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Now is the time to challenge life insurance risk assumptions

By Lori Helge | December 4, 2023

Questioning the status quo on assumptions, through sensitivity testing and finding your “breaking points,” can help create a more meaningful risk management dialogue for all stakeholders.
Insurance Consulting and Technology
Insurer Solutions

Regulators and rating agencies are pushing for life insurance companies to better understand risks, with good reason. In our experience, successful insurance companies tend to have a more comprehensive understanding of their risks across all levels of the company.

While actuaries are critical to demonstrating more active risk management, the increased scrutiny in fact applies to the whole of management, including senior leaders. That’s because everyone in an insurance business has a role in the understanding of risks, whether you are the communicator or the receiver of the information.

In response, we believe leaders and actuaries have opportunities to add value and meet changing financial stakeholder requirements by questioning risk assumptions that have remained static.

This is not questioning for questioning’s sake: The potential prize is to improve risk management and provide additional confidence to stakeholders in your grasp and handling of your business risks.

To expand on what we mean, let’s take some examples that are central to life insurance business.

COVID-19 mortality

The prevalent industry view is that excess mortality from COVID-19 is no longer an issue for life insurance company financials. The reality is still a big unknown, and risks remain.

Although no one knows the answer, what if infection rates start to increase again, potentially involving new strains? Sensitivity tests are particularly helpful when the future is truly speculative. These sensitivity tests will quantify the company’s exposure to a range of future scenarios.

The sensitivity test results might reveal that action is needed now — or not. Or the results might reveal which future paths lead to sleepless nights and help you realize when actual experience is following those paths. A key aspect of such analysis, for example, can be to identify “breaking points,” where actual experience would start to have a material impact on company results.

Interest rate scenarios

Interest rate scenarios — projections of risk-free rates and asset returns over horizons of 40, 50 or even 60-plus years — are the backbone of actuarial projections and testing. Yet prevailing interest rate trends have the potential to color assumptions.

Accordingly, the type and range of interest rate scenarios tested should receive a high level of scrutiny. No one has a crystal ball for such a highly unknown future, so it is important to test a wide range of interest rate scenarios. This comes back to sensitivity testing again or knowing your “breaking points” in business performance.

Potentially valuable questions include:

  • Have you overweighted any risks?
  • Have you reflected a range of risks?
  • Is the assumption/scenario set biased toward an optimistic or pessimistic view?

It’s also worth remembering that all economic scenario generators have some degree of inherent bias that will affect the results of stochastic scenario testing. Because of this inherent bias found in scenario generators, stochastic scenario results may not show us a reasonable probability of a good result. Deterministic scenario testing — subject to the same questions above — can provide stories that are easier for everyone to understand.

Dynamic policyholder behavior

Dynamic policyholder behavior assumptions reflect that some policyholders will behave differently under different interest rate environments. The simplest example is that of an annuity held by an individual during a time of increasing interest rates. As interest rates rise on competing investment products available to the individual, industry expectations would be that some individuals will surrender their annuity and move to a product with a higher available interest rate.

The industry has long recognized that this kind of dynamic policyholder behavior is a risk and has taken steps to quantify the risk based on hypothetical beliefs around drivers of the dynamic behavior. As interest rates began to rise recently, the industry watched with anticipation and prepared for the increased surrenders that have long been projected to occur. How did your company’s experience measure up to your assumption? Even if you were spot-on, there are plenty of potential learnings:

  • Historical surrender experience remains limited in times of rapidly increasing interest rates.
  • The assumptions are built around not only policyholder behavior but also competitor behavior, which encompasses a wide range of factors.
  • It is difficult to model the entire range of factors that drive levels of surrenders (no one built the impact of a pandemic into this assumption).

The reality is that every assumption will always be at least a little wrong, and sometimes it will be quite wrong, even when there is industry consensus around it. The future will always be uncertain, and we know that it is good business to understand the impact of a wide range of future risks so you can assess and monitor their impacts and potentially take early mitigative action.

Expand your risk conversations

Maybe these analyses will change your risk management approach; maybe they won’t. But either way, they will demonstrate to your constituents (your managers, your board, regulators, rating agencies, the financial markets) — and you — that you have a firm and proactive handle on the risks to your business.


Director, Insurance Consulting and Technology

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