A head for tails

(Nov 19, 2011)

When an insurer or reinsurer takes on a new insurance risk, there are two things of special interest: the best estimate of the risk and the tail risk.  The best estimate is about the current expectation of claim levels or costs, while tail risk is about how bad things could get if the company were unlucky.  The UK's ICA regime and the pending EU Solvency II regime are both concerned with tail risk at the 99.5th percentile.

When investigating tail risk, we are talking about the right-hand tail of a loss distribution, i.e. the part which contains the rare-but-costly scenarios.  It is therefore critically important that the model used does a good job of estimating the size and shape of this tail.  Since the loss is a random…

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Tags: tail risk, Solvency II, ICA

Partial buy-outs

(Jul 14, 2009)

It is quite common for a pension scheme to want to reduce its risk, but to be unable to afford a full buy-out.  The question is how best to reduce risk with the funds available, i.e. which liabilities to buy out first.  One argument we have come across is to buy out the older pensioners first, since their life expectancy can be more volatile against your funding assumption.

The answer to this depends on what way you want to measure the risk.  If you are looking at the possible percentage change in life expectancy or reserve, then older pensioners do indeed have a higher volatility: an extra year of life is proportionately larger compared to the baseline life expectancy (similarly for reserves).  Reserve calculations…

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Tags: buy-out, concentration risk, trend risk, tail risk

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