Would Principle-Based Reserving Measure Up If Bird Flu Arrives?

The threat of a pandemic "harkens back to a time several years ago when HIV/AIDS became a serious threat to the industry," says Jim Van Elsen, Van Elsen Consulting, Pella, Iowa. The difference, he says, is that if avian flu comes to pass here in the United States, it will affect a lot more people.

What the impact would be on the industry depends on the population that it hits, he explains. For instance, if it hits children and young people, fewer of those victims might be insured. If, however, it hits the 40-60 age group, that would make a bigger difference from a financial point of view because more of that population would be insured.

How it affects the principle-based concept for reserving still would be undefined, he continues. It would require monitoring risks and making adjustments where necessary, Van Elsen adds. He says he would be more aggressive in making assumptions that account for the possibility of the avian flu. "It shouldn't be on your doorstep before you start reflecting it."

But Van Elsen explains that he is not a fan of the additional general padding that a formulaic approach uses. Rather, he continues, he prefers specific reserving for specific risks.

During the time when HIV/AIDS was a major issue, everyone was using standard mortality tables and not individual company mortality experience, says Barbara Lautzenheiser, principal of Lautzenheiser & Associates, Hartford, Conn.

But, with a principle-based approach, companies would use their own mortality experience to establish reserves, she adds. Companies would adjust their reserves accordingly, she says, and it would create a "faster warning system."

If the avian flu becomes a pandemic in the U.S., Lautzenheiser continues, the 35-75 age group would impact the insurance industry.

The models that were created under a principle-based approach would have an automatic adjustment feature built in that would be reflected in reserving, she says. But it would not help with pricing because that would be based on mortality used at the time the contract was established, according to Lautzenheiser.

In the current environment, there is nothing that the formulaic approach even considers that addresses issues such as a pandemic, says Robert Wilcox, president of the American Academy of Actuaries, Washington, and a consulting actuary with Wilcox & Company, Alpine, Utah. Only as companies recognize that they may be affected would they take steps to reflect the impact, he explains.

With the principle-based solution, it would be part of the consideration to look at these possibilities, he adds. Both direct writers and reinsurers could assess the financial impact, he says. And, in the case of a reinsurer, it could take action such as building the event into the premium structure or making a decision to retrocede business, according to Wilcox. "It offers the greatest benefit to all risk takers."

A principle-based approach would measure sensitivity to a pandemic and report to management and to regulators on the company's exposure, and what would happen if mortality increases and what would happen if, for example, there were 3 shocks to a company in 10 years, instead of one major shock in 100 years, says Dave Sandberg, vice president and corporate actuary with Allianz Life Insurance Co. of North America, Minneapolis.

The focus, he says, would be on the long term and how the tools could be built into a company's system so that it would detect such risks.