Ian Burningham considers the differences between pricing actuaries and reserving actuaries roles in the ever-changing motor insurance market
The UK motor insurance market is a highly competitive industry, one that has undergone significant changes over recent years - and it is likely there are more ahead. Some of these may be a continuation of past trends, while others have the potential to fundamentally alter the future of the industry. The impact of this on the role of the actuary is unclear, but it is likely to be very different for those involved in pricing as opposed to reserving.
Motor insurance has struggled to report a profit over recent years - although individual insurers can and do deliver profits (as an aside, it is interesting to consider whether the market exhibits characteristics of a zero-sum game, with profits for any individual insurer essentially being at the cost of the rest of the market).
Figure 1 on page 34 shows reported operating ratios for the industry from FSA returns over recent years. The influence of historical landmark changes can be seen particularly in the reported loss ratios for 2009/2010, when the industry adjusted for the Ogden rate change and started recognising periodic payment orders (PPOs). Sequentially, the years after saw the benefits of reserve releases.
The impact of these landmark changes on profitability is slightly different if the changes in reserves are allocated back to individual accident years. Figure 2 on page 34 contrasts the reported FSA loss ratios above with the adjusted loss ratio from a sample of insurers where reserve changes have been allocated back to the original accident year. Although some approximations are made, it presents quite a different view on the historical industry profitability - essentially a much flatter history but still unprofitable over the long term after allowing for expenses.
Both these views paint a picture of an industry that is intensely competitive, one that has had to respond to environmental changes in order to try to achieve profits - and where sustained profitability is difficult.
The requirements of the actuary during the past 10 years have evolved with the motor insurance market. There have been increasing demands on reserving for PPOs, ongoing sophistication in pricing approaches and models of telematics (and range of data employed), plus the ongoing search for the ability to differentiate risks through segmentation analysis. These have different impacts on both pricing and reserving actuaries. So who is in the driving seat?
There are different potentials regarding the future of telematics, with quite different effects on the industry and the consequent demands placed on actuaries. It is not clear that telematics will necessarily 'take over the industry' the way some of the more evangelistic proponents believe, but it certainly has the potential to be a significantly disruptive influence.
In an extreme scenario, the expansion of telematics may allow for essentially 'individually priced' products for certain segments - an ultimate outcome being a pricing segment of one. Given that traditional insurance relies on pooling of risks, this may create interesting challenges. While such an extreme is unlikely, thinking through how pricing and reserving actuaries might respond to such an extreme can be useful.
The use of telematics devices could become the preserve of 'good' low-risk drivers who choose to have their driving behaviour recorded and use their driving behaviour history to secure lower premiums. This leaves only 'bad', higher-risk drivers, retained within a traditional motor insurance model and paying significantly higher premiums. For the most extreme risks, they may be viewed as uninsurable (at least at an economically affordable level for the driver). Should such an outcome emerge, some form of policy intervention may result to create a 'market' in the face of market failure.
An alternative scenario is that higher-risk drivers are forced to have their driving habits tracked using in-car telematics, with lower-risk drivers kept in a traditional insurance model where it is viable for the risk to be pooled. This may reduce the overall profit pool available in the traditional insurance model, while the financial dynamics of this type of high-risk telematics pool are still to be fully explored.
The growth of telematics usage could have some interesting impacts on reserving actuaries - delays in claim notifications should reduce, and estimates of frequency should be closer to statements of fact. There are, however, a range of things that reserving actuaries may need to consider. These could include:
? Validity of historical data: how will detailed telematics claims data be blended with past (aggregate) reserving assumptions?
? Reserving segments: what groupings or aggregations of segments might be used once individual driving data is available? How closely should these align with pricing segments? (Always a problem, but possibly exacerbated in a telematics world). How often might these change as more and more data becomes available?
? Severity indicators: what information is the best indicator of the severity of the crash, and therefore able to provide guidance as to likely claim outcomes?
? Adequacy of case reserves: will detailed telematics be data-fed into case reserving philosophy? Or will it remain the province of the deeply analytical areas of an insurer, with actuaries having another tool to assess incurred but not reported (IBNR) or incurred but not enough reported (IBNER)?
On the surface, the development of telematics looks like a boon to pricing actuaries - with countless additional data elements to add in to create new rating factors and relationships, and refine existing pricing models. It's not clear, though, how the data will interact with existing models. It is possible to create a driver 'score' to add in as an extra rating variable - one more factor in the multivariate model. Existing rating factors, however, can be viewed as proxies for driver behaviour, which leads to predictions of claims. Telematics data should provide more direct insight into actual driver behaviour - how will the existing proxies interact with the more directly observed data? Actuaries involved in the pricing of motor insurance are experienced at dealing with large data sets, and disentangling the complexities of relationships. It is unlikely their lives will become simpler as they start to blend together the new with the old.
Overall, the development of telematics will have a greater impact on pricing actuaries than reserving actuaries - not least as they are responsible for finding new sources of profit or new profitable segments as the market competitiveness keeps margins down. Reserving actuaries will still have a part to play, including the ongoing challenge of reconciling views with their colleagues setting prices.
Growth in telematics may result in separate 'risk pools' with different mechanisms to transfer risk. Traditional insurance models may be limited to sub-segments of the existing industry.
Expansion of PPOs
Similar to telematics, the recent emergence of PPOs creates challenges for both pricing and reserving actuaries. The past few years in particular have seen an increase in the level of reserving sophistication applied to PPOs, and this is likely to continue.
The treatment of reserving for PPOs has been inconsistent to date, as actuaries have got to grips with the complexities of the liability. In particular, the treatment of PPO IBNR has become more sophisticated over the past few years, with some convergence in market approaches. Overall, the industry has moved on from applying a simple loading or uplift to the portfolio. It is expected that this will remain an area of development.
Challenges continue for reserving actuaries, most clearly in the analysis of the accuracy of prior years' reserves, and incorporating any feedback into current estimates. It is also expected an emerging issue over time will be the development of specific management information and identifying key indicators to assist in managing the PPO liability. While most actuaries are concerned with measuring rather than managing liabilities, as motor insurance moves from a short-tail class to a long-tail class, it will be natural for the organisation to expect the actuary to provide significantly more insight into year-to-year movements.
Pricing actuaries in motor insurance have been used to distilling large volumes of claims data and identifying mis-priced segments in the market place. The past few years have seen the need to develop approaches that extend the large claim analysis undertaken and overlay a range of PPO assumptions. Some of these assumptions (for example, propensity to claim/convert to a PPO) will vary not only with size but with economic conditions.
The impact on the work of reserving actuaries will be more marked than on those who work in pricing. While pricing is likely to see an ongoing development of existing approaches, the reserving function may well need to be transformed as the portfolio becomes essentially a long-tail class of business.
The motor insurance industry will continue to evolve and individual business models will adapt along with it. The role the profession plays will develop alongside this. Just as the future of a successful business model is unknown, it is not clear how pricing and reserving actuaries will respond to these ongoing changes. Ultimately, both will have to collaborate in order to steer towards the future motor insurance market.
Ian Burningham is a director with KPMG and works in the insurance practice