Category Archives: Risk management

Understanding California’s wildfire risk score model

In California, the number of acres burned per wildfire and structures damaged per acre have increased since 2013. Relentless years of devastating wildfires are stretching the California homeowners insurance industry to its limits with losses of $37 billion outstripping premiums of $32 billion since 2016. 

Faced with the inability to recover all the costs of insuring California wildfires, the California admitted insurance market has been reducing its wildfire exposure. Stricter underwriting eligibility guidelines and higher rates for wildfire-exposed properties have pushed more policyholders into secondary markets, such as the California Fair Access to Insurance Requirements (FAIR) Plan. The FAIR Plan is design to accept properties that are having difficulty in finding insurance in the market and does not decline risks due to wildfire exposure. 

To better understand its exposure to wildfire, the FAIR Plan asked Zesty.ai, Inc., a company that provides a wildfire risk score model, to score the FAIR Plan properties relative to wildfire risk. To read more about the FAIR Plan and Zesty.ai’s risk score model, read this paper by Milliman’s Annie ShenSheri Scott, and Katherine Dalis. It is the second in a series of articles examining California wildfire risk and tools that could be used to identify, quantify, and mitigate this risk. 

Infographic: Evaluating reinsurance strategies

Capital management is an increasingly important topic for insurers looking for ways to manage their risks and related capital requirements while optimising their solvency balance sheets. Reinsurance is one of the key capital management tools available to insurers.

In July 2020, Milliman professionals published a research report entitled ‘Reinsurance as a capital management tool for life insurers.’ The paper investigates common reinsurance strategies, along with new developments and innovative strategies that companies should consider implementing. The report was written by consultants Eamon Comerford, Paul Fulcher, Rik van Beers and Rosemary Maher.

Below is an infographic that highlights the key areas of consideration for evaluating reinsurance strategies.

To read the entire paper, click here. An executive summary is also available.

Risk management frameworks are changing alongside the climate

Financial services firms are focusing on risks associated with climate change more than ever now. In part, the heightened attention results from increased regulatory activity in this area.

Firms are now required to evaluate the potential financial impact of climate change and include climate change considerations within their risk management frameworks.

A typical risk framework is anchored around the risk appetite associated with a firm’s key objectives. Milliman consultant Neil Cantle provides more perspective in his article “Look, learn, predict.”

Can innovation and governance coexist?

Big data, technology, and demographic changes have increased competitive pressures to the point where innovation has become essential for insurers. However, innovation is often at odds with many insurers’ governance structures. Governance seeks to define a framework under which business decisions are determined and executed.

In contrast, innovation by definition seeks new methods, ideas, and products. Viewed by many as a natural, or even acceptable, state of affairs, this tension can edge out a potentially profitable initiative, recasting it into a familiar mold with few growth possibilities.

In this article, Milliman’s Paul Fedchak and Stacy Koron discuss whether the process really has to be that way.

Reinsurance and IFRS

In July 2020, Milliman professionals published the research report “Reinsurance as a capital management tool for life insurers,” written by consultants Eamon Comerford, Paul Fulcher, Rik van Beers, and myself.

Capital management is an increasingly important topic for insurers as they look to find ways to manage their risks and the related capital requirements and to optimise their solvency balance sheets. Reinsurance is one of the key capital management tools available to insurers. The paper investigates common reinsurance strategies, along with new developments and innovative strategies that could be implemented by companies. This blog post is one of a series being released in relation to this research. Each blog post will give an overview of a certain section of the Milliman report.

Reinsurance and IFRS

The new International Financial Reporting Standards (IFRS) accounting standard for insurance contracts, IFRS 17, is expected to have an effective date of 1 January 2023. This will change the accounting treatment of reinsurance contracts under IFRS reporting. IFRS 17 requires a reinsurance contract to be accounted for separately from the underlying insurance contract, which hasn’t previously been the case under IFRS 4.

Both insurance contracts and reinsurance contracts held will have a separate contractual service margin (CSM) on the balance sheet, which is a mechanism to spread profit over the lifetime of the contract.

The separate accounting treatment of reinsurance and insurance contracts will mean that there may be earnings volatility due to mismatches between the accounting treatment of the contracts.

Accounting mismatches may occur in a number of areas:

  • The underlying insurance contracts and reinsurance contracts may have different terms, which may lead to different measurement models being used to value them. If the coverage period of a reinsurance contract is one year or less, it may also be possible to model the reinsurance contract under the premium allocation approach. A mismatch will occur if the underlying insurance contracts are modelled using the general measurement model.
  • Differences in contract boundaries can occur between reinsurance contracts and the underlying insurance contracts. Reinsurance contracts often have cancellation clauses where contracts can be cancelled prematurely, leading to instability in financial results.
  • Aggregation of contracts into units of accounts may also differ between insurance and reinsurance contracts. Insurance contracts may only be aggregated into cohorts that are incepted no more than one year apart, whilst reinsurance contracts may cover many years of insurance contracts.
  • Coverage units used to allocate the CSM over an accounting period may differ between the underlying insurance contracts and the reinsurance contracts, which may result in differences in the timing of profit and loss recognition.
  • The CSM of the reinsurance contract can be both positive and negative, but the CSM for an insurance contract must be positive or floored at zero. Losses from onerous groups of insurance contracts are recognised immediately in the profit and loss (P&L) statement. Onerous reinsurance contracts can have a negative CSM which is spread over the lifetime of the reinsurance contract. This can lead to an accounting mismatch between the reinsurance contracts and the reinsured portfolio.
  • Inception dates of reinsurance and reinsured portfolios often differ as reinsurance is taken out after insurance contracts have been written. This will lead to different locked-in rates being used to value contracts, leading to a mismatch in finance income and expenses.
  • The separate presentation of insurance and reinsurance contracts can lead to balance sheet accounting challenges. The risk adjustment is the compensation that an entity requires for bearing the uncertainty about the amount and timing of nonfinancial risks. The risk adjustment of the reinsurance contract is not netted against the risk adjustment of the underlying insurance portfolio. This leads to the question of how to allocate diversification benefits to the reinsurance contract.

As a result of changes in financial reporting impacts, including possible additional earnings volatility, some insurers may require some elements of reinsurance treaties to be commuted or rewritten (where possible) to remove some of this earnings volatility. This will affect both internal and external reinsurance contracts and will depend on the reinsurance treaty terms.

As insurers develop familiarity with IFRS 17 reporting requirements, their appetite for reinsurance solutions
will evolve.

Insurers taking out new reinsurance contracts for capital relief should also consider the impact on financial reporting in addition to capital optimisation.

Milliman research paper

The full research paper can be found on Milliman’s website here. At the same site, you can also find an executive summary version that notes some of the key highlights of the research and acts as a guide to the full paper.

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 profiles. 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 the ORSA.