carry over credit previously taken for these actions into Solvency II.

Here is an excerpt from the paper discussing the modelling of management actions:

In order to take credit for management actions, the actions need to be reflected in the model used to calculate the best estimate. This can be challenging where actions depend on the solvency of the insurer, creating a circular logic in the calculations which need sophisticated techniques to solve or model simplifications to remove the circularity.

There may be a number of actions available and the action, or actions, taken will depend upon the circumstances applying at the time. Some modelled management actions may not be undertaken in circumstances where the model assumes they will be taken. In this case, the board will need to consider whether it remains appropriate to take credit for that action and regulators may well seek justification from firms wishing to continue to take credit for such actions.

There may also be some non-modelled actions which will be available to the insurer in adverse circumstances. For example, a mutual insurer will need to reduce, or remove, discretionary policyholder benefits in significantly adverse circumstances to meet minimum benefits guaranteed to all policyholders. If the mutual is currently well capitalised, then it is unlikely to be modelling such an action, because the consequential reduction in liabilities and capital would be small. That is, the implicit margin included in the reserves by not modelling that action would be small. However, if capital becomes constrained, then the implicit margin would increase and it is likely the model would be enhanced to include that action.

For more insight about management actions and how they provide a crucial link between Pillar I and Pillar II of Solvency II, read this research paper on dynamic management actions.