Non-life insurers seeking an investment ‘silver bullet’ to offset the potential liabilities accumulating from the growing number of periodical payment order (PPO) settlements in the UK are likely to be sorely disappointed, Towers Watson has concluded in a new research paper.
Since 2005, claimants who typically require lifetime care due to a serious bodily injury have been able to opt for a PPO comprising a reduced lump sum and inflation-linked annual payments. The total number of PPOs awarded has increased markedly since 2008, so that many insurers have at least some cases on their books.
As a result non-life companies that are typically used to managing their assets against short-term claims liabilities face the introduction of very long-term PPO liabilities onto the balance sheet. These create new investment challenges that many have not previously faced. There are also added difficulties and uncertainties associated with predicting the life expectancy of award recipients and the fact that PPOs are index-linked to the Annual Survey of Hours and Earnings (ASHE). All of these factors will require a shake-up of existing investment strategies, the company says in ‘Investing for PPOs’.
Alasdair MacDonald, Head of Investment Strategy, UK at Towers Watson, said: “The UK non-life market has progressively moved more of its assets into bonds since 2000 but it is not possible to fully match the PPO payments using bonds given their particular characteristics: the potentially very long payment term; the ASHE linkage (no asset classes currently provide any sort of direct link to this); and the uncertainty associated with the life expectancy of the individual. In addition, attempting to match the payments from the PPOs using long duration bonds is currently unattractive due to the very low level of yields.”
“Conceivably, affected companies may have to fundamentally revise their investment strategy with their PPO exposure in mind,” he added.
Alasdair MacDonald said that insurers can, however, take a leaf out of the investment strategy book of pension funds which, by the very nature of their liabilities, have always had to deal with matching assets to payment commitments that might last for a very long time with an uncertain term of payment.
“Even then, the risks inherent in PPOs are greater because of the typically longer payment term (the average age at settlement is around 34 years) and the lack of available data for the life expectancy of people with severe injuries. However, the work our Investment team has done with a number of pension funds shows that a better fit of assets to liabilities can be achieved by restructuring the asset mix and using derivatives.”
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