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Spotlight on periodical payment orders: The benefits of transferring PPO risks to a life insurer

Transferring data concept_for CMS

Start-up life insurer AUL Assurance is targeting general insurers, offering them an opportunity to reduce their exposure to periodical payment order risks. What are the benefits of such transfers and why might the recent ASHE inflation figures make this option more attractive in the future?

Why do you think it is sensible for general insurers to “transfer” Periodical Payment Order risks to life insurers?

AULA CEO Paul Hately
Paul Hately, CEO, AULA

These arise from a casualty risk; but having claimed as a PPO it is then a liability contingent on [the] survival [of the claimant] and therefore it is life insurance, and should be managed by a team with expertise and resources at managing that longevity risk.

That is not to say that you could not get that in a P&C company, but at an annuity company that is their focus, so I would therefore say it is logical once they materialize and the PPO is awarded to transfer it where it can be best managed and that could be in a composite company with a life division. Otherwise, a specialist like AULA.

We think 14% of P&C reserves on a Solvency II basis are linked to PPOs. So on average P&C balance sheets are 14% life risks, and that is quite high. And we expect that to go up.

One of the reasons that has been suggested why general insurers might be reticent to transfer PPO risks is because volume are not as high as some were predicting; how would you respond to that?

So the new cases did fall off from about 2010 onwards. And they have been quite low of late predominantly because the Ogden rate was pretty generous, and lump sums were high. But also, not all claimants are aware they have the option of a PPO. And if your liability is to pay for your care costs for the rest of your life, and those care costs are going to go up with the Annual Survey of Hours and Earnings Index inflation, you might not want a lump sum that you invest and run the risk of it running out. You want something that matches your liability to pay [for care costs] and that is a PPO from the general insurer or a PPO annuity bought by the general insurer from a life company.

But even though they are falling off in terms of new ones, the portfolio continues to grow because these involve quite young lives and they are going to live a long time so there aren’t going to be as many deaths as new cases, so it is getting larger.

Another factor was the availability of reinsurance, do you see this as potentially hampering the emergence of a market for PPOs?

If the reinsurers don’t have commutation clauses they are going to help you manage the longevity and ASHE risk. But the reinsurers on the whole are wanting their own claims to be ‘lump sum-like’ as they want the profile to be as short tail as possible. And the reinsurance deductibles are often indexed. So, therefore, you could reinsure the risk, but you are not mitigating the real risks in PPOs by using reinsurance.

Given PPOs are a relatively recent risk to contend with how do you underwrite these risks?

Our raison d’etre is having the resources and expertise to assess longevity and life expectancy and then manage the risk of that not being right. So if you think someone is going to live 40 years there is statistically a good chance they will live for less; and there is a good chance they will live for more; and that is a risk that has to be costed.

So we start by pricing with medical underwriting expertise, using as many papers, and as much research and medical evidence as we can get our hands on to assess the life expectancy and shape of the mortality risk. And once you have that you can start to price it using actuarial methods. And we are not a cheap alternative to a lump sum. We are a more appropriate alternative. So a PPO is often more expensive than a lump sum, and we are a more appropriate place for that PPO to sit.

Another obstacle that has been mentioned as possibly slowing down the market for PPO transfers is the recent ASHE range. Would you agree?

Yes, one key obstacle [participants] identified is the ASHE risk and if they transfer it to someone else it becomes someone else’s ASHE risk. We’ve solved that obstacle by reinsurance, so we have bought reinsurance on the longevity risk linked to the difference between ASHE and RPI. So net liabilities are RPI linked, which are matchable. We have a very good reinsurance arrangement to cover off the ASHE risk. We think that is key to success in this market.

The recent trends of stagnation in earnings fades into the distant past fuelled by issues specific to the care sector: Brexit, real increases in the minimum wage, lifting of public sector pay freezes and ‘levelling up’.”

Over the year to April 2021, ASHE increased by 2.3% vs an RPI of 1.5% over the same period – so care earnings increased by 0.8% above inflation. I think that if ASHE was measured at October rather than April we would be seeing a higher ASHE inflation number, and therefore should expect that this year.

Over the two years to April 2021, ASHE increased by 7.8% vs an RPI of 4.1% over the same period – so care earnings increased by 3.7% above inflation. Going forward this annual increase of at least 1% to 2% per annum above inflation is likely to continue in the long-term as the recent trends of stagnation in earnings fades into the distant past fuelled by issues specific to the care sector : Brexit, real increases in the minimum wage, lifting of public sector pay freezes and ‘levelling up’. And of course we are already seeing huge increases in price inflation perhaps even up to 10% in 2022, so we should expect higher ASHE in the short-term too as a result of wages being driven higher by price inflation. This will be reflected in AULA’s gross reserves and prices but also should be in the reserving assumptions of the casualty insurers.

What are your overall observations about how general insurers currently manage PPOs?

[General insurers] are becoming more sophisticated. A few years ago the most popular way was to take the life expectancy and then value that as an annuity certain – assuming they would live for exactly that long. So they started off very simple just deducting the number of years that have already passed.

Then they started to become a bit more sophisticated and take into account life expectancy based on how old the customer is now – and their medical profile. Some have also started to take a probabilistic approach looking at the likelihood of death in every year. So it is getting more sophisticated; but not as sophisticated as it would be for a specialist annuity provider. Especially taking into account how divergent ASHE can be from long term gilt yields for example.

Do you see a difference in how composite and specialist GI players manage PPOs?

No, I don’t see a big difference; maybe the composite is a little bit more sophisticated, but I don’t think they are talking to their life colleagues. Where I do see a difference is between large global insurance groups and smaller companies, who tend to be less sophisticated, irrespective of whether they are composites or not.

The insurers we spoke to seemed assured of their reserving position, did that surprise you?

We did a survey and the bulk of correspondents did say they were reserving appropriately. But they also said they did not have the expertise to match a specialist annuity company, so on the one hand they are saying they are reserving appropriately and on the other they don’t have the expertise, so how do they know [they are reserving appropriately?

And the PRA did issue a ‘Dear CEO/chief actuary’ letter in late 2019 saying they expected more attention to the level of reserves. Our survey indicated that on the whole that would not make a lot of difference.

So respondents said they would not change; but I think they will and we’ll see a strengthening of reserves. We would have seen it anyway, but given the way it looks with how care worker salaries are moving I think that strengthening of reserves will happen and a bit quicker than it otherwise would have done.

Potential comparisons have been drawn between PPOs and defined benefit pension schemes; do you think that could be a fair comparison?

With DB pension schemes, companies have been offering solutions for more than 15 years now but only two to three years ago did the market start to mature and people started to do more than they did than in any year before.

So my guess is that it takes about 10 years from someone introducing the concept of transferring risks whether it is DB pension schemes or PPOs – in payment, or at the point of order. It takes a decade from [solutions] being offered to them becoming the norm to do it. But I do think it will become the market norm because like in any other industry there will be specialisation and people will be encouraged economically or through regulation to go to where the specialist is to hold the risk. 

 

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