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The recent allegations against General Electric (GE) read like a financial thriller: Bernie Madoff whistle-blower teams up with anonymous hedge fund to expose the alleged financial misdeeds of one of the most recognizable brands in American history.

But most people’s interest in this story ends abruptly when they hear about the crux of the allegations, which can be summarized in eight words: “… inadequate loss reserves for long term care (re)insurance.” This topic is esoteric at best, and sleep-inducing at worst. It’s impossible to spin into media clickbait. And it’s clear that media is struggling to describe exactly what Harry Markopolos, the whistle-blower, is alleging in his 175 page report

So, in this blog post I’m going to give it a shot in my own words, and as a reward for my work, a mention of my company’s excellent products at the end of the article (this is a corporate blog, after all).  

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First, about myself: I cut my teeth in the insurance industry at a workers’ compensation startup, which was acquired by Blue Cross Blue Shield of Michigan. Workers’ comp is considered a “long tail” line of business, meaning that the time elapsed between collecting premium and paying claims can be long. For example: if a business buys a workers’ compensation policy and its employee sustains a serious injury, the claim could last years (or even decades), leaving the insurer paying claims long after the policy expires.

This “long tail” issue is at the center of GE’s predicament. In Long-Term Care (LTC) Insurance, the average age of the insured at the time of policy issuance is 55, but the average age of a claimant is 80. That’s a whopping 25 years between when the policy is sold, and the claim is filed. Imagine you are an insurance executive, going to work every day with the knowledge that the policies you write won’t experience a claim for more than 25 years. 

This fact might give rise to the wrong incentives, such as underpricing the coverage by ignoring the increases in longevity and healthcare cost. This would lead to higher policy sales and higher bonuses, promotions, awards, and industry recognition. So how does the insurance industry (and the regulators) prevent this from happening, and keep these incentives in check?

In a word: actuaries. Actuaries are the statistical wizards of the insurance industry, and one of their jobs is to project an insurer’s claims obligations very far into the future. I won’t pretend to understand the arcane and complex things they do to achieve this, but suffice to say every year they must put their signature to a statement of actuarial opinion, attesting that an insurer’s loss reserves are reasonable. The analysis leading to this is a serious undertaking and it puts the actuary’s name, reputation, and credentials on the line. (As with an accountant when blessing a company’s financial statements).  

In Mr. Markopolos’ report, he alleges that the company actuaries “… are getting paid by GE, so of course they’ll never question GE’s Long-Term Care reserves.” That’s a bold accusation, and unfortunately it will take years to determine its accuracy. In the meantime, GE’s loss reserves will be the subject of considerable investigation.

The uncertainty in loss reserving can be tremendous, particularly in lines of insurance whose profitability depends on long-term mortality assumptions such as life and long-term care. Today’s loss reserves might be adequate, but what if an incurable epidemic emerges 10 years from now? What if we cure cancer?  What if lifestyles change unpredictably? The impact of these future developments simply cannot be measured with an insurer’s claims experience.  And that is why RMS developed its LifeRisks Solution Suite, enabling insurers to measure the impact of future improvements in longevity across five categories that affect longevity we call “vitagions”:

1. Lifestyle trends: Personal decisions like smoking habits, diet and exercise which have a strong influence on mortality levels.

2. Medical intervention: New medical treatments, drugs, and advances in biotechnology that bring about extensions in life expectancy.

3. Health environment: The availability of healthcare and public health standards controlling the living conditions that determine mortality.

4. Regenerative medicine: New technologies such as stem cell therapy and nano-medicine which promise future mortality improvements.

5. Anti-Aging processes: Research into radical new approaches of extending healthy lives that impact mortality levels sometime in the future.

Projecting future medical improvement is challenging because it is random. It is impossible to know when the next game-changing discovery will occur, or what form it will take – but this can be informed by research and scientific study about technology, medicine, and lifestyle. In order to account for this randomness, leading scientists from RMS built an event set representing the ways each vitagion could affect longevity, then built a simulation engine that sampled from that event set. Finally, RMS modeled the likelihood and time it would take these changes to impact longevity. The result is some very good insight into the range of scenarios an insurer could face, and the ability to act on those scenarios.

