Is the insurance industry losing faith in their actuaries?
While there has been a general decline in faith-based worship in the western world, one would have thought that life companies’ faith in the core tenets of their business remained intact.
So what are we to make of the news that Aegon is hiving off risk, not to a re-insurer but to a bank? Aegon’s announcement that they have agreed a life expectancy swap deal with Deutsche Bank, covering €12 billion of their reserves can only be seen as a lack of confidence in the ability of the actuarial body to accurately forecast life expectancy. It does make you wonder where exactly the actuarial expertise now is seen to rest.
It also makes you wonder what levels of risk Deutsche Bank is prepared to take on. Their expertise in longevity is surely less than Aegon’s, so someone is going to take a bath on this one. However, Michael Amori, Deutsche’s co-head of the bank’s longevity group, was open about their lack of actuarial expertise. “This is not about the bank telling anyone what the right life expectancy is. It is about finding a way to help a client transfer risk to others willing to take the risk on in exchange for a return”.
Deutsche Bank will ultimately package these as risk products, and sell them on to other investors after taking a cut for their trouble. Those who buy from Deutsche may retain them or may repackage again and sell on, bringing back frightening memories of the triple A-rated Collateralized Debt Obligations (CDOs) that lay at the heart of the Lehman Brothers collapse.
Aside from the dangers to the economic system, if longevity risk ultimately starts getting rated and sold by non-experts in the area, each layer in this process will need to make a margin in order to justify the approach. And, at the base of this inverted pyramid it is the customer who is propping up the whole thing, from whose contributions all of the ‘margins’ required by those businesses ultimately have to come.
So what seems like a prudent move by Aegon in order to protect its future earnings could just be the start of a chain that actually destabilises everyone in it. In the end, only the customer will pay.
Of course, this whole process was inevitable from the moment Solvency II raised its head. Faced with the restrictions imposed by the need to increase their reserves to meet the new regulations arising from Solvency II, it was inevitable that Insurers would begin to look beyond traditional re-insurers in order to reduce their reserve requirements and allow better use of their capital for growth.
While a single deal, even of this size, is not worrying, Deutsche Bank is forecasting a big increase in the use of capital markets to hedge against longevity risk. This is a development that regulators will need to monitor closely.
If more and more life companies are losing faith in their own actuarial body, are we to be left placing our trust in the sagacity of the banks and market investors to get it right regarding the liabilities of the life and pensions sector?
Somehow we have to make sure that actuarial assessment remains to the forefront of risk management in the life business. Otherwise we may all end up with nothing to believe in.
Tom Murray
What do you think? Is the insurance industry losing faith in their actuaries? Tell us what you think in the comments below!
Comments
The use of capital markets to hedge longevity risk is not a new thing, although agreeably, its use is likely to increase as a result of Solvency II. I don't however see the connection between this and a loss of faith in acturaries. Actuaries measure risk and advise on the appropriateness of the means insurance companies use to mitigate these risks. Its likely that insurance companies that send risks off to the capital market consult their actuaries before doing so, and probably wouldn't try it without actuarial opinions. Actuaries are required to be creative in their thinking about risk, so if there is a perfectly reasonable means of mitigating longevity risk outside of the insurance and reinsurance market, I don't see why an actuary would refuse. I would see them saying go for it! Its a misconception to think that actuaries and the insurance industry are joined at the hip and that the minute companies move their risks out of the industry they are moving away from their actuaries. Its also likely that banks will consult actuaries to price the risk from their side, because like it or not, even though no one fully understands emerging longevity trends perfectly, actuaries have the training to understand it best.
You're point is right and this is not an entirely new phenomenon. My point is though that the bank was cheerfully admitting that they were re-packaging the risk and selling it off without getting heavily involved in the process of establishing the actual liabilities involved. While the comments on actuaries is slightly tongue-in-cheek, the world has recent experience of the transfer of risk from one area to another with those taking it on not really understanding the risk they were taking. We really should be wary of transferring risk away from those who have dedicated a lifetime to understand it to those who may not have the same level of understanding.
