Insurers Risk-Return Management: Some insights

With the increasing convergence of financial institutions, the financial products as well as the risk exposures of all the constituents of the financial markets is also becoming similar. As a result, insurance companies are now facing challenges from within the industry and as well from other players in the financial markets. Therefore, insurance companies, today need to efficiently manage their unique risks as well as financial risk exposures. On the other hand, like any other financial intermediary, insurance companies also need to maximize the interests of their policyholders and shareholders, by maximizing the returns from their investments. All this calls for good financial or money management rather than mortality or morbidity management. This paper aims to focus on the risks exposures of insurance companies, which have serious financial implications, and the risk management techniques adapted by insurance companies, to strike a trade off between risk and return. What are the challenges faced by insurance companies today? What is the specialty of insurance companies? What are the actuarial and the financial risks of these companies? Why do these companies manage these risks and how? Where and how do they make their investments? How do they strike a risk-return trade off?

Pricing: Pricing is determined based on components of expected loss, volatility of historical

losses and management expenses.

Insurance Profit Testing

Insurance Profit Testing is a modern approach to actuarial calculations carried out using cash flow techniques where one views particular life insurance contracts as cash flow systems; typically, profit tests generate expected profit signatures of particular tranches of business on the basis of premium rates assumptions with the goal to keep the profitability in acceptable bounds; convenience of such an approach consists in:

effective measurement of profitability (e.g. momentary losses will be compensated by future insurance profits) realistic analysis due to realistic basis of calculation flexibility of pricing (i.e. the calculation of premiums) and valuation (i.e. the calculation of reserves) effective exploitation of modern computing facilities (e.g. simulations ofscenarios, stress testing, and the like)

Risk discount rate (rdr): is the interest rate used for discounting future cash flows in modern approaches to life insurance; it reflects the price ofinvestment capital and the risk due to its investment in insurance business; the components of rdr are: risk free rate rfr costs of investment capital risk margins for given market and business other margins (e.g. due to risk corresponding to the country of business) (risk discount rate according to the model CAPM (see Sect. 13.3): is constructed by means of risk free rate rfr, expected market return (expected return of market portfolio) rM and factor 3; the term (rM - rfr)-ftis called risk margin) Denotation for Insurance Profit Testing: Pt (gross) premium at the beginning of the year t E't actual expenses by insurer at the beginning of the year t i' actual investment rate of return by insurer (i.e. actually earned interest rate) tVxstat statutory premium reserve (i.e. the premium reserve calculated bymeans of mortalities and technical interest rate as were assumed for thepremium calculations) at the end of the year t for a life aged x at entry (see Sect. 18.3) Stdeath death benefit at the end of the year t on death during this year Stsurvsurvival benefit at the end of the year t on survival up to this moment Stsurrsurrender benefit at the end of the year t on surrender during this year px' actual probability of survival at age x (see Sect. 17.2) qx' actual probability of death at age x (see Sect. 17.2) wt' actual probability of surrender (see Sect. 18.9) during the year t

(annual profit per policy in force: is the profit expected to be earned during the year t per policy of the given type, which is in force at the beginning of the year t; if the values assumed for calculations (without apostrophes) are equal to the actual ones (with apostrophes) then PROt = 0)

(annual profit signature per policy: is the future profit expected at entry agex to be earned during the year t per policy of the given type)

(present value offuture profits expected per policy of the given type) Criteria of profitability applied in profit testing: - profit as percentage of PV of premiums (profit margin):

- profit as percentage of PV of commissions (commissions Com for insurance agents may be used as a basis if one measures profitability of the given insurance business):

- profit according to payback of invested capital: the criterion prefers the insurance business with the shortest payback periods (see Sect. 6.3) defined as the first k such that PVFPk > 0:

Data Management in Insurance Industry To create value, proper data management is key. Data management, in general, happens in three major stages. Data acquisition in the insurance industry uses new business management, operational, HR, accounting, distribution and product/policy management systems that make data available in their respective data structures in an integrated way. They can further be consolidated into data warehouses and document management systems. This can be referred to as the universe of an insurance companys enterprise data. (This paper excludes the physical availability (hardware availability, backups, etc.) and security, as they are significantly large by themselves to cover separately). The data consolidated are further exploited for various needs such as revenue growth, cost controls, operations efficiency gains, business expansion plans, new product ideas and basic services to all stakeholders such as customers, distribution and employees. The data exploitation happens in the forms of reports and analysis using various technology tools and applications. Data mining techniques are applied to reveal patterns and trends. Since most big insurance enterprises exist for more than several decades, the data available with them are not 100% accurate due to their legacy nature. Many such insurance enterprises

still use green screens for various types of systems support and policy administration. To maintain accuracy, data quality needs to be continuously managed by checking, correcting and preventing data errors. The link between these three important data management stages can be best described in the ICO (Input-Check-Output) model.

ALM: http://www.kesdee.com/pdf/alminsurance.pdf

Interest Rate Risk In 2012: With Low Rates Persisting, Insurance Companies Try To Muddle Through
http://www.standardandpoors.com/ratings/articles/en/us/?articleType=HTML&assetID=124532586 8800

The insurance industry includes many of the companies Standard & Poor's Ratings Services rates highest. Insurance companies also have some of the most significant interest rate risk, especially given their exposure to predominately fixed-income assets. These instruments and the liabilities they back create the potential for significant interest rate risk. Interest rates have fallen to record lows, exacerbating the risk to insurers (see chart 1). Fortunately, most insurance companies learned from past missteps and have developed enterprise risk management (ERM) programs that generally have mitigated much of the risk and tempered our concern from a ratings perspective.

IRDA issues uniform norms to ensure solvency of insurance companies

NEW DELHI: Insurance regulator IRDA today introduced uniform asset-liability management norms for market players to ensure their solvency and asked firms to undertake stress tests to ascertain their ability to meet financial obligations in the event of a crisis. The Asset-Liability Management (ALM) norms, IRDA said, are "critical for the sound management of the finances of the insurers that invest to meet their future cash flow needs and capital requirements." The guidelines, which would come into effect from April 1, 2012, make it mandatory for insurance companies to prepare an ALM policy and have it approved by the Insurance Regulatory and Development Authority (IRDA) by March-end. With regard to stress-testing, IRDA has asked the insurance companies to determine their ability to meet financial liabilities after taking into account factors like a 30 per cent fall in equity values and a one percentage point decline in yields on fixed investments, among others. IRDA has issued these guidelines to bring about uniformity in the ALM norms being followed by both life and non-life insurance companies.

Upon examination of the extant norms being followed by insurance companies, IRDA found they were "incomplete and inconsistent. As the mandate by the authority was very broad, each insurer had adopted their own measures in reporting such details". The insurers, it said, would have to put in place effective procedures for monitoring and managing their asset-liability positions to ensure that their investment activities and asset positions are appropriate to their liability, risk profiles and solvency positions. The ALM policy should enable the insurers to understand the risks they are exposed to and develop ALM policies to manage them effectively, IRDA said. In addition, the ALM can be used to measure the interest rate risk faced by insurers, it added.