Life Insurance Underwriting Risks

Illustration of Life Insurance Risk Concepts 

Biometric Risks

Biometric risks in life insurance refer mainly to the risk that the company has to pay more mortality, disability or morbidity benefits than expected or the company has to keep paying pension payments to the pension policy holders for a longer time (longevity risk) than expected when pricing the policies. The specific case in which a single event or series of single events of major magnitude leads to a significant deviation in actual benefits and payments from the total expected payments is called catastrophe risk.

Long duration of policies and restriction of Mandatum Life’s right to increase tariffs increases biometric risks. If the premiums turn out to be inaccurate and pricing cannot be changed afterwards, technical provisions have to be supplemented with an amount corresponding to the expected losses.

The table Claim ratios after reinsurance, Mandatum Life, 2012 and 2011 shows the insurance risk result in Mandatum Life’s Finnish life insurance policies. The ratio of the actual claims costs to the assumed was 82 per cent in 2012 (77 per cent in 2011). Sensitivity of the insurance risk result can also be assessed on the basis of the information in the table. For instance the increase of mortality by 100 per cent would increase the amount of benefit payments from EUR 15 million to EUR 30 million.

Claim Ratios After Reinsurance
Mandatum Life, 2012 and 2011

	2012			2011
EURm	Risk income	Claim expense	Claim ratio	Risk income	Claim expense	Claim ratio
Life insurance	42.4	25.2	59%	42.6	23.0	54%
Mortality	25.9	14.9	57%	26.7	13.5	51%
Morbidity and disability	16.5	10.3	62%	15.9	9.5	60%
Pension	57.7	57.3	99%	58.9	55.6	94%
Individual pension	9.5	10.1	106%	9.5	10.1	106%
Group pension	48.2	47.2	98%	49.4	45.5	92%
Mortality (longevity)	43.5	44.2	102%	44.6	41.8	94%
Disability	4.7	3.0	64%	4.8	3.7	76%
Mandatum Life	100.1	82.5	82%	101.5	78.6	77%

Longevity risk is the most critical biometric risk in Mandatum Life. Most of the longevity risk arises from the with-profit group pension portfolio. With-profit group pension policies have mostly been closed for new members for years and due to this the average age of members is around 68 years. In the unit-linked group pension and individual pension portfolio the longevity risk is less significant because most of these policies are fixed term annuities including death cover compensating the longevity risk.

The annual longevity risk result and longevity trend is analyzed regularly. The assumed life expectancy related to the technical provisions for group pensions was revised in 2002 and additional changes were made in 2007. The cumulative longevity risk result has been positive since these revisions. The longevity risk result of group pension for the year 2012 was EUR -0.7 million (EUR 2.7 million in 2011).

Mortality risk result in life insurance is positive. A possible pandemic is seen as the most significant risk that could adversely affect the mortality risk result.

The insurance risk result of other biometric risks has been profitable in total, although the different risk results differ considerably. In a longer term, disability and morbidity risks are mitigated by the company’s right to raise insurance premiums for existing policies in case the claims experience deteriorates. New gender neutral pricing creates uncertainty, although risk result is expected to remain at the same level.

The insurance portfolio of Mandatum Life is relatively well diversified and does not include major concentration risks. To further mitigate the effects of possible risk concentrations, Mandatum Life has the catastrophe reinsurance in place.

Policyholder Behavior and Expense Risks

Uncertainty related to the behavior of the policyholders is a major risk as well. The policyholders have the right to cease paying premiums (lapse risk) and the possibility to interrupt their policies (surrender risk). Ability to keep lapse and surrender rates in a low level is a crucial success factor especially for the expense result of unit-linked business. From ALM point of view surrender and lapse risks are less significant because in Mandatum Life, approximately 90 per cent of with-profit policies are pension policies in which surrender is possible only in exceptional cases. For ALM risk, surrender risk is therefore only relevant in individual life and capital redemption policies of which the related technical provisions amounts to only 6 per cent (EUR 259 million) of the total with-profit liabilities. Furthermore, the supplements to technical provisions are not paid out at surrender which also reduces the surrender risk related to the with-profit policies.

Surrender and lapse risks are taken into account when the company is analyzing its ALM risk. This is described in more detail in the Market risks chapter.

The company is also exposed to expense risk, which is a risk that the future operating expenses exceed the level that was anticipated when pricing the insurances. Policy terms and tariffs cannot usually be changed materially during the lifetime of the insurance, which increases the expense risk. The main challenge is to keep the expenses related to insurance administrative processes and complex IT infrastructure at an efficient level. In year 2012, expense result was EUR 5.8 million (EUR 9.8 million in 2011). Mandatum Life does not defer insurance acquisition costs.

