Spotlight on Recurring Payment Orders: The Benefits of Transferring PPO Risk to a Life Insurer

The start-up life insurer AUL Assurance targets general insurers by offering them the possibility of reducing their exposure to periodic scheduling risks. What are the benefits of such transfers and why might recent ASHE inflation figures make this option more attractive in the future?

Why do you think it makes sense for P&C insurers to “transfer” periodic payment order risk to life insurers?

Paul Hatley, CEO, AULA

These result from a risk of accident; but having claimed as PPO it is then a liability subordinated to [the] survival [of the claimant] and therefore it is life insurance and should be managed by a team with the expertise and resources to manage this longevity risk.

That’s not to say you couldn’t get this in a P&C society, but in an annuity society which is their goal, so I would say it makes sense once they materialize and the PPO is assigned to transfer it to where it can be better managed and that could be in a composite company with a life division. Otherwise, a specialist like AULA.

We believe that 14% of P&C reservations on a Solvency II base are related to PPOs. So on average P&C the balance sheets include 14% life risk, which is quite high. And we expect that to increase.

One of the reasons given why general insurers may be reluctant to transfer PPO the risks are due to the fact that the volume is not as high as some expected; how would you answer that?

Thus, new cases decreased from around 2010. And they’ve been pretty low lately, mostly because the Ogden rate was pretty generous and the lump sums were high. But also, not all applicants know that they have the option of a PPO. And if your responsibility is to pay your childcare costs for the rest of your life, and those childcare costs are going to increase with the inflation of the Annual Hours Survey and the Earnings Index, you might not want to not be a lump sum as you invest and manage the risk of running out. You want something that matches your obligation to pay [for care costs] and it’s a PPO the general insurer or a PPO annuity purchased by the general insurer from a life insurance company.

But even though they’re going down in terms of new cases, the portfolio is still growing because these are pretty young lives and they’re going to live a long time so there won’t be as many deaths as new cases, so it’s enlarges.

Another factor was the availability of reinsurance, do you think this might hinder the emergence of a market for PPOs?

If reinsurers do not have commutation clauses, they will help you manage longevity and ASHE risk. But reinsurers as a whole want their own claims to be “lump sum-like” because they want the profile to be as short as possible. And reinsurance deductibles are often indexed. Therefore, you could reinsure the risk, but you are not mitigating the actual risks by PPOs using reinsurance.

Given PPOs are a relatively new risk, how do you underwrite these risks?

Our raison d’être is to have the resources and expertise to assess longevity and life expectancy, and then manage the risk that it is not correct. So if you think someone is going to live to be 40, there’s a statistically good chance they’ll live less; and there is a strong chance that they will live longer; and it is a risk that must be quantified.

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

Another hurdle that has been mentioned as potentially slowing down the market for PPO transfers is the recent ASHE interval. Would you accept?

Yes, a key obstacle [participants] identified is the ASHE risk and if they transfer it to someone else, it becomes someone else’s ASHE risk. We solved this obstacle with reinsurance, so we bought reinsurance on the longevity risk related to the difference between ASHE and RPI. The net liabilities are therefore RPI related, which are matchable. We have a very good reinsurance agreement to cover the ASHE risk. We believe this is the key to success in this market.

Recent trends of income stagnation are fading into the distant past, fueled by issues specific to the care sector: Brexit, real increases in the minimum wage, lifting of the public sector wage freeze and “race to the top” .

Over the year until April 2021, ASHE increased by 2.3% vs one RPI 1.5% over the same period – thus care incomes grew 0.8% above inflation. I think that if ASHE was measured in October rather than April, we would see an increase ASHE inflation number, and should therefore expect that this year.

In the two years to April 2021, ASHE increased by 7.8% compared to a RPI by 4.1% over the same period – thus care income grew by 3.7% above inflation. Going forward, this annual increase of at least 1% to 2% per year above inflation is likely to continue over the long term, as recent trends of earnings stagnation fade into the distant past, fueled by issues specific to the care sector: Brexit, real increases in the minimum wage, lifting of the public sector wage freeze and “race to the top”. And of course we are already seeing huge increases in price inflation, possibly even up to 10% in 2022, so we should expect a rise ASHE in the short term also due to the increase in wages due to price inflation. This will be reflected in AULAgross reserves and prices, but should also be included in P&C insurers’ provisioning assumptions.

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

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

Then they started getting a little more sophisticated and factoring in life expectancy based on the client’s current age – and medical profile. Some have also begun to take a probabilistic approach by looking at the probability of death each year. So it gets more sophisticated; but not as sophisticated as it would be for a specialist annuity provider. Especially considering the difference ASHE can come from the long-term returns of gilts, 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 bit more sophisticated, but I don’t think they speak to their life mates. Where I see a difference is between the large global insurance groups and the smaller companies, which tend to be less sophisticated whether composite or not.

The insurers we spoke to seemed confident in their provisional position, did that surprise you?

We did a survey and the majority of correspondents said they were booking appropriately. But they also said they don’t have the expertise to match a specialist annuity company so on the one hand they say they book appropriately and on the other hand they don’t have 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 so. But I think it will become the market norm because, like in any other industry, there will be specialization and people will be encouraged economically or by regulation to go where the specialist has to take the risk.

About Matthew R. Dailey

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