Prof. Dr. Martin Balleer Yalta Forum, September 2009 The role of actuarial technologies for insurance companies in crisis conditions Prof. Dr. Martin Balleer Yalta Forum, September 2009

Introduction Martin Balleer Member of Board Gothaer Insurance Group, CEO Gothaer Life, 1975 – 2002 Member Presidential Board of the German Insurers Association (GDV) 1998 – 2003 Member Advisory Board German Supervisory Authority (BaFin) 1997 – 2007 Past president (1995-2003) German Actuarial Association (DAV) Member of Board German Actuarial Academy (DAA); initiator and founding member of the European Actuarial Academy (EAA) Lectures in insurance technics, insurance law and risk management at Göttingen University

The financial crisis… The financial crisis… is generated by products (asset backed securities, subprimes etc.) is generated by human behavior that is against prudency, consumer protection and social responsibility, focussed on shareholder value is infuenced by procyclic panic behaviour within the financial market sector is influenced by globalization of asset management without an equivalent globalization of regulatory systems is also a crisis of an efficient and serious risk management and of corporate governance, especially in the asset management

Actuarial technologies… traditionally used in pricing, valuation of technical reserves are also the basis for an efficient risk management and enable the companies to monitor and to manage risks and to stabilize the financial results Some very few examples: Reinsurance techniques used to decrease risks and to implement risk mitigation Hedging techniques used to eliminate risks Market Consistent Embedded Value (MCEV) and cash flow analysis Modelling techniques used for asset-liability management and solvency concepts

Financial crisis and insurance risks Risk structure in the insurance industry (Germany) Influenced by financial crisis Source: Popielas, JP Morgan

Financial crisis and insurance risks Influences on the insurance market by financial crisis: Critical assets in the asset portfolio (ABS, structured products, subprimes etc.), even in asset funds that cover guaranteed liabilities - even assets nobody would have anticipated Depreviations with regard to the stock market and shares in the banking sector Policyholder behaviour that is correlated with the financial crisis (underwriting new policies, cancellation rates etc.) But generally: The infection of the life insurance and pension market generated by the financial crisis is managable; less problems within the insurance industry compared with the banking sector. Why ?

Financial crisis and insurance risks Influences on the insurance market by financial crisis: In most countries (especially within EU) a legal framework of actuarial requirements is implemented that requires prudency in pricing and technical provisions and asset management: These requirements influenced a cautious management of the asset fund for guaranteed life products In the unit linked sector the asset risks are transfered to the policyholder; so there is no asset risk for the companies; the victims are the consumers

Financial crisis and insurance risks Influences on the insurance market by financial crisis: Germany: No real problem against the background that there are strict rules for the asset management A strong actuarial infrastructure and competence But: If the German HypoReal would have become insolvent because of its international involvement this would have infected the classical asset portfolios (Pfandbriefe=mortgage bonds) of the German life insurers dramatically; therefore the German government stabilized that institute by financial guarantees of more than 100 Billion (!) Euro; it is now a state owned company.

Financial crisis and insurance risks Germany: Asset allocation of life insurers

Financial crisis and insurance risks Germany: Critical assets investments in German life insurance companies Source: Deloitte

Actuarial technologies How can actuarial techniques help to manage the actual crisis ? Actuaries are not able to solve the actual financial crisis; the crisis has been made by investment managers against the background that there are no global regulations with regard to risk management, But actuaries are able to analyse the actual risk situation of the company more efficiently in order to navigate the operating risk management and to stimulate actions, i.e. to identify risk potentials that have to be reduced, it is important to measure the risk potentials on the asset side by actuarial technics as soon as possible to reduce risks by reinsurance and hedging; the technologies are available (stress tests, stochastic simulations etc.)

Actuarial technologies How can actuarial techniques be implemented in the market in order to avoid a future crisis ? to encourage the companies to implement an efficient risk management driven by actuarial techniques that are able to monitor the risks potentials on the asset side to encourage the countries to implement solvency requirements that are based on actuarial technics and to implement a risk based supervision (Ukraine !) 3. to implement actuarial responsibility, techniques and behaviour even in the banking sector, minimum in all those product lines that are related with savings (pension fund, saving banks etc.); otherwise…a loss of moral standards should be substituted by an increase of regulation (?)

Actuarial technologies (Example 1) Actuaries have to deal with the risk potentials of the assets Risk capital Equity free reserves on liabilities free reserves on assets High quota of shares ask for high risk capital and/or low guarantees Products have to generate sufficient risk capital as free reserves on liabilities Key challenges: determining the risk exposure asset-liability-matching Asset allocation e.g. quota of shares Quality of products e.g. Level of guarantees, risk adjusted products

Actuarial technologies (Example 2) ALM in Life Insurance modelling capital market modelling assets modelling liabilities Actuarial kernel modelling consumer market projections simulations valuations actuarial analysis cash flows office modelling ALM etc. management rules stochastic deterministic

Actuarial technologies (Example 3) Actuarial driven MCEV as tool for risk management

Actuarial technologies Some conclusing comments: Modelling the asset/liability portfolio is the central actuarial technique to control the risk management; but: it‘s only a necessary navigator that can fail and isn‘t able to reflect the real world perfectly Actuarial models can never predict crisis, but models are able to prevent crisis The principles of actuarial techniques have to be understood also by the leading persons who run the company; so actuaries have to be integrated in the management best practice A legal framework and competence has to be developed in order to implement risk management

Thank you for your attention ! Prof. Dr. Martin Balleer European Actuarial Academy GmbH (EAA) martin.balleer@actuarial-academy.com