There’s a joke in the actuarial community about a junior analyst who, when pressed to defend his loss projections, responded that he “pulled them from the ‘multi-year actuarial support system’.” The clever acronym embedded in this joke sometimes elicits a chuckle. But the joke’s underlying message is about the purpose of actuarial science: to be precise about imprecision, to quantify uncertainty, and to capture the range of possible loss outcomes. There is a large and growing body of scientific research that can help accomplish this – and risk models must leverage this science to help insurers better understand their long-term risks and to insulate themselves against the kinds of allegations that GE is now facing.

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Wildfire: Managing a Peak Peril

A new wildfire season looms on the horizon across the United States, and as the last two years of huge wildfire insured losses and extensive devastation to lives and property clearly illustrates, wildfire is no longer an easily manageable loss for the (re)insurance industry – but a new peak peril. So, what could be in store for the 2019 season? The industry is reeling from back-to-back seasons with losses over US$10 billion. This is unprecedented even during a period when average losses between 2011-2018 were at US$3.7 billion. And looking back, this is up 40x compared to 1964-1990, where losses were below US$100 million in today’s prices. What is changing with this peril, what are the risk drivers that we need to look out for? It is becoming clear that wildfire risk must be managed much more actively by the (re)insurance industry, with more advanced modeling, analytics and research. I was honored to be invited to present a webinar together with Daniel Gorham, research engineer from the Insurance Institute for Building and Home Safety (IBHS) entitled “Navigating Wildfire Risk Catastrophe Analytics for a New Peak Peril”. This webinar is available on-demand for you to view, see the video below. In this webinar, I examine each of three growing drivers of wildfire risk: exposure growth changes in the fuel landscape, and climate change. What is also apparent when examining these drivers is the need for more granular, robust modeling to capture the complexity of wildfire hazard. The factors that need to be considered when assessing the hazard must of course look at the type of fuel, the basis for many conventional wildfire models. But it needs to go way beyond that, to look at the terrain – how it slopes, the rate of fire spread, the intensity, plus critical factors such as the concentration of smoke, and ember accumulation and travel – pivotal to recent urban conflagrations such as the one in the Coffey Park Neighborhood of the 2017 Tubbs Fire. And for the vulnerability side of wildfire modeling, the webinar examines the crucial work of the IBHS and its research around building ignition mechanisms – from direct flame contact, radiative heat transfer and embers. Some studies suggest that up to 90 percent of buildings that are destroyed by wildfires were ignited by embers, and these can be embers that land directly on a building or “indirect” on flammable material just outside a building. Many building characteristics can help resist ignition, such as roofing, siding, eaves, vents and decks. In the webinar, Daniel takes viewers through the impact of each and discusses the importance of defensible space around a structure. Working together with the IBHS, RMS created an industry-leading vulnerability module that accommodates these important mitigation features. The sheer volume and range of questions we received during the webinar indicates the industry’s interest in managing this pervasive peril much more effectively. If you would like to find out more about the RMS® U.S. Wildfire High-Definition (HD) Model, part of the RMS North America Wildifre HD Models suite, please click here to explore our dedicated microsite, and click here for more on wildfire research by the IBHS. …

Chris folkman
Chris Folkman
senior director of product management

Chris Folkman is a senior director of product management at RMS, where he is responsible for specialty lines including terrorism, casualty, wildfire, marine cargo, industrial facilities, and builders' risk. He has extensive experience on both the broker and carrier sides of insurance, where he has led many aspects of property and casualty operations including underwriting, pricing, predictive analytics, regulatory affairs, and third-party commercial coverage and claims.

Prior to RMS, he was a managing director at CompWest Insurance Company, a workers’ compensation start-up that was acquired by Blue Cross Blue Shield of Michigan. Chris holds a bachelor's degree from Stanford University. He is a licensed insurance broker and a Chartered Property and Casualty Underwriter (CPCU).

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