By Kim Durniat, FIA, Partner and Head of Insurance & Longevity Consulting at Barnett Waddingham
"But where there are challenges, they are often also opportunities - artificial intelligence (AI), significant increases in long-term interest rates, and changes in the work environment are all sources of exciting new prospects for the insurance sector."
Let’s look in more detail at the challenges and opportunities in each area.
The aftermath of covid-19 on mortality and morbidity rates
The years leading up to the pandemic saw fairly steady mortality rates, with only modest improvements. 2020 saw mortality rates increase dramatically at all ages, but since then there has been a sharp difference in experience by age. At pre-retirement age mortality remains high but post-retirement rates have fallen close to pre-pandemic levels.
While mortality projections have always been a source of debate, the split in views between pension consultants and insurers seen in the recent Continuous Mortality Investigation (CMI) consultation is wider than ever. Consultants are typically attaching greater weight to the post-Covid experience when projecting mortality rates, resulting in them assuming lower life expectancies which poses challenges for Bulk Purchase Annuities (BPA) business.
The disruption of the pandemic means that traditional models, based on all-cause mortality, are struggling and the CMI has announced yet another review of its methods. More than ever, insurers should look at underlying causes of mortality to understand what might come next.
The outlook can seem bleak, however there are promising developments on the horizon that could provide opportunities including anti-obesity drugs, universal flu vaccines, and treatments for cancer and dementia.
Economic and geopolitical uncertainty
Geopolitical risks posed by elections, polarisation and conflicts have inevitable knock-on effects on the economy, including interest rates, both globally and for individual countries. In addition, the impact to the global supply chain presents challenges for general insurance business.
This economic environment raises a plethora of opportunities and challenges:
Unprecedented growth in the BPA market - The BPA market is booming like never before. Higher business volumes are attracting new market entrants and global capital, whilst at the same time attracting greater supervisory scrutiny (if that’s possible!). This is driving higher regulatory expectations across a range of insurers’ key risk management areas such as reinsurance, counterparty risk, assessing illiquid asset risks and planning for unexpected exits.
The positive impact of soaring interest rates - Higher long-term real rates make all forms of long-term savings more attractive and viable. Could this environment foster greater innovation in the defined contribution (DC) market, and the emergence of new forms of lifetime income solution from life assurers? Higher interest rates could suddenly make what was previously loss-making general insurance business more palatable due to better investment returns, and offer a temporary reprieve for businesses to turn things around.
Tightening credit spreads - Whilst rates have increased, credit spreads have remained tight or tightened further. Will DB schemes’ preparations for buyout result in more buying of corporate bonds and further compression of spreads? Could this motivate insurers outside the BPA sector to increase their illiquid asset appetite in a search for higher spreads?
Capital models – Across general insurance, capital models have got used to performing in an environment with low investment returns. Insurers should consider how they can best allow for these returns while ensuring that market downside risk remains adequately captured.
Increasing general insurance premiums - Particularly in the consumer insurance sector, inflating premiums have largely been attributed to inflation. Whilst it’s fair from the insurer’s perspective, these increases have been scrutinised particularly with the recent consumer duty legislation. The suspension of the sale of Guaranteed Asset Protection (GAP) insurance by the Financial Conduct Authority (FCA) suggests that regulators are taking these issues seriously and will not hesitate to crackdown on practices that they consider to be unfair for consumers.
Regulating the financial sector
A recent focus on the impact of Brexit is how the UK financial sector will be regulated without a guiding hand from Brussels.
The development and implementation of the Solvency UK reforms has arrived just as the once-in-a-generation transfer of assets and obligations from the DB sector to the life sector really gathers momentum; and also at a time where politicians are attracted by the prospect of private capital funding the increasingly-needed long-term infrastructure investments in the UK economy.
The key outcomes of this reform process for the BPA sector will become clearer in a few weeks, but one thing is already apparent – this year’s Solvency UK reforms are unlikely to signal the end of the regulatory reform program, especially in the contentious topic of investment flexibility in MA portfolios. The Prudential Regulation Authority’s (PRA) recent announcement that it has established a Subject Expert Group (SEG) on sandboxes before its current round of investment flexibility reforms has even been finalised makes that clear.
Solvency UK has not had much impact on general insurance business. On the one hand, the lower cost of NOT changing regulation alongside maintaining equivalence with Europe has its appeal. On the other hand, is there a missed opportunity that would allow UK general insurers to evolve and stay at the forefront of the insurance market, considering Solvency II was first made into law in 2009? Even if the Solvency UK changes were not material for some sectors, it does not stop insurers from assessing their Solvency II processes to ensure they remain fit for purpose, given the maturity and understanding of their stakeholders.
Climate change
Insurers must consider their impact on the environment and how this effects their policyholders. Climate change will also inevitably become an important theme in the regulatory agenda, both in the UK and globally. Is climate change a new form of forward-looking risk that is absent from our historical data and that requires special attention and adjustments in our models, risk assessments and attestations?
The increasing pace of technology
New technology and AI comes with risks of spurious results, plagiarism, and cyber risks.
We are seeing more firms looking to move from traditional actuarial modelling systems to opensource solutions such as Python or R, to improve flexibility and reduce costs. However, this move also increase model risk – a big area of focus for the regulators of banks. Moving to any new tech will require a key focus on model risk governance and policies to ensure it captures any new risks that may exist.
"Although embracing new tech comes with risks that insurers need to be mindful of, it will also improve learning, increase productivity, enhance decision making, streamline processes and optimise customer experience. If the risks are mitigated effectively and ample time is given to adapt to new processes, tools and workflows, AI provides huge opportunities for insurers."
Leveraging opportunities
So, all in all there are lots of opportunities for insurers. Risks are becoming more complex, and the increasing interconnectivity of risks is often difficult to manage and comprehend, but taking the time to understand risks more and manage them appropriately will ultimately lead to more opportunities for insurers.
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