PwC advises on new strategies for risk management of insurance firms

As firms continue to grapple with changing economic environment to remain relevant and meet the expectation of stakeholders, experts have suggested that insurers companies need to take a long-term view of their business and investment portfolios.

Besides that, they should establish a more top-down view of balance sheet risks and develop risk management approaches that allow them to more successfully withstand volatile markets and be able to effectively manage their risks in changing economic cycles.

Experts from PricewaterhouseCoopers in their report on the risk management of life insurers observed that although near-term survival is still a pressing issue for many insurers since after the economic crises, it is currently the right time for the industry as a whole to revisit its risk management strategies.

“As the crisis unwinds, it is almost certain that there will be a more deleveraged financial system and a substantially different regulatory environment and in the near- to medium-term, it is likely that the global economy will remain volatile, with accompanying uncertainty in the equity and credit markets.”

With all of this in mind, what should insurers focus on in this changing environment? What changes to Asset/Liability Management (ALM) and Enterprise Risk Management (ERM) can help companies ride out the current crisis and even come out of it even stronger?

Rethinking portfolios first and foremost, insurers need to take a longer term view of their business and investment portfolios. If they establish a more top-down view of balance sheet risks and develop risk management approaches that allow them to more successfully withstand volatile markets, then they should be able to effectively manage their risks in changing economic cycles.

The life industry’s portfolios in particular have changed significantly in the past few decades. They are much more complicated than they used to be. Assets include structured classes and both callable and embedded options. Liabilities include some embedded options that policyholders’ have an economic incentive to exercise, and others which they cannot.

Dynamic risk management also can include adjusting risk and product design pricing. At the bottom of an economic cycle, when policyholders’ risk aversion is high and there is increased demand for guarantees, insurers that maintain high ratings have the ability to charge higher prices for the long-term risks (e.g., long-term disability) they offer. Management should have a clear understanding of policyholders’ economic incentives and how they may exercise guarantees.

For example, in anticipation of higher future interest rates, companies may offer products with higher or longer surrender charges on their products. Furthermore, some existing variable annuity guarantees, such as roll-ups, step-ups and ratchets, are clearly at odds with dynamic cycle management; accordingly insurers should determine if they can continue to offer them.

Another way for individual companies to manage economic cycles is by purchasing contingent capital as a supplement to economic capital. As one example, in the midst of the financial crisis, many variable annuity writers started macro-hedging programs to avoid further losses and protect their balance sheets from equity market declines.

Finally, management should have a clear view of and strategies for determining which risks on their balance sheets it needs to transfer or exit, and when to do so.

For example, at the bottom of an equity market cycle, it is probably unwise to exit the variable business and expand the general account business. As another example, when they face considerable equity or credit market uncertainty, companies should consider expanding into less capital intensive businesses and take on risk (e.g. mortality) that is less correlated to the markets.

By: Modestus Anaesoronye