Discount Rate Risk in Technical Provisions

Discount rate risk in technical provisions is the main risk affecting the adequacy of technical provisions. The guaranteed interest rate in policies is fixed for the whole policy period. Thus, if market interest rates and expected investment returns fall, technical provisions may have to be supplemented.

In most with-profit policies, the guaranteed interest rate is 3.5 per cent. In individual policies sold in Finland before 1999, the guaranteed interest rate is 4.5 per cent, which is also the statutory maximum discount rate of these policies. With respect to these policies, the maximum discount rate used when discounting technical provisions has been decreased to 3.5 per cent. As a result, technical provisions have been supplemented with EUR 71 million in 2012 (EUR 79 million in 2011). In addition, EUR 37 million has been reserved to lower the interest rate of with-profit liabilities to 2.5 per cent in 2013 and EUR 9 million for the year 2014 to lower the interest rate of with-profit liabilities to 3.25 per cent, i.e. Mandatum Life has set up an extra reserve of EUR 118 million as part of technical provisions.

The provisions related to each product type and guaranteed interest rates are shown in the table Analysis of the change in provisions before reinsurance, Mandatum Life, 2012. The table also shows the change in each category during 2012.

Analysis of the Change in Provisions Before Reinsurance
Mandatum Life, 2012

EURm	Liability 2011	Premiums	Claims paid	Expense charges	Guaran- teed interest	Bonuses	Other	Liability 2012	Share %
Mandatum Life parent company
Unit-linked total	2,937	780	-269	-44	0	0	295	3,699	47%
Individual pension insurance	753	87	-8	-13	0	0	74	894	11%
Individual life	1,095	247	-140	-12	0	0	110	1,301	16%
Capital redemption operations	823	379	-119	-14	0	0	73	1,140	14%
Group pension	266	68	-3	-6	0	0	37	364	5%
With-profit and others total	4,229	169	-422	-37	147	3	-37	4,052	51%
Group pension	2,494	76	-202	-9	82	3	-34	2,411	31%
Guaranteed rate 3.5%	2,404	64	-193	-8	80	3	-30	2,321	29%
Guaranteed rate 2.5% or 0.0%	90	12	-9	-1	2	0	-4	90	1%
Individual pension insurance	1,275	23	-145	-7	55	0	14	1,216	15%
Guaranteed rate 4.5%	1,075	15	-118	-5	48	0	0	1,015	13%
Guaranteed rate 3.5%	157	5	-18	-1	6	0	8	157	2%
Guaranteed rate 2.5% or 0.0%	43	3	-8	0	1	0	5	44	1%
Individual life insurance	298	33	-61	-10	10	0	-17	253	3%
Guaranteed rate 4.5%	77	5	-9	-2	3	0	-3	72	1%
Guaranteed rate 3.5%	158	11	-41	-4	5	0	-8	121	2%
Guaranteed rate 2.5% or 0.0%	63	17	-11	-5	2	0	-5	61	1%
Capital redemption operations	6	0	-1	0	0	0	-1	6	0%
Guaranteed rate 3.5%	0	0	0	0	0	0	0	0	0%
Guaranteed rate 2.5% or 0.0%	6	0	0	0	0	0	-1	6	0%
Future bonus reserves	0	0	0	0	0	0	0	0	0%
Reserve for decreased discount rate	108	0	0	0	0	0	10	118	1%
Assumed reinsurance	2	2	-1	0	0	0	-1	2	0%
Other liabilities	46	34	-13	-12	1	0	-9	47	1%
Mandatum Life parent company total	7,166	949	-691	-81	147	3	257	7,751	98%
Subsidiary Mandatum Life Insurance Baltic SE	137	33	-23	-3	1	0	8	153	2%
Unit-linked	117	30	-20	-2	0	0	9	134	2%
Others	19	3	-4	-1	1	0	-1	19	0%
Mandatum Life group total	7,303	983	-714	-84	148	3	266	7,904	100%

With-profit pension and saving policies have not been Mandatum Life’s new sales focus area for years and the trend is downward. During 2012, with-profit liabilities decreased by EUR 178 million, and the decline is expected to be at the same level for several years. Average guaranteed rate for policyholder’s savings, excluding the effect of discount rate reserve, is 3.7 per cent, which is gradually decreasing because policies with 4.5 per cent guarantees mature sooner than policies with lower guarantees. The trend of unit-linked technical provisions is upward, except in years like 2008 and 2011 when investment losses of unit-linked savings have exceeded the net subscriptions. Almost 50 per cent of technical provisions are unit-linked savings and their proportion is increasing.

