SOA Leadership & Development Section newsletter article by Timothy Paris

I find leadership inspiration in many places—books and movies, fiction and nonfiction, old and new, widely popular and niche. But I tend to revert to the classics. And from a leadership standpoint, I think that... Read the rest of the article here in The Stepping Stone SOA Newsletter.

Curtain Call

In the six years since the financial crisis, actuaries have played an integral role in steering the variable annuity industry from an abrupt and tragic ending.  Actuaries developed the new simplified and “de-risked” products that have become the norm, refined and expanded hedging programs, and reset product charges commensurate with current capital markets conditions.  They have also helped many companies go so far as to offer buyouts to inforce policyholders, in an effort to mitigate the large and complex risks associated with legacy products.

It all sounds so sensible, positive, and tidy – through the tumult, hard lessons have been learned, most of the players have survived, and actuaries have lead the way to a new normal.  Curtain.

Not so fast.

The potential for a repeat performance of legacy blocks in the next financial crisis will put claims of improved risk management to the test.  The mismatch risk of using the available short-term investment hedges to support decades-long product guarantees is well documented and perhaps part of the scenery at this point.

But since the financial crisis, as the variable annuity market has reconciled itself to a new normal in the capital markets, we have seen the sudden emergence and star turn of a new threat – policyholder behavior.  This includes surrenders, partial withdrawals, annuitizations, and mortality within the context of living benefit and death benefit guarantees.  Previously only a bit player – estimated by pricing actuaries, fine tuned by valuation actuaries, and scripted for the hedging managers – adverse policyholder behavior and subsequent extrapolations to future behavior have been responsible for billions in losses over the last three years.

Surely it cannot end like this.  It is not just the surprise losses due to policyholder behavior, particularly surrenders, but that it begs the question – is there more?  Is this a one time event or a harbinger of worse tidings?  And what is being done about it, beyond the modest level of inforce policyholder buyouts?

Mortality rates continue to fluctuate, making the cost of death benefit guarantees a moving target.  The repeated underestimation of longevity improvements can dramatically increase the cost of living benefit guarantees.  Surrender rates continue to be very low, myriad factors seem to affect wide ranging partial withdrawal behaviors, and the industry is on the front edge of a wave of annuitization eligibility for products guaranteed in those terms.  Incredibly, with all of this, the main strategy for managing policyholder behavior risk seems to be the “hope sandwich” – hope to determine a margin for conservatism in excess of best estimate assumptions, reflect it in product pricing, and then hope it is adequate for decades after launch.


This is exactly where actuaries need to turn their attention, to rewrite this flimsy script and allow the variable annuity market to be repositioned on solid ground for the long run.  One way to do this is through the intelligent use of reinsurance.

In much the same way that the life insurance industry has used reinsurance to actively manage its mortality risk exposure, the variable annuity industry can use reinsurance to actively manage its policyholder behavior risk exposure.

Carving mortality risk out of death benefit guarantees is straightforward, and follows life reinsurance mechanics with a similar potential audience of life reinsurers.  The ceding company pays reinsurance premiums equal to an agreed tabular mortality basis times the amount at risk each period, in exchange for receiving reimbursement for actual death claims.  The economic cost to the ceding company depends on the excess, if any, of the agreed tabular rates over the actual mortality rates for the term of the reinsurance.

Elective policyholder behaviors require a different mindset because the primary concern for direct writers is not short term fluctuations, but sustained and significant adverse deviation relative to expectation.  This triggers revisions to best estimate assumptions, which means dramatic reserve and/or capital increases, as we have seen over the last three years.  So direct writers really need catastrophe reinsurance for these risks – they should be willing to pay a premium in exchange for a much larger reimbursement in the event that an extremely unlikely event occurs.  This “cat” risk profile is familiar to many property and casualty reinsurers, hence they are a natural audience for this type of reinsurance.  Structuring, positioning, and negotiating this type of reinsurance is bespoke work, based on deep analysis of credible company and industry experience data, segmented in shorter reinsurance terms, and isolated from the ceding company’s retained capital markets risks.

