Jul 14, 2010

Solvency II Project Management Pitfalls

When you - just like me - wonder how Solvency (II) projects are being managed, join the club! It's crazy...., dozens of actuaries, IT professionals, finance experts, bookkeepers accountants, risk managers, project and program managers, compliance officers and a lot of other semi-solvency 'Disaster tourists' are flown in to join budget-unlimited S-II Projects.

On top of it all, nobody seems to understand each other, it's a  confusion of tongues..... 

Now that the European Parliament have finally agreed upon  the Solvency II Framework Directive in April 2009, everything should look ready for a successful S-II implementation before the end of 2012. However, nothing is farther from the truth.....

Solve(ncy) Questions in Time
The end of 2012 might seem a long way of...
While time is ticking, all kind of questions pop up like:
  • How to build an ORSA system and who owns it?
  • What's the relation between ORSA and other systems or models, like the Internal Model
  • Where do the actuarial models and systems fit in?
  • What are financial, actuarial, investing and 'managing' parameters, what distinguishes them, who owns them and who's authorised and competent to change them?
  • How to connect all IT-systems to deliver on a frequent basis what S-II reporting needs......?
  • How to build a consistent S-II IT framework, while the outcomes from QIS-5 (6,7,...) are (still) not clear and more 'Qisses' seem to come ahead?
  • Etc, etc, etc, etc^10

The Solvency Delusion
Answering the above questions is not the only challenge. A real 'Solvency Hoax' and other pitfalls seem on their way....

It appears that most of the actuarial work has been done by calculating the MCR and SCR in 'Pillar I'.

It's scaring to observe that the 'communis opinio'  now seems to be that the main part of the S-II project is completed. Project members feel relieved and the 'Solvency II Balance Sheet' seems (almost) ready!

Don't rejoice..., it's a delusion!  The main work in Pillar II (ORSA) and Pillar III (Reporting, transparency) still has to come and - at this moment - only few project managers know how to move from Pillar I to Pillar II.

Compliancy First, a pitfall?
With the Quantitative Impact Study (QIS-5) on its way (due date: October 2010) every insurer is focusing on becoming a well capitalized Solvency-II compliant financial institution.

There is nothing wrong with this compliance goal, but 'just' becoming 'solvency compliant' is a real pitfall and unfortunately not enough to survive in the years after 2010.

Risk Optimization
Sometimes, in the fever of becoming compliant, an essential part called "Risk Optimization" seems to be left out, as most managers only have an eye for 'direct capital effects' on the balance sheet and finishing 'on time', whatever the consequences......

Risk Optimization is - as we know - one of the most efficient methods to maximize company and client value. Here's a limited (check)list of possible Risk Optimization measurements:


1. Risk Avoidance
- Prevent Risk
   • Health programs
   • Health checks
   • Certification (ISO, etc)
   • Risk education programs
   • High-risk transactions
      (identify,eliminate, price)
   • Fraud detection
      (identify,eliminate, price)
   • Adverse selection
      (identify, manage, price)

- Adjust policy conditions
   • Exclude or Limit Risk  
      (type,term)
   • Restrict underwriter
      conditions
      (excess, term, etc)

- Run-off portfolios/products

2. Damage control
- Emergency Plans (tested)
- Claims Service, Repair service
- Reintegration services


3. Risk Reduction
- Diversification

- Asset Mix, ALM
- Decrease exposure term
- Risk Matching
- Decrease mismatch
   AL/Duration
- Outsourcing, Leasing

4. Risk Sharing
- Reinsurance (XL,SL,SQ)
- Securitization, Pooling
- Derivatives, Hedging
- Geographical spread
- Tax, Bonus policy

5. Risk Pricing
- Exposure rating, Experience rating
- Credibility rating, Community rating
- Risk profile rating

6. Equity financing
- IPO, Initial Public Offering
- Share sale, Share placement
- Capital injections

Solvency-II Project Oversight
Just to remind you of the enormous financial impact potential of 'Risk Optimization' and to keep your eye on a 'helicopter view level' with regard to Solvency-II projects and achievements, here's a (non-complete but hopefully helpful) visual oversight of what has to be done before the end of 2012.....