The development of the structure and amount of Mandatum Life’s technical provisions is shown in the figure Development of with-profit and unit-linked technical provisions, Mandatum Life, 2004–2012.

 

Development of With-profit and Unit-linked Technical Provisions
Mandatum Life, 2004–2012

The table Expected maturity of insurance and investment contracts before reinsurance, Mandatum Life, 31 December 2012 shows the expected maturity and duration of insurance and investment contracts of Mandatum Life. The sensitivity of technical provisions to changes in discount rates can be assessed on the basis of the durations shown in the table.

Expected Maturity of Insurance and Investment Contracts Before Reinsurance 
Mandatum Life, 31 December 2012

EURm	Duration	2013-2014	2015-2016	2017-2021	2022-2026	2027-2031	2032-2036	2037-
Mandatum Life parent company
Unit-linked total	8.6	524	474	842	564	501	216	242
Individual pension insurance	11.0	46	83	193	162	124	84	97
Individual life	7.2	260	200	286	167	119	65	72
Capital redemption operations *)	7.7	200	160	282	165	206	33	31
Group pension	11.2	18	31	81	70	51	34	41
With-profit and others total	9.0	896	718	1,320	900	617	414	643
Group pension	10.5	389	358	771	599	440	317	512
Guaranteed rate 3.5%	10.6	373	346	751	584	429	309	498
Guaranteed rate 2.5% or 0.0%	9.7	15	12	20	15	11	8	13
Individual pension insurance	6.6	333	294	445	238	131	62	64
Guaranteed rate 4.5%	6.6	278	249	386	205	109	50	52
Guaranteed rate 3.5%	6.8	43	37	49	28	19	10	9
Guaranteed rate 2.5% or 0.0%	6.4	12	8	10	6	3	2	3
Individual life insurance	9.7	64	50	80	51	40	32	65
Guaranteed rate 4,5 %	10.0	16	18	25	16	12	11	21
Guaranteed rate 3.5%	10.2	24	23	39	26	20	16	30
Guaranteed rate 2.5% or 0.0%	8.4	24	9	15	10	7	5	14
Capital redemption operations *)	7.5	1	0	2	1	1	0	0
Guaranteed rate 3.5%	0.0	0	0	0	0	0	0	0
Guaranteed rate 2.5% or 0.0%	7.5	1	0	2	1	1	0	0
Future bonus reserves	1.0	0	0	0	0	0	0	0
Reserve for decreased discount rate	3.9	65	13	20	10	5	2	3
Assumed reinsurance	0.5	2	0	0	0	0	0	0
Other liabilities	0.9	42	3	2	0	0	0	0
Mandatum Life parent company total	8.8	1,419	1,192	2,162	1,464	1,118	630	885
Subsidiary Mandatum Life Insurance Baltic SE		15	12	35	21	20	16	33
Unit-linked		11	10	29	18	19	15	33
Others		4	2	7	3	1	1	0
Mandatum Life group total		1,434	1,204	2,197	1,485	1,138	646	918

 *) Investment contracts

Life Insurance Risk Management

Biometric risks are managed by careful risk selection, by pricing to reflect the risks and costs, by setting upper limits for the protection granted and by use of reinsurance.

Reinsurance is used to limit the amount of individual mortality and disability risks. The Board of Directors annually determines the maximum amount of risk to be retained on the company’s own account, which for Mandatum Life is EUR 1.5 million per insured. To mitigate the effects of possible catastrophes, Mandatum Life participates in the catastrophe reinsurance bought jointly by Finnish life insurance companies.

Risk selection is part of the day-to-day business routines in Mandatum Life. Mandatum Life’s Underwriting Policy sets principles for risk selection and limits for sums insured. Compliance with the principles and limits set in the Underwriting Policy are monitored continuously.

The risk result is followed actively and analyzed thoroughly annually. Mandatum Life measures the efficiency of risk selection and adequacy of tariffs by collecting information about the actual claims expenditure for each product line and each type of risk and comparing it to the claims expenditure assumed in insurance premiums of every risk cover.

Technical provisions are analyzed and the possible supplement needs are assessed regularly. Assumptions related to technical provisions are reviewed annually. Adequacy of technical provisions is tested quarterly. Tariffs for new policies are set and the underwriting policy and assumptions used in calculating technical provisions updated based on adequacy tests and risk result analysis. Tariffs and prices, as well as the reinsurance principles and reserving principles are reviewed and approved annually by the Board of Directors of Mandatum Life.