EUROPEAN PAPERS ON THE NEW WELFARE

Longevity, Systemic Models and Business Risk

8. Risk limits
Against this background, it is vital that the maximum impact of the risk be absorbed by other income sources generated by the business, however difficult it may be to identify consistent negatively correlated income sources, apart from the one deriving from the mortality risk: in addition to being sound, the ideal player must be well diversified.
This makes the it plausible to hypothesise that competent risk managers should be capable of generating income from other sources and not niche operators for whom the longevity risk is their core business. So far this is precisely what happened at least in the Italian market where operators in the pension market tend to be the main insurance groups.

9. Dynamic adjustment of operational variables

If the hypotheses used proves to be inadequate, immediate action is vital to employ future generations: together with the risk limits, this allows the containment of the risk within absolute limits consistent with the size and risk tolerance of the business. In general, we believe that the demographic risk needs to assume a precise organisational importance and exceeds mere technicalities.
Financial risk management has become an important instrument thanks to the development of A.L.M. systems and their respective organisational processes, such as interfunctional committees; in the same way, equivalent operational mechanisms need to be developed over time to deal with the longevity risk in a profitable way.

10. Product flexibility and risk-sharing with the insured

The insured is the main bearer of the risk whenever it arises and tends to remain so unless articulate alternative mechanisms are developed.
It should not come as a shock therefore that a share of the risk is taken on by the subscriber, not only by allowing modification of the conversion coefficients during the deferment period, but for example also by means of bonus mechanisms, i.e. the participation in the mortality proceeds or losses related to a generation of annuitants.
We are aware of the limits and inevitable commercial scepticism, but it is an option worth exploring. Also the implementation of projected survival tables (future — and not current — expected longevity is ‘sold’) is crucial but not sufficient. The same should hold true as regards risk differences. Gender and age remain general variables, which could be usefully integrated with other assessments aimed at a correct ‘calibration’ of the risk: sooner or later the issue of a longer life expectancy for the affluent population will have to be dealt with pragmatically.
Also the diagnosis of genetic propensity to certain diseases could contribute to the correct calibration of the risk, but I prefer not to venture into an area whis is extremely thorny from the insurance point of view.
Research and development conducted by reinsurers can and must make an important contribution, since they appear to be the most obvious and natural instruments in terms of product development, provided that returns from the investments made are possible on a global scale.

11. Bundling marketing policies

Longevity risk cover is a very precious ‘commodity’ both in itself and as part of the commodity of insurance in general. In other sectors, access to ‘precious goods’ becomes possible if other goods are also bought. Without going so far, it can be worth exploring all possible forms of bundling, by encouraging a wider range of cover and including them in integrated packages. In the case of an individual customer, such a model would allow adding a source of further profit to cover the risk, while offering the traditional benefits of one stop shopping and integrated assistance.
If we take only the most technical example with reference the customer’s profitability, those who take a pension at the end of a 20-year term assurance policy obviously would enjoy a very different profitability profile from that of a new customer who subscribes to an immediate annuity.
Term assurance and annuity in the same side of the balance are a form of natural hedge insofar as the expected life extensions take place proportionally in all age groups. In this sense the mortality gap, i.e. the widespread lack of cover in case of an early death, may provide other opportunities.
Compensation between long and short positions fosters bundling: of course the correlation between the life increases of younger age groups and older age groups needs to be calibrated. The existence of a mortality derivatives market would really be decisive, since it would allow greater flexibility in ‘adjusting’ the positions taken on naturally through commercial activities.


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