(Download big picture JPG, PDF)

Be aware that all Key Performance Indicators (KPIs), Key Risk Indicators (KRIs) and Key Control Indicators (KCIs) must be well defined and allocated. Please keep also in mind that one person’s KRI can be another’s performance indicator(KPI) and a third person’s control-effectiveness indicator.

Value Added Actions
As actuaries, we're in the position of letting 'Risk Optimization' work.
We're the 'connecting officers' in the Solvency Army, with the potential of convincing management and other professionals to take the right value added actions in time.

Don't be bluffed as an actuary, take stand in your Solvency II project and add real value to your company and its clients.

Related Links:

- A Comparison of Solvency Systems: US and EU
- UK Life solvency falls under qis-5
- Determine capital add-on
- Reducing r-w assets to maximize profitability and capital ratios
- Risk: Who is who?
- Balanced scorecard including KRIs (2010)
- Solvency II, Piller II & III
- Risk Adjusted Return On Risk Adjusted Capital (RARORAC)
- ERM: “Managing the Invisible" (pdf; 2010)
- Unlocking the mystery of the risk framework around ORSA
- Risk  based Performance: KPI,KRI,KCI
- Risk of risk indicators (ppt;2004)
- Defining Risk Appetite
- Risk appetite ING KPI/KRI
- Board fit for S II?
- How to compute fund vaR?
- Technical Provisions in Solvency II
- Insurers should use derivatives to manage risk under Solvency II 
- Solvency Regulation and Contract Pricing in the Insurance Industry
- Overview and comparison of risk-based capital standards 
- Solvency II IBM
- Reinsurance: Munich Re  , Reinsurance solvency II

Jul 10, 2010

Actuarial Limit 100m Sprint

In June 2009 Professor of Statistics John Einmahl and (junior) actuary Sander Smeets, calculated the ultimate record for the 100-meter sprint. The actual World record - at that time - was set by Usain Bolt at 9.69 seconds (August 16, 2008, Beijing, China).

With help of the extreme-value theory and based on 'doping free' World Record data (observation period:1991 to June,19 2008) Smeets and Einmahl calculated the fastest time that a man would be ultimately capable of sprinting at: Limit = 9.51 seconds.

However....
As often in actuarial calculation, once your model is finally set, tested and implemented, the world changes...

Or, as a former colleague once friendly answered when I asked him if his ship (project) was still on course:


In this case, the 'model shifting event' took place in Beijing, exactly one year later, on August 16, 2009: Usain Bolt sets a new astonishing 100m World Record in 9.58 seconds !

Of course 9.58 secs is still within the scope of Smeets' and Einmahl's model limit of 9.51 seconds...

Nevertheless, as a common sense actuary, you can see coming a mile away, that this 9.51 secs-limit will not hold as a final future limit.

As is visual clear, one can at least question the validity of the 'extreme-value theory approach' in this 100m sprint case.

Math-Only Models
In this kind of projections (e.g. 100m world records) it's not enough to base estimations only on historical data. No matter how well historical data are projected into future data, things will mesh up!
Why? Because these kind of 'math-only models' fail to incorporate the changes in what's behind and what causes new 100m World Records. To develop more sensible estimates, we'll have to dive into the world of Biomechanics.

To demonstrate this, let's have a quick -amateur - look at some biomechanical data with respect to Usain Bolt's last World Record:



Let's draw a simple conclusion from this chart:


Hitting 9.50 secs seems possible


Just like Bolt stated in an interview: "I think I can go 9.50-something", appears to be realistic:
  • 0.026 secs faster by improving his reaction time to the level of his best competitors: 0.12secs, instead of  0.146secs
  • 0.060 secs faster by reaching his maximum speed (12.35 m/s) at V50 and maintaining this speed for the remaining 50 meters. 

