Financial Security

Key Developments During 2018

Financial Protection

  • People are living longer, often with complex long-term conditions and high expectations about the treatments they will receive. This increasing demand for social care for the elderly combined with the increasing costs of care, is putting an ever-increasing strain on NHS resources. In this environment NHS Trusts make individual decisions which are often referred to as a ‘postcode lottery’ (as illustrated by the recent debate over provision of diabetes monitors). The degree of provision can vary significantly between different regions of the UK. For actuaries working in this area, there is a risk that using pricing or valuation assumptions based upon aggregate data may be inappropriate particularly where business volumes are concentrated by geography. Actuaries may also face challenges in sourcing appropriate granular data and should be aware of any risks to the credibility of statistical analysis from small data sets.
  • Insurance, pensions and investment products often provide individuals with coverage or benefits for a long period or in complex situations. There is a risk to financial security if consumers’ understanding of the products is low, the price is prohibitive, or the product choice is limited (e.g. for vulnerable groups). The quality of communications and disclosures throughout the life of the product can contribute or inhibit customer understanding. During 2018, there has been increased regulatory scrutiny of firms’ touchpoints with consumers. For example, the FCA and CMA recently reviewed market practices in the areas of general insurance pricing, treatment of with-profits consumers and advice provided to pension transferees.
  • Protection Gap

  • There is evidence of low financial resilience and a protection gap. In the UK, for example, the FCA’s Financial Lives 2017 Survey revealed that just under a third of the UK adult population have ‘low financial resilience’ due to factors such as over-indebtedness, an inability to cover living expenses for even a week if they lost their main source of income, or being overdrawn constantly or usually by the time they are paid or receive other income. Despite this apparent financial vulnerability and need for a safety net, the FCA research study also highlighted that 65% of the UK adult population does not have any form of protection insurance.
  • In September 2018, the Social Metrics Commission reported its findings on a poverty indicator that goes beyond a simple measure of relative income and takes account of living costs such as housing, childcare and the extra costs of disability. The adoption of this poverty indicator may lead to different populations accessing government support or changing demand for private savings and insurance solutions.
  • Vulnerable groups may be particularly at risk from changes in state benefits (e.g. Universal Credit or provision of social care) or developments in the savings and insurance markets (e.g. the increased personalisation of products and changing levels of risk pooling and cross subsidy). There is also the risk of expectation gaps (e.g. in relation to the switch away from defined benefit pensions and the level of benefits that are likely to arise from the payment of minimum auto-enrolment pension contributions) and poor decisions as a result of people being unable or unwilling to pay for advice (e.g. investing in very low risk or high risk pension strategies rather than more traditional annuities).
  • Risks to Consumers

  • The FCA has decided that a package of measures is necessary on insurance pricing which include: addressing conduct by firms, a market study on general insurance pricing practices and a wider discussion paper on fairness of pricing in financial services. The CMA included household insurance in its review identifying a loyalty penalty and providing several recommendations. The FCA review into the fair treatment of with-profits customers, which reports in Q1 2019, has assessed the strength of governance, capability and influence of the With-Profits Chair/Actuary. In relation to pension transfers, FCA research showed that a significant number of DB members do not receive suitable advice and as such the FCA has reiterated that the starting position should remain that a transfer is not in the individual’s best interest.
  • In light of these challenges, government, the regulators and providers are changing the information provided to consumers and the methods used to interact with them in order to help inform their decisions. Initiatives such as the Key Information Document under PRIIPS, the disclosure of the prior year’s premium at renewal in general insurance and the CMA proposal to publish information on the loyalty penalty may alter the decisions made by consumers. Furthermore, technology and behavioural economics may be used to increase access to new or more tailored information or products. Changes in consumers’ actions and behaviours would limit and possibly eliminate the use of historic data as a guide to future behaviours in these areas and could impact the data and assumptions used by actuaries e.g. on lapse rates.

Actuarial Considerations

  • As work and retirement patterns change, demand for products to be designed to accommodate changing lifestyles whilst continuing to provide value for money increases e.g. demand for more flexible pension products or provision of social care. Changes in the pension environment are illustrated by the recent DWP consultations on CDC, Pension Scheme Consolidation and Pensions Dashboard. If implemented these will lead to changes in the design and provision of pension products and the information used by individuals when selecting them. There may be increased risk in actuarial work whilst the impact on individuals’ behaviour and data, models and assumptions is embedded.
  • Cross-subsidy and risk sharing can be either detrimental or beneficial to consumer interests (e.g. gender-neutral rating factors in insurance pricing or the proposals for pension superfunds and CDCs). Actuaries often need to make judgements when advising on the levels of cross-subsidy and in these circumstance ethics, professionalism and speaking up will be key considerations, especially if using limited or uncertain data.
  • However, there is also an opportunity for actuaries and the profession to be leaders in providing information to support decisions and as a profession to raise awareness of the impacts of government or industry practices to protect the public interest. For example, the IFoA produced a series of papers on Intergenerational Fairness in 2017 and will produce five Social Care briefings in 2019 giving an insight into the demographic, financial and societal challenges facing the social care system. In addition to making consumers aware of the benefits and drawbacks of products, actuaries could also assist in raising awareness of the circumstances where these products may become unaffordable in the longer term due to increasingly variable levels of income or ‘stress’ events such as illness, redundancy or taking on caring responsibilities.

Summary of 2017 Discussion and Actuarial Implications

  • Many actuaries are involved in actuarial work in relation to products that provide financial security. Products such as pensions, long-term care, permanent health insurance, third party and employer’s liability all provide elements of protection either required by law or designed to meet gaps in the financial security provided by government.
  • Changes to the benefits provided by government, access to employer sponsored benefits and individual’s attitude to ensuring their own financial security will all impact on the assumptions and judgements made by actuaries in areas requiring valuations. These can result from economics impacting both the wealth of individuals and government’s willingness to provide social welfare benefits, considerations of intergenerational fairness and international drivers such as migration and will reduce the validity of historical data. These forces make the selection of assumptions particularly uncertain.
  • Insurance, pensions and investment products often provide benefits for a long period after the original purchasing decision. Changes in government policy and economic conditions can impact the ongoing suitability of products over time. Actuaries are well placed to manage the risk of emerging poor value to consumers e.g. reviewing the charges on old products, ongoing benefit of financial guarantees, impact of changing pension’s regulations or applicability of tax breaks. Actuaries may be involved in the design of new products and could help incorporate new technology and data sources to facilitate new features and broader market penetration.
  • The risk to financial security may be increased by a lack of public understanding of financial products, low saving rates and mistrust of banks and insurers. There is a risk that consumers do not understand the benefits and drawbacks of products and as such make poor decisions and suffer material financial loss e.g. making inappropriate decision with regards to pension transfers or drawdowns. There is also a risk that some consumers will find it difficult to source the products they require at an affordable cost due to a lack of capacity or competition in the market.
  • Actuaries may be well placed to advise boards and trustees on the potential impact of product design and other assumptions on consumers and should consider their obligations under the Actuaries’ Code to have due regard to a wider stakeholder group such as policyholders or pension scheme members.

Further Reading

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