A General Actuarial Approach for Life Insurance Companies

Insurance contracts are contracts that transfer risk from the insured to the insurer.  These contracts often, also, transfer financial risk.  Significant insurance risk is defined as the possibility of paying significantly more in a scenario where the insured event occurs than in a scenario in which it does not.  Scenarios considered are those with commercial substance.  The risk under any one insurance contract is the possibility that the insured event occurs and the uncertainty of the amount of the resulting claim.  By the very nature of an insurance contract, the risk is random, and, therefore, unpredictable.  The principal risk that the insurer faces under its insurance contracts is that the actual claims and benefit payments exceed the carrying amount of the insurance liabilities.  Factors that aggravate insurance risk include lack of risk diversification in terms of type and amount of risk. 

In contracts with a discretionary participating feature, a significant portion of the insurance risk is shared with the insured.  Discretionary participating features entitle policyholders to receive additional benefits or bonuses, in addition to the guaranteed benefits of the policy.  These future bonuses are non-guaranteed, and are dependent on the future performance of the fund, and other factors related to the premiums invested, and the insurer’s performance.  The insurer retains the discretion to vary the amount or timing of the distribution of these bonuses.  For contracts with fixed and guaranteed benefits, and fixed future premiums, there are no similar mitigating terms and conditions that can reduce the insurance risk accepted.  In this case, the insurer mitigates the insurance risk by imposing underwriting limits to the size and type of risks, and underwriting to price the accepted risks. 

We understand that the larger the portfolio of similar insurance contracts, the smaller the relative variability about the expected outcome will be.  The insurer’s underwriting strategy, in such a case, is to diversify the type of insurance risks accepted.  Within each of these categories, it seeks to achieve a sufficiently large population of risks to reduce the variability of the expected outcome.  The insurer also mitigates insurance risk for contracts with fixed and guaranteed benefits and fixed future premiums through risk transfer. 

There are a few options here.  The first is by sharing risks with reinsurers.  Mortality risk and morbidity risk in excess of their respective retention limits are ceded to reduce fluctuations in claims payments.  The retention limits are mainly based on underwriting expertise, operational results, the expected size of the business portfolio, along with other considerations.  The yearly renewable term reinsurance is used for most products.  For new products or risk types with greater uncertainty in claim experience, quota share arrangements or co-insurance are used. 

There is also catastrophe reinsurance to protect the insurer from catastrophic loss exceeding its risk tolerance.  Catastrophic loss means all individual losses arising out of and directly occasioned by one or series of accidents, disasters, casualties, or happenings arising out of or caused by one event, subject to meeting the limitations on duration and extent of the loss occurrence. 

Insurers have risk concentration, which arises where a particular event or series of events could significantly impact the insurer’s liabilities.  Insurers in Singapore are exposed to geographical concentration of risk since most of the business is resident in Singapore.  It stands to reason that the individual insurers manage their economic sectoral concentration by diversifying insurance portfolio across the population of Singapore, and actively seek business in the region, all covering different working classes and different levels of society.