Modelling management actions and policyholder behaviour in Asia
Milliman recently conducted a study on modelling management actions and policyholder behaviour based on a survey with 33 insurers covering six countries in Asia. While distribution of the full report and its findings is limited to the participants at this time, we have summarised some of the findings to provide insight on this subject to others in the industry. Management actions reflect operational decisions that are available to the management of an insurance company. They can be direct (through the reduction of benefits to the policyholders) or indirect (by lowering the volatility of future payouts). Based on our survey, simple modelled non-dynamic management actions appear to be more popular in Asia. A common modelled direct management action consists of adjusting non-guaranteed benefits via a profit-sharing mechanism and sharing some or all sources of surplus with the policyholder on a market-value or book-value basis. A common indirect management action considered in practice is the modelling of future investment strategies via a simple, and often non-dynamic, mechanism, which aims to rebalance an asset portfolio to the target asset allocation of a company at each future projection period. The modelling of other management actions appears to be less common. Less than 40% of the participants in our survey with hedging strategies in place model hedging, while 45% model future capital injections or shareholder dividends. The term ‘policyholder behavior’ refers to the decisions that policyholders make in the selection and utilisation of benefits and guarantees embedded in life insurance products. Based on our survey, 32% of the respondents model some type of dynamic policyholder behaviour; most are European multinationals or those who have material books of universal life business (typically in Hong Kong or Singapore). When modelled, the most common types of behaviours captured in the model are early lapses, surrenders and partial surrenders. Other dynamic policyholder behaviour, such as annuity option take-up rates or options to switch funds, are much more unlikely to be incorporated in models.
Increased importance due to new regulatory frameworks
With the introduction of new risk-based capital (RBC) regimes in some countries in the region, the update of existing RBC regimes in others and the introduction of the new International Financial Reporting Standard 17, the concept of using management actions to reduce technical provisions will become increasingly important. This is likely to encourage insurers to improve their typical, existing non-dynamic models in various areas, including:
- The enhancement of existing investment strategy modelling to reflect additional realistic dynamic drivers which are typically not captured currently. These drivers include the timing of realisation of unrealised gains and losses, the duration gap between assets and liabilities and the target solvency ratio.
- The modelling of hedging strategies to better reflect actual strategies, including dynamic hedging.
- The modelling of future capital injections and shareholder dividends, as well as the modelling of particular dynamic actions under some specific extreme scenarios (e.g., adjusting the level of charges, managing the expense level), and the knock-on effect on policyholder behaviour.
Risk management and capital management will become an increasingly important priority. The use of a stochastic approach will likely increase due to a need to better assess the time value of options and guarantees and further assess the asset liability management position and risk exposure of the company under various scenarios. Based on our survey, 39% of the respondents currently use a stochastic approach when modelling participating contracts and 52% use it when modelling universal life contracts. We would expect this proportion to be significantly higher in the future. However, it is important to ensure that the model enhancements are sufficiently realistic, but at the same time no more sophisticated than required for the specific purpose of the model.
Defining and monitoring future management actions:
External parties, such as regulators or auditors, might be concerned about the judgement or subjectivity embedded in management action modelling and whether the modeled management actions would effectively be taken if the corresponding trigger points are reached in practice. It is, therefore, key for companies to establish a comprehensive future management action plan approved by the board of directors. This plan should cover the identification of relevant future management actions, the circumstances in which they would be carried out, and those circumstances in which it might not be possible to implement them. Setting management actions is one key part of this process and would typically require companies to identify factors driving their management actions and the internal processes to determine their management action rules. Documenting and monitoring management actions will also be key. Based on our survey results, there appears to be significant room for improvement in this area, as only a few companies in Asia seem to document clearly the intentions of the management under specific predefined scenarios.