The benefit to variable annuity companies is clear – mitigate policyholder behavior risks in order to stabilize their financial profile around asset-based fee income.  The benefit to reinsurers is to profitably grow their speciality risk portfolio into a huge market where their expertise and capacity are sorely needed.  The benefit to the public is continued access to variable annuity products that provide vital benefits for a secure retirement.  The benefit to actuaries is nothing less than the successful realization of our profession’s vision of a sound and sustainable financial security system.

I know that we are up to this challenge, and we will write a worthy end to this final act.  Let’s save the curtain call until then.

High Stakes

For actuaries and other risk managers in the insurance and reinsurance industries, these are exciting times.  Perhaps too much so!

Let us count the ways:

  • Equity markets are frothy, interest rates continue at historic lows, and “implied vols” are back down around pre-crisis levels.

  • The Fed continues to taper its quantitative easing to about 65% of last year’s levels, while the unemployment rate is now below 7% and inflation is only about 1%.

  • Solvency standards are in flux globally.  Details for major jurisdictions are very much under debate and will probably vary, but we seem to be headed toward a world of computationally intensive and data-driven dynamic solvency assessments based on assumptions sets and stress tests that are attuned to economic conditions and the full range of product, investment, and operational risks across the enterprise.

  • The reinsurance markets, an important and enduring part of the insurance industry’s risk management arsenal, face their own challenges:  continued consolidation among major life reinsurers and a decade of increasing retention rates by direct writers; meanwhile, the P&C reinsurance market is bearing the brunt of competition from non-traditional capital markets sources, creating pressure to expand beyond well-trodden markets while maintaining underwriting discipline.

  • Private equity investors have increased their presence in the life and annuity market, often with the aim of gathering assets to manage, prompting speculation about how their investment horizon and business strategy may contrast with that of traditional insurance shareholders.

  • Some inforce annuity products have become so problematic for insurers that they are offering to “buyout” policyholders in cash or in exchange for a different product.  This for long-term guarantee products that could be inforce for decades!  Some insurers have resisted this urge, noting the irony of these “buyouts” relative to their usual objectives of positioning themselves as long-term solid.

  • On the heels of adverse results in the variable annuity industry since the crisis, the phrase “policyholder behavior risk” has entered the lexicon of the C-suite and equity analysts, heightening the importance of actuaries and complex data analytics.  More broadly, risk management decisions are made much higher in the organization and with much greater collective scrutiny and strategic thinking than in years past.

High stakes, high degree of difficulty, and high visibility!

Are you and your company going it alone?  Do you have the internal knowledge and bandwidth needed to synthesize complex market and risk dynamics, and develop and implement appropriate risk management programs for your company?  Are your plans based on stale information and techniques, subject to internal biases or blind spots?  Are you connected with the right potential counterparties globally for various types of risks, including emerging risks such as longevity and policyholder behavior?  Do you know what you don’t know?  Do your competitors?

At Ruark, we help our insurance company clients face these difficult issues head-on, armed with wisdom from successfully completing bespoke risk management projects since 1998, a strong reputation and deep connections across the rapidly-evolving sectors of the insurance and reinsurance industries, and a combination of advanced technical and data analysis skills and creative business development acumen.  These efforts are complemented by the actuarial consulting services and industry-leading experience studies of policyholder behavior performed by our affiliate Ruark Consulting.

In times like these, don’t go it alone or with the usual +1.


Plotting Risk Management: The Variable Annuity Market in Five Acts

The 21st century actuary -- highly trained expert in mathematics, finance, insurance, and risk management; quantitatively astute skeptic and business person; playwright -- wait a minute.  Perhaps we’re getting carried away.  The actuary as playwright?!

Yes, it’s quite possible, in a manner of speaking.  Let’s consider the plot arc of the last decade of the variable annuity market in five acts.

