What are the risks of having inaccurate treaty data in your reinsurance administration system? Are those risks top of mind for actuaries? While the impact of inaccurate treaty data might not be apparent on a day-to-day basis, over the long term, they present a serious risk for insurance companies.
Why should actuaries care?
Regardless of their role within the reinsurance ecosystem, actuaries will experience the downstream effect of inaccurate treaty data in reinsurance systems. Thus, it is critical for actuaries to understand this impact and take an active role in mitigating this risk. Below, I’ll explore the relationship three types of actuarial professionals have with treaty data, the impact of errors, and how to mitigate risk.
What relationship do actuaries have with treaty data?
Pricing actuaries develop premium rates for new insurance products based on historical performance, product design specifications, profitability, competitive requirements, and oftentimes based on how much of the new product will be ceded to reinsurers. Reinsurance premiums can be a very important assumption within a pricing actuary’s modeling work.
Valuation actuaries determine the reserves companies should hold, both on a gross (before reinsurance) basis and a net (after reinsurance) basis. Like pricing actuaries, valuation actuaries make assumptions based on historical data trends and reinsurance treaty terms (i.e., how much is being ceded to reinsurers).
Risk Management Actuaries
Since most insurance organizations choose to mitigate risk through the use of reinsurance, risk management actuaries are often closely tied to treaty development. They are involved in everything from negotiating treaty terms and pricing to working on treaty provisions and maintaining strong relationships with reinsurers.
How do actuaries feel the impact of treaty data errors?
Given that pricing actuaries rely on historical system data to price new products, the need for accurate data is imperative. If there are errors in treaty data, new products could be priced inaccurately which in turn, can negatively impact the company’s future profitability and/or competitiveness. Errors can also impact current profitability if they lead to the incorrect reinsurance premiums being paid (either underpaying or overpaying).
If there are errors in a reinsurance administration system’s treaty data, valuation actuaries could be calculating reserves inaccurately.
For example, let’s say they calculate that 10 million dollars are required in reserves based on the treaty data when it should more accurately be 13 million dollars. This shortfall could impact the company's ability to pay future claims.
Or, if they calculate that 10 million dollars is required in reserves based on the treaty data and it should only be 7 million dollars. In this case, profits are understated since too much is being held in reserve.
Risk Management Actuaries
Part of their role is to negotiate financially viable deals. Which means determining how much to pay reinsurers to reimburse them for claims in the future. Risk management actuaries are often tasked with ensuring that relationships with reinsurers are maintained in good standing and that treaty terms are accurately adhered to.
Errors in reinsurance systems can translate into significant relationship issues, even to the point of reinsurers deciding not to pay a claim. For example, if a reinsurer discovers that an 85-year-old was erroneously ceded in a treaty that is supposed to be only for 20-80 years olds, they may choose to reject that policy at the time of claim. The insurance company may have to absorb the total amount of that claim (which could be millions of dollars) and also be at risk of losing a reinsurer in the process.
The downstream effect of the financial impact
There are various financial consequences that can occur due to errors in system data as described above, but the impact doesn’t end there. Financial ramifications can also negatively impact an organization’s market reputation and as mentioned above, damage its relationship with reinsurers. Both of which actuaries will have to deal with. A lack of trust between insurance companies and their reinsurers can also lead to more audits being performed which is an increase in overhead cost.
There is a lot on the line when it comes to errors in treaty data, but luckily actuaries can take an active role in achieving accurate data.
How can actuaries mitigate the risk of errors in system treaty data?
1. Implement sound administration processes and infrastructure
Actuaries need to be aware of the importance of strong reinsurance administration operations which includes:
- Ensuring the right infrastructure is in place
- Make sure administration systems are set up properly
- Implementing training, processes, and controls around administering ceded reinsurance
- Accessing the right expertise to manage reinsurance administration
Given they rely so heavily on the data that comes from the reinsurance systems, actuaries should contribute to maintaining the operations. This can be done by working closely with reinsurance operations teams. This leads to my next tip.
2. Develop and maintain strong relationships
By building and maintaining strong relationships with administration teams, both their own company’s ceded operation and those of their reinsurers, actuaries can reduce the potential for errors. Having close relationships with these stakeholders ensures that everyone is on the same page, sound practices are in place for maintaining accurate data and open lines of communication exist to discuss red flags.
3. Review treaty data and compliance
Without diligent audit and review processes in place, errors and inconsistencies in system treaty data can be hard to detect and even go unnoticed for many years. And the longer they go unnoticed, the more the impact has the opportunity to multiply. Taking an active role in testing what was agreed upon in the treaty is actually happening in the system, is another way actuaries can mitigate the risk of errors.