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Management Strategies

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Actuaries Adopt New Risk-Modeling Technologies

As the U.S. insurance industry moves toward principle-based reserving to demonstrate capital adequacy, actuaries are collaborating with their IT departments to adopt more-sophisticated risk-modeling technologies.

If one were to attempt to identify a core of conservatism in the traditionally conservative business of life insurance, one probably would point to the assumptions built into the formulaic statutory accounting by which insurers have demonstrated their ability to cover the risks they assume.

The conservatism of those assumptions imparted a certain financial solidity to the industry, and its tendency to cause insurers to err on the side of overpricing was easily reconciled within the industry's long-standing mutual company system: When end-of-year accounting revealed that premium had been overpriced, carriers could simply send their policyholders higher dividends.

Statutory reserving -- and its one-rule-fits-all-companies application of prescribed risk assumptions -- still prevails today, but it is not long for this world of demutualization and financial services consolidation. Life insurers increasingly sell variable annuities and other products that compete with financial services institutions -- and that require different risk management approaches to establish proper reserves and ensure carriers' solvency.

These issues, along with other market pressures, are leading regulators and rating agencies to demand more-sophisticated reporting, and many insurers are taking advantage of the competitive edge provided by the more advanced stochastic modeling technologies (which generate multiple complex, random scenarios) needed to calculate the risks implied by equity market-sensitive products. But it is not only newer products that are driving a shift to a more current and company-specific approach to risk and financial management. It simply makes more sense in today's world to get a more realistic picture of an insurer's assets and liabilities by including company-specific assumptions into risk calculations.

Recognition of that fact is driving the National Association of Insurance Commissioners (NAIC; Kansas City, Mo.) to issue different requirements for demonstrating capital adequacy, and it eventually will drive the industry to principle-based reserving (PBR). An economic rather than a statutory approach already prevails in Europe and most of the English-speaking world, including Canada. And as the United States moves in the same direction, actuaries are working in closer collaboration with their companies' IT organizations and adopting more-sophisticated technology tools. >>

Sophisticated risk modeling technology is not new to the insurance industry, however. While actuaries' proclivity for the use of Excel spreadsheets is legendary, they have been using stochastic modeling for quite some time, according to Ed Robbins, the Chicago-based director of life actuarial services, SMART Business Advisory and Consulting (Devon, Pa.), and current president of the Society of Actuaries. "Actuaries have had to 'model-up' their companies' assets and liabilities since the early 1990s," he says. "What has happened is that the processes themselves have become much more sophisticated."

Since those days, carriers have used increasingly sophisticated tools predominantly developed by actuarial firms or specialist vendors, such as Towers Perrin's (Stamford, Conn.) TAS-MoSes, Milliman's (Seattle) ALPHA, GGY's (Toronto) AXIS and SS&C's (Windsor, Conn.) PTS. Newer, more robust systems are also being produced by the usual suspects, for example in the case of Towers Perrin's RiskAgility, but technology vendors such as SunGard (Wayne, Pa.) are also supplying products in response to new demands, and others, such as SAS (Cary, N.C.), are beginning to enter the financial modeling space. The increasing sophistication these solutions imply is also shaping the requirements of the regulators and rating agencies.

"Investments have become so much more sophisticated than they were five or 10 years ago. And the technology to be able to capture and analyze this information continues to improve, and we're continuing to improve our tools," comments Matthew Mosher, group VP for rating agency A.M.Best (Oldwick, N.J.). "Insurers have more-sophisticated asset/liability management tools, and we're asking for more information in that regard."

Mosher affirms that the industry is moving in the direction of economic- or principles-oriented rather than statutory-based risk management and that the raters are expecting carriers to keep up with the trend. "We do expect companies to be able to move with it," he says. "It's not as if the sophistication of the portfolios is going to decrease. [Carriers] are going to need additional data requirements for internal management, and we expect them to provide us with similar information."

Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio

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