12.5 External Systemic Risk

Definition 12.5 External systemic risk = systemic risk that are not internal

• Risks external to the liability valuation process

Need to consider systemic risk not in the data set (i.e. Can’t only consider actual episodes of systemic risk in the data set)

See risk categories in section below

Remark.

• A handful of these risk categories will dominate the uncertainty for that valuation group

• Useful to rank the risk categories in order of impact on the uncertainty of a valuation group

  (This will give guidance on how to score them)

• Lots of the above should be something the valuation actuary already discussed with the business and with claims:

  • Underwriting and risk selection

  • Claims management

  • Portfolio management process

  • Expense management

  • Emerging trends - portfolio and claims

12.5.1 CoV for External Systemic Risk

Use bench marking technique similar to internal systemic risk

Directly select the CoV

• Rank the risk in order of importance to help with the selection

Quantitative approach can provide in insight

• But we need to also consider possible emerging and potential future sources of external systemic risk

• Should bare in mind the skewness (might not be relevant for 75^th percentile if it is very skewed)

Consider risk that affect u/w and risk selection, claims management, expense management, economic/legal environment

12.5.1.1 Risk Categories

Economic and Social Risks

• Inflation; unemployment; GDP growth; interest rates; driving patterns; fuel prices; social trends

• For inflation we are concern with the systemic shifts not just randomness (randomness is in the independent risk)

• Some are more important for PL than OCL (e.g. driving conditions is more important for PL)

Legislative, Political Risks, Claims Inflation Risks:
Change in law, frequency of settlement vs suits to completion, loss trend (Long tail lines)

• All grouped together since each category needs to be uncorrelated with each other

• Long tail lines: more material to long tail LoBs since these changes could impact the entire portfolio of unpaid claims

  Considerations:

  • Impact of recent legislative changes, change in court interpretation

  • Potential for future legislative amendments with retrospective impacts

  • Precedent setting in courts

  • Changes to medical technology costs

  • Change to legal costs

  • Systemic shifts in large claim frequency or severity

• Short tail lines: can impact premium if there are sudden shifts in law or inflation

Claim Management Process Change Risk:
Change in process of managing claims e.g. case reserve practice

• Understand current philosophy and know any current or potential future process changes

• Discuss reporting patterns, payment patterns, finalization rates ,reopen rates, case estimate process

• More important to OCL, only impact PL when a change in process change the cost level of claims

Expense Risk:

• Claim handling expense and policy maintenance expense

• CoV should be small

• Need to understand the drivers of policy maintenance and claim handling expenses

• Event claims can have a material impact on expenses, typically lower the ratio of expenses to indemnity paid amounts \(\therefore\) consider these expense separately

Event Risk:
Natural or man-made CAT (Premium liabilities for property)

• Mostly premium risk

• Can model from past experience (with adjustment to portfolio size, geographical spread, inflation, policy terms and reinsurance), CAT modeling or input from reinsurers

Latent Claim Risk:
Claim from source not currently considered to be covered

• Unlikely for most LoB but can be severe

• Due to low probability, likely not worth to commit substantial resources to estimate the risk

• Discussion with reinsurers can guide in preparing a range of scenarios

Recovery Risk:
Recoveries from reinsurers or non-reinsurers

• S&S for non reinsurer on LoB like auto

• Reinsurers, consider reinsurance contracts in place specifically for reinsurers where a large amount of premium is ceded