First, the exposition:  in the United States, variable annuities are tax-favored retirement savings products with a central investment component, often accompanied by additional guarantees in the form of a death benefit or lifetime income stream.  Fundamentally, the purpose of these products is to help individuals manage their retirement savings through tax-deferred investment earnings in the accumulation phase and a lifetime income stream in the retirement phase.

The action rose as these products evolved dramatically from their earliest forms decades ago:  what was once a handful of simple mutual fund-like investments with the benefit of tax deferral was replaced by a dizzying array of investment options surrounded by dozens of types of guaranteed death benefits and lifetime income benefits.  In the years leading up to the financial crisis, product competition and growth were very strong, with sales increasing from $129 billion in 2003 to $184 billion in 2007 (source:  LIMRA).  With these volumes, variable annuities transformed from a complementary product line to a position at center stage for the insurance companies offering them and for the insurance industry at large.

The financial crisis was the climax, and exposed the massive and complex risks embedded in these products.  As global equity markets and interest rates declined precipitously, the value of the guarantees that were provided to variable annuity policyholders increased in value, but the value of insurers’ investment assets failed to keep up.  The industry buckled, as several companies reported losses of hundreds of millions of dollars, and many that had been leaders in variable annuity sales significantly curtailed or closed to new sales.  Sales dropped to $128 billion in 2009.

In the falling action since then, the industry seems to have gradually and reluctantly found a new normal, with “de-risked” products featuring more modest guarantee features around simpler investment options, with higher charges to policyholders.  Sales have increased to $147 billion in 2012.  But this is hardly a resolution.  As a result of the last decade of drama, shareholders, regulators, and rating agencies have become keenly aware of the risk dynamics for these products.  In spite of a reasonable recovery in terms of sales and product re-design, the industry still has about $2 trillion of inforce variable annuity assets of the old vintages that were so problematic during the last financial crisis (source:  IRI).  What is to prevent the next financial crisis from triggering catastrophe for the variable annuity market?

That is the question for the variable annuity industry.  And it is most pointedly the question for its actuaries.  How will these actuaries, uniquely qualified through their powerful combination of quantitative risk management skills, business savvy, and insurance heritage, write a creative denouement that avoids a tragic ending?  I’ll share mine in the next post.

Uncommon Sense

The funny thing about this risk management stuff is that everyone is supposedly doing it already. In business, from the solo practitioner or individual employee, to the department manager, to the chief executive, everyone has their internal compass as to what they should be doing or avoiding, or what specific result would constitute failure or success. Most people call this common sense.

Find XBut common sense can be surprisingly uncommon and inconsistently applied. Modern principles of risk management emphasize the importance of laying things out explicitly, in advance, taking actions that are consistent with these objectives, then monitoring progress and making adjustments over time. Sometimes the actions need to be adjusted, but sometimes the objectives do too. Even the most well thought out plan and risk management strategy will need to be changed eventually. Here is where we can easily slip off into abstract philosophical ruminations or highly technical risk management methodologies that would be virtually impossible for most business people to implement. I’m more of a pragmatist so let’s just start with the idea of questioning our assumptions, which is the bedrock of a sound risk management strategy.


Fragile or unrealistically precise assumptions are very dangerous things, and can lead well- intentioned business people astray. A simple example that I have seen repeatedly is the assumption that a new company can make a lot of money by entering a very large and mature market, if they can just eke out a tiny market share. It’s so tempting – surely we can get at least 0.5% market share, and with a $100 billion market, that’s $500 million in sales for us. Yes, there are large start-up costs, but once we break in, our profit can be $50 million annually in five years! This siren song is always accompanied by detailed financial projections, under baseline assumptions and stress tests. Ostensibly, this is good risk management practice, as the assumptions are explicit. But all too often I’ve seen these assumptions insufficiently justified, the stress tests not broad or severe enough, and the risks inadequately addressed.


