Category Archives: Risk

Credit risk modeling for risk-neutral valuations

Until recently, many companies limited stochastic valuation of options and guarantees to interest rate risk and equity risk. In reality, credit risk is an important risk factor that has often been neglected. The volatility of credit spreads can be an important contributor of the cost of options and guarantees, particularly for products with guaranteed surrender values. In many countries, regulators used to look at this issue quite liberally, but this attitude has started to change, which has led to an increased focus on this risk.

In this paper, Milliman’s Grzegorz Darkiewicz, Ed Morgan, and Aldo Balestreri look at the way joint interest rate and credit risk for risk-neutral valuation are typically offered by providers of Economic Scenario Generators.

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.

Considerations for climate risk metrics

The European Insurance and Occupational Pensions Authority (EIOPA), the G20-supported Task Force on Climate-related Financial Disclosures and the United Kingdom’s Prudential Regulation Authority (PRA) have all published various papers and statements aiming to encourage companies to disclose the impact of climate change on their business. The emphasis is felt across the board with regulators aiming to ensure that both firms and individuals are able to take into account the risks of climate change when making financial decisions. In this paper, Milliman professionals explore what metrics are most useful to insurance companies when considering the risks and effects of climate change.

Critical Point takes a look into the costs and risks associated with black lung disease

A recent Centers for Disease Control and Prevention (CDC) report indicates that the rate of black lung disease is going up. Black lung disease is also known as coal workers’ pneumoconiosis, and it’s brought on from inhaling coal dust and working in a coal mine. According to the CDC, black lung cases in miners are the highest they’ve been since recordkeeping began in the early 1970s.

In this episode of Critical Point, Milliman’s Christine Fleming and Travis Grulkowski discuss what these statistics mean for companies and insurers looking to manage this risk for their employees.

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

Climate change risk and COVID-19

Short-term relief

One of the few unexpected, if short-term, impacts of the current COVID-19 crisis is a reduction in carbon emissions. The rapid shutdown of economies and transport across many countries throughout the globe has resulted in an unexpected drop in fossil fuel use and resulting emissions. A study by Carbon Brief, estimates that China’s carbon emissions dropped by around 25% over a four-week period at the beginning of the year. Meanwhile, in Europe, figures from Sia Partners cited by the Financial Times (subscription needed) indicate that daily carbon dioxide emissions have reduced by 58% across the EU since the introduction of so-called coronavirus “lockdowns”.

The extent to which these reductions will have a lasting impact on emission volumes depends upon the extent to which manufacturing and production could speed up to make up for periods of lost output, and the extent to which there is a demand for a speeding up of production. If world economies enter a period of recession, reduced wages and economic damage as a result of the lockdown period could result in reduced demand for goods and services for a period after the easing of measures.

Opportunities for the future?

Much also depends upon the actions of governments after the pandemic. Economic stimulus packages which focus on fossil fuel-intensive industries could result in high emission volumes, outweighing the benefit of the short-term reduction. There is also the possibility that governments continue to be consumed by efforts to focus on recovery from the pandemic at the expense of climate change initiatives which were beginning to gain traction.

On the other hand, the article by Carbon Brief points out that targeting clean energy and energy-efficient investments could be a positive solution to marry the need to encourage economic growth with government spending and continue to work on climate change targets. The sectors in which and the type of spending governments engage in could therefore be important in determining the extent to which progress on climate change is damaged by priorities created by the current crisis.


The coronavirus pandemic certainly demonstrates the ability of societies and government to rapidly adapt to monumental changes in lifestyle and behaviours in times of crisis. As discussed in an FT article, “How coronavirus stalled climate change momentum”, values are starting to shift, with the possibility that some behavioural changes could last long after coronavirus. Some changes in behaviour which have arisen through necessity could have longer-term beneficial impacts; for example, increased use and acceptability of virtual meetings could help contribute to longer-term reductions in air and other forms of travel, should fewer face-to-face meetings and conferences take place. Such acceleration of digitalisation across workplaces and socialisation will certainly have benefits from a climate change perspective, although admittedly from a wider risk view will bring new (primarily cyber related) risks.

Risk management

With COVID-19 likely dominating the current and ongoing agendas of risk managers, risks such as climate change may become lower priority in the short term. However, lessons can be learnt from the current crisis which might well be relevant to management of other risks such as climate change.

As an example, the current crisis highlights the importance of health systems in determining the severity of the outcome. As highlighted in a World Economic Forum article, “A first lesson we are drawing from the COVID-19 pandemic and how it relates to climate change is that well-resourced, equitable health systems with a strong and supported health workforce are essential to protect us from health security threats, including climate change.” Although an external factor, the strength and operational resilience of health systems could be a key determinant of the extent to which life insurers suffer increased mortality rates as the physical risks of climate change begin to crystallise. The importance of understanding interrelated external factors, which determine the severity, timing and nature of the onset of risks such as climate change, is therefore an important benefit to firms approaching management of these risks.

Finally, we should not ignore the possibility of a significant climate event that rapidly and unexpectedly raises global temperatures and destabilises weather patterns; in such circumstance there will almost certainly be no short-term or even medium-term remedy. This might be considerably more unlikely than the onset of a global pandemic such as COVID-19, but nonetheless the possibility should not be ignored. Indeed, today’s crisis and the unprecedented mitigating responses from governments have demonstrated to firms the need to be agile in their decision making. Properly thought through plans are key to enable firms to adapt or transition their operating models at short notice, whilst the length of the lockdown also suggests firms need to bear in mind that operational stress scenarios can last much longer than typical business continuity plans (BCPs) allow for.