Biomechanical explanations
On top of this, Bolt outperforms his competitors on having a higher step length and a lower step frequency. This implies there must be deeper biomechanical factors like body weight, leg strength, leg length & stiffness (etc), that need to be included in a model to develop more realistic outcomes.

Newest biomechanical research ("The biological limits to running speed are imposed from the ground up" ) shows maximum (theoretical?) speeds of 14 m/s are within reach, leading to potential World Records of around 9 secs on the long run.....

Based on this new biomechanical information output in combination with an appropriate chosen corresponding logistic model, we can now predict a more realistic ultimate World Record Estimation (WRE) in time.

Curvefitting at ZunZun with the 1968-2009 data (including Bolt's 9.58 secs record) on basis of a Weibull CDF With Offset (c), led to the next, best fit equation:

 
With: y=WRE in seconds, x=Excel date number, and:
a =  -3.81253229860548
b =  41926.0524625578
c =  8.97894916004274 (=final limit)

As we may learn more about biometrics in the near future, perhaps the ultimate 9 seconds (8.9789 seconds, more exactly) can possibly be reached faster than we currently estimate (year 2200).


Playtime
Now, just play around with (estimate) world records in this Google time series plotter:




Finally
As actuaries, what can we learn from this 'sprinting example'?
 
Well... Take a look at estimating future (2030 a.f.) mortality rates.

Just like with estimating World Records, it seems almost impossible to estimate future mortality rates just on basis of extrapolating history.

No matter the quality of the data or your model, without additional information what's behind this mortality development, future estimations seem worthless and risky.

Although more and more factors affecting retirement mortality are being analysed, (bio)genetic and medical information should be studied by actuaries and translated into output that strengthens the devlopment of new mortality estimate models.

Actuaries, leave your comfortable Qx-houses and get started!

Related links and sources:
- Ultimate 100m world records through extreme-value theory
- 90 years of records
- Usain Bolt: The Science of Running Really Fast
- Biomechanics Report WC Berlin 2009 Sprint Men
- BP WC Berlin 2009 - Analysis of Bolt: average speed 
- The biological limits to running speed (2010)
- Limits to running speed in dogs, horses and humans (2008)
- Improving running economy and efficiency
- Factors Affecting Retirement Mortality and Their Impact ... 
- Cheetah Sets New World Record 100 meter sprint2009 (6.130 sec)
- 100m World record data and WRE (xls spreadsheet)

Jul 5, 2010

Exceptional Longevity Predictable

A genome-wide association study (Paola Sebastiani et al) based upon 1055 centenarians, showed that Exceptional Longevity (EL)  - living 90 years or more - can be predicted with 77% accuracy!


EL Genetic Passport
This research development will have major impact on 'life insurance' and pensions. With an EL Genetic Passport in your pocket, you'll have the power to conclude with 77% certainty whether it's profitable (or not) to buy life insurance or to invest more or less in your pension fund.

Genetic Loss by GAS
To prevent major losses caused by 'adverse selection', life insurance companies and pension funds have no other choice left, than to base life insurance premium prices and pension contributions on 'genetic passport information'.

Just like it's (from a company's perspective) devastating to sell mortgages to people who cannot afford it, it's also killing to sell life annuities to people who have knowledge of getting 90 years or older with 77% certainty.

As Genetic Adverse Selection (GAS) also negatively affects current provisions and value of an insurance company or pension fund, GAS development effects should be included and estimated in actual liability calculations.

Without doubt, GAS will generate large Genetic Losses in the next decades. Perhaps GAS can be qualified as a substantial new kind of risk in Pillar I calculations.


Related links - Sources:
- Science: Genetic Signatures of Exceptional Longevity in Humans
- PDF: Genetic Signatures of Exceptional Longevity in Humans
- BU: Signatures of Human Exceptional Longevity (video)
- Centenarians in some European countries, 2007