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Gauging The Industry's Biological Terrorism Risk

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Gauging The Industry’s Biological Terrorism Risk

What impact will the threat of terrorism have upon the business practices, and the solvency, of United States life insurance companies?

Life insurance executives must grapple with decisions on administrative, marketing, underwriting, pricing and reinsurance practices, as well as surplus levels.

Such decisions will vary with the level of risk being considered, such as the single incident World Trade Center disaster, compared to the threat of biological warfare being imposed on a larger, more national, basis.

Administrative concerns include the location of the home office and major service centers. Are they in major cities, or high-rise buildings, that have a high-profile risk with terrorism? Are back-up systems adequate?

Marketing concerns include the concentration of a company’s business, including its geographic spread, mix of corporate clients, and any focus on upper-income clients.

Underwriting concerns could result in a more detailed look at an applicant’s life. Besides examining skydiving, speedboat racing and other avocational interests, companies may review where an applicant lives and works, days spent per year in large cities, attendance at large sporting and concert events, foreign travel habits, etc.

Mortality pricing will not likely be affected by the World Trade Center disaster, but the possible impact of biological terrorism could justify higher pricing on term insurance and the mortality component of life policies.

Reinsurance needs are likely to be the most heavily examined concern throughout the life insurance industry, both for primary companies and for reinsurance companies.

Primary companies may wish to diversify their in-force business, and reduce risks concentrated in geographic areas, single business entities, and high-income insureds.

For example, should Presidential Life (with 33% of its life premiums written in New York), Jefferson-Pilot Life (20% of life premiums written in North Carolina) and Jackson National (15% of life premiums written in California) reinsure geographic risk?

Similarly, when a life insurance company insures a large number of employees in a single company, or a large number of members in an association which meets annually, the insurer might want to reduce its aggregate risk exposure.

Primary companies seeking to reduce their mortality exposure would then have to choose between catastrophe covers, coinsurance, or yearly renewable term reinsurance.

Or mortality pools might be formed, either directly by primary companies, or by reinsurers for primary companies, to reduce excessive geographic and business risks.

It is interesting to note that the 135 largest U.S. life insurers (each writing $100 million or more annually in individual life premiums) already reinsure 41% of their individual life insurance in-force.

It is prudent for a company to review retention limits per life insured, and to relate retention limits to both its insurance in-force and its surplus. This leads into the topic of solvency.

Terrorism risk in the insurance industry has been focused on the property-casualty industry, with the large losses it realized in the attacks on the World Trade Center.

While sizeable losses were realized on death claims and accidental death benefits in the life insurance industry, no concerns were raised about life insurance company insolvencies because aggregate claims did not represent a large percentage of any one company’s surplus.

A larger threat posed to the life insurance industry is the possibility of a biological terrorist attack that causes a large number of deaths, either nationally, or where any one company’s in-force business is concentrated.

Our review of annual statements showed that 473 U.S. life insurers had more than $1 billion face amount of individual and group life insurance in-force at Dec, 31, 2000.

In the event of a biological terrorist attack, how much of each company’s life insurance in-force would have to incur death claims to exhaust a company’s surplus?

If a primary company’s reinsurers remain solvent, then one can look at PONIES (Percent of Net In-force Equal to Surplus) for that answer.

If there is a risk of the reinsurers not being able to meet their obligations, then a primary company must also look at POGIES (Percent of Gross In-force Equal to Surplus).

Table 1 shows the distribution of PONIES, and Table 2 shows the distribution of POGIES, for the 473 companies.

Table 1 shows that 67 companies (14%) of the 473 large U.S. life insurers would exhaust their surplus if they incurred claims (net of reinsurance) equal to 0.5% of their insurance in-force.

Similarly, 49% of the 473 companies would exhaust their surplus if they incurred net claims equal to 1.5% of their insurance in-force. With the U.S. population at 280 million, this would be a scenario with 4.2 million deaths.

