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Life Health > Life Insurance

Would Principle-Based Reserving Measure Up If Bird Flu Arrives?

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Reinsurers and direct writers could prepare, actuaries say

If the bird flu does become a pandemic in the United States, leading actuaries say that for reinsurers and insurers facing the issue may be akin to the way they had to face AIDS when it first hit in the early 1980s.

While there is general agreement that the current formulaic system for reserving would offer safeguards such as asset adequacy analysis, there is also optimism that a principle-based approach to reserving would pass muster should a pandemic materialize.

Currently, there is support among many insurers, actuaries and regulators to try to develop a principle-based reserving and capital system that would use capital efficiently and create flexibility but also protect contract holders and policyholders against insolvency in the event of negative experience from a cataclysmic event such as a pandemic.

Last month, the American Council of Life Insurers, Washington, said it would work to develop such a system.

There are some in the industry, however, who say the current formulaic approach to reserving would create more solvency safeguards for reinsurers and insurers.

If a pandemic hits, reinsurers could be impacted heavily because of the trend for direct writers to reinsure excess mortality risk, according to Donna Claire, president of Claire Thinking, Fort Salonga, N.Y.

The current system offers asset adequacy analysis as a way of measuring a pandemic’s impact on the financial health of a company, she explains.

A principle-based solution would reflect any volatility that resulted from an increase in mortality, Claire explains, so when a blip in company mortality appears, the company would start tracking it.

However, she adds, the formulaic approach builds in a degree of conservatism with a 10% load built into the basic formula of the CSO Tables.

Under the current formulaic system, reserves would not be set aside in anticipation of an event such as a pandemic, according to Larry Gorski, an actuary in the New Berlin, Ill., office of Claire Thinking. A small recognition of such a possibility could be included when establishing capital requirements, he adds.

A pandemic would be detected in asset adequacy reserving under the current formulaic approach and would be reflected as the event became a reality, Gorski says.

The threat of a pandemic “harkens back to a time several years ago when HIV/AIDS became a serious threat to the industry,” says Jim Van Elsen, Van Elsen Consulting, Pella, Iowa. The difference, he says, is that if avian flu comes to pass here in the United States, it will affect a lot more people.

What the impact would be on the industry depends on the population that it hits, he explains. For instance, if it hits children and young people, fewer of those victims might be insured. If, however, it hits the 40-60 age group, that would make a bigger difference from a financial point of view because more of that population would be insured.

How it affects the principle-based concept for reserving still would be undefined, he continues. It would require monitoring risks and making adjustments where necessary, Van Elsen adds. He says he would be more aggressive in making assumptions that account for the possibility of the avian flu. “It shouldn’t be on your doorstep before you start reflecting it.”

But Van Elsen explains that he is not a fan of the additional general padding that a formulaic approach uses. Rather, he continues, he prefers specific reserving for specific risks.

During the time when HIV/AIDS was a major issue, everyone was using standard mortality tables and not individual company mortality experience, says Barbara Lautzenheiser, principal of Lautzenheiser & Associates, Hartford, Conn.

But, with a principle-based approach, companies would use their own mortality experience to establish reserves, she adds. Companies would adjust their reserves accordingly, she says, and it would create a “faster warning system.”

If the avian flu becomes a pandemic in the U.S., Lautzenheiser continues, the 35-75 age group would impact the insurance industry.

The models that were created under a principle-based approach would have an automatic adjustment feature built in that would be reflected in reserving, she says. But it would not help with pricing because that would be based on mortality used at the time the contract was established, according to Lautzenheiser.

In the current environment, there is nothing that the formulaic approach even considers that addresses issues such as a pandemic, says Robert Wilcox, president of the American Academy of Actuaries, Washington, and a consulting actuary with Wilcox & Company, Alpine, Utah. Only as companies recognize that they may be affected would they take steps to reflect the impact, he explains.

With the principle-based solution, it would be part of the consideration to look at these possibilities, he adds. Both direct writers and reinsurers could assess the financial impact, he says. And, in the case of a reinsurer, it could take action such as building the event into the premium structure or making a decision to retrocede business, according to Wilcox. “It offers the greatest benefit to all risk takers.”

A principle-based approach would measure sensitivity to a pandemic and report to management and to regulators on the company’s exposure, and what would happen if mortality increases and what would happen if, for example, there were 3 shocks to a company in 10 years, instead of one major shock in 100 years, says Dave Sandberg, vice president and corporate actuary with Allianz Life Insurance Co. of North America, Minneapolis.

The focus, he says, would be on the long term and how the tools could be built into a company’s system so that it would detect such risks.


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