VM-20 framework presents new product design and pricing considerations

The new reserve framework outlined in Chapter 20 of the Valuation Manual (VM-20) focuses largely on term and universal life insurance with secondary guarantee products. The VM-20 aims to “right size” the reserves by employing a principle-based approach.

This new approach allows companies to use mortality, surrender rates, and discount rates that reflect their experience, and that are based on their actual investments and strategies. Starting in 2020, this framework is now the required reserving approach for all U.S. life insurance products issued.

The new framework outlined in VM-20 will likely create some fundamental changes in the products available on the market. Some of these changes are clear, while others are yet to be explored or even contemplated. In this paper, Milliman’s Paul Fedchak, Ian Laverty and Uri Sobel explore some of the possibilities.

Survey highlights impact of COVID-19 on Latin America’s life insurance landscape

Milliman’s Fernando Mesquida, Héctor Gueler, and Ariel Hojman conducted a survey among a number of companies in Argentina, Colombia, Mexico, and the Caribbean to show the effects of COVID-19 on life insurance markets.

To read the report by, click here.

FCA guidance on “Product value and Coronavirus”

On 3 June 2020, the Financial Conduct Authority (FCA) operating in the United Kingdom issued guidance on its expectations of insurance firms in relation to product value arising from the COVID-19 pandemic. This guidance applied to all non-investment insurance products, including all general insurance and private medical insurance (PMI) products. The guidance is available here.

What does the guidance say?

The main purpose of the guidance is to “identify any material issues from coronavirus that affect the value of [insurers’] products, and their ability to deliver good customer outcomes.” The FCA defines product value as “what the customer is paying for and the quality of the product or service it is intended they receive.” The measures were placed into effect from the day of the release of the guidance and the FCA stated that it would review the response from insurers after six months. At a minimum, the FCA is expecting insurers to review their products and take appropriate actions.

In this blog post, we have put together some further guidance on how UK non-life insurers can go about reviewing their products.

Key highlights
  • If insurers are unable to provide benefits or pay claims in the usual way, they should seek alternatives to ensure that policyholders are getting product value.
  • If the level of insured events is reduced during the pandemic, then insurers should make suitable adjustments to their policies and premium levels to ensure that the value of the policy to the policyholder is not materially worse.
Analysis: Product review process

Firstly, insurers should review the impact of COVID-19 on their claims experience both during and after lockdown. There are many types of insurance products that will have seen lower levels of claims as a result of the lockdown during the pandemic. Insurers should regularly review loss ratios, as a decrease in loss ratios could indicate that customers are getting less value from their products. However, insurers should not ignore the possibility of a spike in claims post-lockdown, e.g., warranty or breakdown cover insurance policyholders might have been reluctant to have a technician enter their homes during the lockdown period, leading to reduced claims. However, as the lockdown eases, and policyholders become more comfortable with such repairs, there may be a spike in claims. Insurers should also be mindful of cross-subsidies within their portfolios, and of their overall solvency, as some lines of business will likely experience claim levels well in excess of normal levels.

Insurers should also analyse the driving factors behind decreased claims experience. The FCA identifies two main drivers of decreased claims experience:

  • The insurer’s own ability to provide claim benefits is reduced, e.g., the reduced availability of repair services for motor vehicles due to lockdown measures. In this case, insurers should seek alternative ways of providing benefits and paying claims. This issue could also affect insurers in other lines such as:
    • Motor own property damage
    • Extended warranty
    • Household contents
    • Boiler breakdown
  • A genuine decrease in the insured activity below the level expected at underwriting. For example, annual travel insurance policies that are no longer useful to policyholders. In this case, policyholder refunds or decreased premium rates may be the ideal way to ensure product value. When the reduction of risk under the policy is such that there is “little or no utility to consumers,” the FCA’s expectation is that firms carry out a product level assessment of value. Lines affected in this way could include:
    • Travel insurance
    • Motor insurance
    • Public liability
    • Marine & Aviation policies linked to passenger travel

At the time of writing, the first major lockdown of the UK is easing, although the risk of further waves of the pandemic and future lockdowns, local, regional or national, remains. Therefore, insurers need to be aware of precedent-setting and managing consumer expectations. These considerations remain equally valid for any future waves of the virus, and insurers should take advantage of their learnings from the first wave of COVID-19 infections to enact responses to decreasing product value in a manner that is rapid and more specific to the nature of the outbreak.

