20 August 2021
My previous blogs set out three principles that should underlie every stage of the Actuarial Function opinions:
- Target value-add, not just compliance
- Actuarial Function activities should occur before decisions are made
- Achieving best practice may be an iterative process
In this blog, I continue discussion of the underwriting opinion, focussing on business mix, anti-selection and emerging risks.
We often see comments like “the business has a low exposure to anti-selection risk” in underwriting opinions. However, they are rarely supported by evidence, and often may not be true, especially when businesses are growing or changing their strategy.
It is actually very difficult to measure the level of anti-selection introduced by a new portfolio because there are so many factors involved in taking on new lines. For example, will your new underwriter bring with them their entire portfolio? Are your ambitious growth plans at the expense of relaxing terms & conditions? If some of the growth in business is coming through new brokers, do they access market segments with different features from the rest of your portfolio?
Because it is so difficult to isolate the effect of anti-selection, the main tool of the actuary is to ask the right questions, and then relay these to the board in a way that they can understand. For example:
- Which classes of business have a higher anti-selection risk?
- Has anti-selection risk increased or decreased since last year?
- Does our proposed strategy increase or decrease anti-selection risk?
- Are we taking specific actions to minimise exposure to anti-selection risk?
The answers to these questions may inevitably be mainly qualitative, and this is not necessarily a bad thing. Remembering that our first principle is “Target value-add, not just compliance”, raising the issues clearly and unambiguously can add just as much value as tables of numbers.
You can then add quantitative information, for example by looking at scenarios where the business is hit by anti-selection, allowing for the magnitude of the relevant business lines, and the speed at which the situation would be recognised and corrected. Some of the underlying assumptions will necessarily be judgemental, but can still help give the board meaningful insight in this important area.
Emerging risks is another challenging area and one where can be difficult to produce quantitative information. Our Virtuous Cycle publication noted that many firms rated themselves highly on the strength of their emerging risks process, but our feeling was that firms struggle to make concrete plans for quantifying these risks as part of the core actuarial numbers.
I recommend downloading the example emerging risks framework from that report which takes you through the following suggested steps:
- Risk identification
- Understanding the risk
- Assessment of exposure
- Assessment of impact
- Refinement and validation
As the risk starts to crystallise, the processes are likely to evolve from horizon scanning, to scenario analysis, to making some allowance as an ENID (event not in data), to being an integral part of the best estimate.
As we noted in Part 2 of my blog, there may well be differing views between the reserving and underwriting teams. For example, the reserving team may want to add a margin for certain risks, but underwriters may not feel they can increase the rates in a competitive market. The Actuarial Function can help the board understand the differences, for example by showing the effect on profitability of using the reserving actuary’s more prudent assumptions.
The Actuarial Function can add enormous value to the board’s understanding of emerging risks by engaging early and ensuring that the risk appetite clearly articulates the board’s attitude towards emerging risk, in a way that can be monitored over time.
So again, we see that our principles of targeting value-add and providing opinions at the time they matter (before decisions are made), are the core of a well-performing Actuarial Function.
Next time I will look at reinsurance and how the actuary’s opinion can add value to this important business decision.