This is where the actuary – the quantitatively astute skeptic and businessperson – can be invaluable. The actuary recognizes that market share is a function of how you distinguish yourself relative to competitors, and this is amenable to quantitative and qualitative analysis. The actuary needs evidence for assumptions, and can trace them back to specific operational actions or broader business conditions. The actuary recognizes that numerical assumptions should only be considered as placeholders for a range of possible outcomes, not an exact prediction; deviations can be multiples of the original assumption, not just plus or minus 20%. The actuary recognizes that these deviations represent risks to the business and should be managed attentively, not hoped away. And here’s the best part: the actuary is equipped to help manage these risks, sometimes through operational actions, sometimes through investment transactions, and sometimes through insurance transactions. Common sense meets modern risk management – now that is a powerful combination.

Don't Be Fooled by Forecasting

One of the things that I have always loved about mathematics, particularly in my quickly receding undergraduate days, is that there is almost always a right answer.  At least for the problems posed in math classes.  Usually the answer could be determined exactly.  Sometimes, you could only approximate it, and if you couldn’t do that, you could often at least prove that it exists.  And every now and then, you’d just have to take solace in the fact that you could prove that there is no solution.  At least that’s something.  That type of certainty is comforting to the young and idealistic, and to those who limit themselves to tidy categories of problems.

The passage of time and accumulation of experience has broadened my perspective.  While I still enjoy finding an exact and correct answer when the opportunity for that luxury presents itself (balancing the checkbook, reviewing my kids’ homework, etc.), I have come to recognize that these situations are not the norm in the real world.  All of us, including, and perhaps especially, actuaries – highly trained professionals in the fields of mathematics and finance, engineers of the insurance industry, and Jedi knights of the risk management profession – are surrounded by intractable problems.  By intractable, I don’t mean that these problems cannot be solved, at least partially.  I mean that they are not amenable to an exact and correct solution that can be determined in advance.

All too often, when the mainstream media mentions the actuarial profession, a trite description like “the folks who set your insurance rates” or “the folks who predict your life expectancy” is often used.  The inference, often quite direct, is that actuaries are capable of predicting the future.  Actuaries naturally scoff at this characterization, as we know that it is absurd, but I think that a fair number of us secretly enjoy the mystical powers that are ascribed to us.  All of which contributes to a general notion that actuaries and other mathematical and financial wizzes are capable of predicting the future and eliminating risks.

The good news is that we cannot.  No one can.

Why is this good news?  It is good news because risk is the flip side of opportunity.  A business without risks is impossible, whether we care to admit it or not.  And even if it was possible, it would be a business without opportunity for gains.  The gains that businesses earn from opportunities are in compensation for the risk of losses.  Moreover, a business can be characterized as a decision, explicit or implicit, to participate in certain types of risks.

Which risks, and to what extent?  Those are the real questions.  Any entrepreneur or business leader understands this intuitively.  The actuary’s role is to plumb the depths of these questions, determine and implement answers that are appropriate for the business given its risk appetite, and review, learn, and modify over time.  Historically, much of the work of actuaries has centered around management of specific risks in the insurance industry, but there is no reason for this limitation prospectively.  Business risks are all around us – materials supply, delivery logistics, financial liquidity, competitive analysis, customer behavior, and the list goes on.  Actuaries can help evaluate and manage these risks, even if they can never be fully eliminated.  Actuaries can identify the cost-benefit trade-offs that are central to the risk management process for any business.  And perhaps most importantly, actuaries can help identify and manage the other risks – the ones that are very subtle, perhaps possibilities that we have never wanted to see or consider before.

The job of the actuary is to see the world as it is, and help manage business opportunities and risks realistically.  The job is not to do exhaustive calculations for their own sake, or impart a false sense of precision to complex financial projections, or just “run the model”.  The job is to think and do, sometimes with the aid of rigorous mathematical and financial techniques, but avoid being fooled about what is and what can never be.  Can your business use this?