Additionally, due to the virus and the ensuing recession, policyholders could find themselves in financial difficulties, and may miss insurance payments. In this case, firms have been instructed to consider the value of the product to the customer when deciding on a course of action. The FCA has also issued some additional guidance on treating customers fairly in this type of situation, which may be found here.

Case study: Private medical insurance in the UK

In the UK, all nonemergency procedures were postponed as hospitals made preparations to deal with the worst-case scenarios. During this period, loss ratios have lowered significantly, as a material number of operations have been deferred. While insurers have ramped up their telehealth coverage, many policyholders have had treatment delayed and, therefore, have received much more limited value from their products than they would expect. One option for insurers would be to provide some form of a refund to customers during the period where hospital facilities were shut, as has happened in Ireland. A number of larger UK medical insurers have promised a future refund if claims remain low for an extended period. However, early indications are that, not only will the vast majority of the deferred treatments occur, but that there is a significant potential for the claims cost to be higher than anticipated, due both to delays in treatment and to increased provider costs resulting from new social-distancing and cleaning guidelines for treatment.

Using ORSA to navigate new COVID-19 risk environment

The economic impacts along with the epidemiological aspects of the COVID-19 pandemic will reshape the outlook for the insurance industry over the next three to five years.

Insurance companies will need to adapt their overall operating models, incorporating the effects of the virus to continue to achieve their strategic objectives and goals. These effects will include elevated operational risks like cyber threats related to new remote work environments for employees.

The Own Risk and Solvency Assessment (ORSA) process provides the framework for insurance companies to understand, evaluate and quantify their risk profile. It is inevitable that the ORSA will form a major part of the backdrop to work in 2020 and likely further into the future.

In this paper, Milliman’s Ian Penfold, Sophie Smyth and George Barrett discuss how insurers can explore their future exposures to COVID-19 through their ORSA.

Increased economic risk from COVID-19 puts pressure on mortgage performance in Q1 2020, but losses not expected to rise to global financial crisis level

Milliman today announced the first quarter (Q1) 2020 results of the Milliman Mortgage Default Index (MMDI), which shows the latest monthly estimate of the lifetime default risk of U.S.-backed mortgages. Default risk is driven by various factors, including the risk of a borrower taking on too much debt, underwriting risk (such as loan term, loan purpose, and other influential mortgage features), and economic risk as measured by historical and forecast home prices. The goal of the MMDI is to provide a benchmark to understand trends in U.S. mortgage credit risk.

During Q1 2020, the economic component of default risk for government-sponsored enterprise (GSE) acquisitions (purchased and refinanced loans backed by Freddie Mac and Fannie Mae) climbed 20 basis points—a 40% increase—as a result of housing pressure from COVID-19. For Ginnie Mae loans, which have a higher level of borrower risk relative to GSEs, economic risk jumped 80 basis points—an increase of 33%.

Despite the increased economic risk in Q1, the MMDI for GSE loans decreased to an estimated average default rate of 2.02%, down from 2.06% in Q4 2019. This means that the average lifetime probability of default for all Freddie or Fannie mortgages originated in Q1 2020 was 2.02%. The lower quarterly default risk in the face of economic pressure is because, as interest rates continued to decline, less risky refinance loans offset an increase in default risk for purchase loans. For Ginnie Mae acquisitions, however, the MMDI rate increased from 10.29% in Q4 2019 to 10.48% in Q1 2020. Beginning in 2014, Ginnie Mae has experienced a credit score drift relative to GSE and increased economic risk from COVID-19.

While we anticipate that the large number of unemployment claims will translate to an increase in mortgage delinquency rates, default rates (i.e., the number of borrowers who lose their homes) will likely not be as severe as during the global financial crisis, thanks to the robust home price growth we saw over the past several years.

The models used in Milliman’s MMDI analysis rely on home prices to forecast default rates, and do not rely on unemployment rates, nor do they have specific adjustments for special legislative actions or programs such as the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

For more information on the MMDI, click here.

Critical Point examines COVID-19 and the mortgage credit risk market

In this episode of Critical Point, Milliman consultants Chris Harner and Michael Schmitz discuss mortgage credit risk and market trends in light of the COVID-19 pandemic. This episode is the first in a two-part series on credit risk. The next episode will look at the potential that cyberattacks may increase within the financial sector as a result of the pandemic.

To listen to other episodes of Critical Point, click here.