Expenses and expense inflation assumptions impact

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This blog has been authored by a group of Life actuaries led by IFoA Fellow Natalia Mirin (workstream lead)*. This blog discusses the potential impact of Covid-19 on expenses and expense inflation valuation assumptions for non-linked life products and is working as part of the IFoA Covid-19 Action Taskforce.

This blog is one in a series of articles and blogs published on behalf of the ICAT Life 3 Workstream – Assumption setting in current uncertainty. The Workstream is researching the impact on the year-end 2020 valuation assumptions setting process due to the recent Covid-19 pandemic. 

Introduction
Covid-19 is disrupting the way the insurers operate. This is leading them to innovate and adopt numerous measures to ensure business continuity during these challenging times. Regulators too, in the best interests of the policyholders, have responded in different ways. It's also observed that there is contraction in the sales of some products while increase in volume of others. For e.g. contraction in the savings lines observed mainly in Italy, France and Asia while growth is observed in pure risk lines1. All these developments can potentially impact insurer's expenses.

Actuaries need to consider such potential impacts and allow for these appropriately while reviewing the expenses and expense inflation assumptions. Factors that may potentially impact these assumptions are discussed below. 

Factors impacting expenses and expense inflation assumptions
The measures taken by insurers, regulators, governments as well as insured and non-insured population would impact the expenses and expense inflation assumptions.

a.    Digitisation

  • To curb the spread of the virus, insurance companies are collaborating with policyholders via virtual platforms for presales, on-boarding, servicing requirements, claim intimation or to address their queries/grievances. This may involve a one-off expenditure on infrastructure followed by regular expenses in the form of maintenance expenses by insurers on IT systems.
  • Insurers have built chatbots to address policyholders’ queries/grievances quickly. Some insurers also have dedicated customer care service line in place to address Covid-19 related queries.
  • Insurers have also come up with e-learning modules and online learning videos for the purposes of training their staff.
  • Travel costs have reduced significantly as meetings are held online.
  • It's also important to consider that unprecedented times such as these, along with employees working from home, have impacted the employees’ mental health. This could lead to increased expenses for insurers to ensure well-being of their staff.

Insurers should allow for such one-off expenditures and maintenance/regular expenses over an appropriate period while setting their expense assumptions. Also, insurers need to consider the fact that not many of these developments would in fact result in reduced expenses in long-term.

b.    Persistency

  • The current uncertain environment, where there is no certainty as to when virus would get eradicated, risk of potential further disruption to the economy has increased2 the perceived value of insurance especially for protection products, which might increase the persistency levels of such contracts.
  • While on the other hand, redundancy, or the risk of redundancy, have led individuals to spend their savings more judiciously.  This might result in reduced persistency levels.
  • Policyholders are anxious about their financial future with increased interest in life and health products since the COVID-19 outbreak3.

Actuaries should consider potential persistency impacts on the portfolio that they are analysing and accordingly set the renewal assumptions. This process may involve significant amount of expert judgement as future experience can be very different to the experience so far.

c.    Expected New Business

  • There would be an impact on expected new business levels varying from product to product. Actuaries should review their expected new business level projections in order to spread the fixed expenses between existing business and new business appropriately. Contraction in the savings lines is observed in Italy, France and Asia while increase in volumes of pure risk and health lines1.

d.    Impact on expenses due to regulatory actions

  • Actuaries should consider regulatory actions which might have an impact on their expenses and whether to reflect these in the expense assumptions. For example, in some countries, regulators asked insurers to speed up the claim settlement process related to Covid-19 claims or accept delays in premiums and waive off any late payment fees. This would increase insurers’ termination expenses and administration costs respectively.

e.    Other considerations
Insurers should also consider the following while reviewing the expenses assumptions: 

  • Cyber-security: there is an increased focus on protecting against cyber-security risk due to employees working from home. As such, actuaries should allow for the expenses incurred towards procuring the secured network. 
  • Any expenditure incurred towards research and development essentially to take the current pandemic environment as an opportunity to innovate and increase the market presence.
  • Corporate Social Responsibility (CSR): expenses incurred towards such initiatives. For example, supporting hospitals through provision of ventilators and consumables like sanitizers and masks.
  • Termination expenses: Now when employees from claims department would also be working from home and delays in processing the claims in general due to disruption caused by covid-19, insurers might incur greater expenses in verifying the claims thereby increasing the overall termination expenses.
  • Investment related expenses: this would depend upon on the size of the reserves and the extent to which insurers have incurred transaction costs related to buying/selling of assets during the market downturn.
  • For with-profits products, change in the expense assumptions would depend on the extent to which any adverse experience is shared with policyholders through regular or terminal bonuses3
  • Impact on expense assumptions would also depend on outsourcing agreements in place.
  • Property costs: because of their staff working from home, insurers might be reconsidering their location strategy and decide to vacate some of their premises. This would result in reduced costs for insurers. At the same time, insurers need to consider any penalties associated with early termination of leases.
  • Savings on operating expenses, for example, electricity costs, which in the grand scheme of things could be small.

Finally, as mentioned above, actuaries will need to apportion the expenses incurred between new and existing business. For example, allowance for expenditure incurred towards infrastructure or virtual platforms allocate appropriately between the expected new business and in-force book.

Expense Inflation

  • Actuaries need to set up expense inflation assumptions.
  • These will be based on the expectations of future inflation and must be consistent with other economic assumptions.
  • The relationship between fixed-interest and index-linked bond yields may be used to give a market view of future inflation.
  • Since March-2020, the movement in fixed-interest gilt yields and inflation rates has been volatile in UK. The rates increased in certain months while decreased in others. And overall, since year-end 2019, gilt yields and CPI, CPIH and RPI rates have fallen in UK4

While setting expense inflation assumptions the recent market movements appropriate for each region need to be allowed for along with the future outlook.

Summary

While reviewing expenses and expense inflation assumptions, actuaries should consider various factors relevant to their countries and insurance portfolios. Some factors that actuaries may want to consider while setting their initial, renewal or termination expenses and investment related costs are mentioned above. These are by no means exhaustive. As the current environment is still volatile and uncertain, insurers might want to err towards the prudent side and add margins to best-estimate assumptions in order to account for any adverse deviations. 

*This blog was authored by the following IFoA members: Natalia Mirin (lead), The members are Anjali Mittal, Burcin Arkut, Isha Aggarwal, Isha Kulkarni, Jagrit Bagga, James Gillespie, Justine Morrissey, Mcebisi Dhlamini, Nainjeet Juneja, Roy Perlson, Sanjoli Choudhary and Thomas Treacy.

Reference articles:

1. https://www.generali.com/it/media/press-releases/all/2020/Financial-Information-as-of-31-March-2020-Press-Release
2. https://www.swissre.com/risk-knowledge/building-societal-resilience/covid-19/market-announcement-covid19-consumer-survey.html,https://www.swissre.com/risk-knowledge/building-societal-resilience/covid-19/covid19-consumer-survey-sea.html
3. https://www.linkedin.com/posts/ugcPost-6722129767556087809-JOb6/
4. https://www.ons.gov.uk/economy/inflationandpriceindices/timeseries/czbh/mm23