Table 2 shows a harsher scenario of gross claims to surplus, which assumes that all of a company’s reinsurers completely default on all claims. The true risk to any company is somewhere between its PONIES and POGIES ratios.

Table 2 shows that claims equal to 0.5% of in-force would exhaust surplus for 28% of the 473 companies in the absence of reinsurance, compared to 14% of 473 companies (in Table 1) if reinsurance is paid in full.

In fact, if a reinsurer were to incur claims in excess of its surplus, it might have a parent company to infuse additional surplus. Absent that, the reinsurer’s surplus would probably be divided pro-rata among all claimants.

On the other hand, if a specific reinsurance company was unable to meet all of its claims, any claim payments might be deferred for many months and possibly create a liquidity crisis for some of its ceding companies.

Tables 1 and 2 assume that death claims are evenly distributed by face amount of insurance inforce. Those percentages would be substantially lower if death claims were concentrated in larger policies (mega-claims) which equal or exceed the company’s retention limit.

Table 3 shows selected data for the 18 largest U.S. life insurers, each with more than $200 billion net face amount of life insurance inforce at Dec. 31, 2000. The 18 companies are ranked by their PONIES ratio.

Table 3 also shows the retention limit per life insured for each company, and the retention limit as a percentage of surplus (RELIAPOS). The last column shows the number of mega-claims equal to surplus (NOMCES).

Large primary companies such as New York Life and Equitable (NY) would need to incur uniform death claims in excess of 2.25% of their insurance in-force to exhaust their respective surplus funds.

But, reinsurers Rga Reinsurance, Munich American Re, and Life Re (now Swiss Re L&H) would exhaust their surplus positions if they incurred uniform death claims equal to 0.2% of their respective insurance in-force positions.

Even in a worst case scenario, a stock life insurer might have a larger, financially stronger, parent company to rebuild its surplus. Mutual companies might have ongoing earning power after claims received from a bioterrorism event, and could rebuild surplus if granted a delay in paying claims by their respective insurance departments.

Retention limits range from under 0.1% of surplus for Reliastar and Allstate, to over 0.5% of surplus for Rga Re and Connecticut General. Surplus of Connecticut General and Rga Re would be consumed by 137 and 200 mega-claims, respectively.

Companies with $25 million retention limits per life (Northwestern Mutual, New York Life, Metropolitan) could have their surplus consumed by 236, 281 and 289 mega-claims, respectively.

In light of the entire question of bioterrorism risk, what are reasonable steps for a life insurance CEO to take? This writer suggests:

First, review your company’s retention limits relative to industry standards, your company’s risk tolerance and solvency standards, and adjust your limits if appropriate.

Second, review the risk levels assumed by your current reinsurers, establish your future ceding standards, and redistribute your current cessions if appropriate.

Third, if you cannot find sufficient reinsurance capacity for your perceived reinsurance needs, seek out other primary companies that are appropriate candidates for pooling mortality risks.

Fourth, if one or more approved (i.e., deemed risk-safe) reinsurers is willing to accept your mortality risks at a price below your pricing assumptions, cede as much as you are comfortable ceding.

Fifth, if you have a concentration of geographic or business risk under your retention limits, seek out pools with similar primary companies to diversify such risks.

Sixth, review your capital needs relative to both the net and gross amounts of insurance in-force in your company. If appropriate, reduce your net amount at risk, or increase your surplus position.

This is an unpleasant subject to speculate about, but I note that National Underwriter (Oct. 22, 2001) wrote, “The American Council of Life Insurers will ask Congress to commission a study on whether there is a need to establish a federal backup for life insurance losses caused by terrorism and on the feasibility of a federal program.”

Frederick S. Townsend, a founder of The Townsend & Schupp Company, is an investment banker in Hartford, Conn.

Reproduced from National Underwriter Life & Health/Financial Services Edition, November 19, 2001. Copyright 2001 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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