Agreed that we should ask questions when risks as uncertain as longevity risk, move to a market that doesn't have an established understanding of the risk. Further that given the failures in risk management in banks in the last few years, seeing them taking on such risks is even more unnerving. My response on actuaries appears to be defensive, although only intended to highlight that actuaries are experts in longevity risk whether this is in the insurance or the banking industry. Given your comments above, I feel I should change the focus on mine to say that actuaries need to change their understanding of their role in the financial markets, and not see themselves as only adding value in the insurance industry, but rather, wherever risks like longevity exist. In response to the increase in transfers of longevity risk to capital markets, there should be a corresponding increase in actuarial publication, interest and employment in the capital market related issues. So basically it is those that know the most about the risk that should take some of the initiative in helping others to see the value they are able to add. The challenge may be in convincing banks that they need actuaries to understand longevity risk. Actuaries tend to be good at this, they have accepted their general lack of persuasiveness which is proportional to their personality and instead go by the philosophy “convince the regulator and they’ll have no choice but to use us” (having at least more personality than the regulator this is the podium they use to practice their marketing skills). Actually (that was partly untrue), the difficulty mainly lies in actuaries tending to be the kill-joy, their profession being mainly preventative such that the benefits are usually reaped in bad things not happening rather than in good things happening. Given that they would likely (although not necessarily) be asking banks to be more risk averse in this area, it’s a difficult sell. So what’s my point after this very long response, you might be wondering?
1. Actuaries need to stay ahead of the curve on this issue, they are best positioned to provide support to both the banks and the insurers on such transactions
2. Banks need to pay actuaries lots of money to manage their exposures to longevity, it’s the right thing to do (spoken like a true actuary, as you might have guessed)
3. We all need to keep our eyes open and keep the financial industry accountable for their actions, like you’re doing, so thank you very much; I enjoyed reading your article and look forward to your comments on my (very long) response.
Agreed that we should ask questions when risks as uncertain as longevity risk, move to a market that doesn’t have an established understanding of the risk. Further that given the failures in risk management in banks in the last few years, seeing them taking on such risks is even more unnerving. My response on actuaries appears to be defensive, although only intended to highlight that actuaries are experts in longevity risk whether this is in the insurance or the banking industry. Given your comments above, I feel I should change the focus on mine to say that actuaries need to change their understanding of their role in the financial markets, and not see themselves as only adding value in the insurance industry, but rather, wherever risks like longevity exist. In response to the increase in transfers of longevity risk to capital markets, there should be a corresponding increase in actuarial publication, interest and employment in the capital market related issues. So basically it is those that know the most about the risk that should take some of the initiative in helping others to see the value they are able to add. The challenge may be in convincing banks that they need actuaries to understand longevity risk. Actuaries tend to be good at this, they have accepted their general lack of persuasiveness which is proportional to their personality and instead go by the philosophy “convince the regulator and they’ll have no choice but to use us” (having at least more personality than the regulator this is the podium they use to practice their marketing skills). Actually (that was partly untrue), the difficulty mainly lies in actuaries tending to be the kill-joy, their profession being mainly preventative such that the benefits are usually reaped in bad things not happening rather than in good things happening. Given that they would likely (although not necessarily) be asking banks to be more risk averse in this area, it’s a difficult sell. So what’s my point after this very long response, you might be wondering?
- Actuaries need to stay ahead of the curve on this issue, they are best positioned to provide support to both the banks and the insurers on such transactions
- Banks need to pay actuaries lots of money to manage their exposures to longevity, it’s the right thing to do (spoken like a true actuary, as you might have guessed)
- We all need to keep our eyes open and keep the financial industry accountable for their actions, like you’re doing, so thank you very much; I enjoyed reading your article and look forward to your comments on my (very long) response.
I think you’re being too hard on yourself, actuaries have plenty of personality. But I agree the points you make are valid. I’ve no doubt that if actuaries were employed by the banks in these deals, there would be good understanding of the risk. The worry is the Deutsche Bank appear to be saying that they will deliberately not get involved in providing assessment of the risk that they are selling on. There is no doubt many end clients who would have the awareness of the dangers but perhaps there are some who don’t. Then again, if the risk is packaged differently, could we end up with insurance and pension funds buying back in the risk they believed they had off-loaded? There comes a point where financial packages become too complex and end up causing more problems than they were originally designed to solve.
As you say, the challenge is in persuading Financial Institutions to use actuarial expertise when packaging longevity risk. I don’t think it’s up to the actuarial profession to do that – it’s probably going to require the regulator.