Fixed indexed annuities with Market Risk Benefits
This paper focuses on the cash flow modeling aspects of Market Risk Benefits on fixed indexed annuities contracts, especially the methodology for projecting indexed account growth.
In today’s growing on-demand economy, insurance companies are developing unique products to cover new risks. Insurance exposures such as home sharing, ride sharing, and fashion rental are growing in popularity. The sharing economy has many benefits for this fast-changing world. Parents of young children can now obtain more space and comfort on vacations with rentals from home-sharing sites. Travelers can obtain cheaper transportation to and from airports with ride-sharing companies such as Uber or Lyft. Fashion-savvy individuals can attain the latest high-end couture with rentals from companies such as Rent the Runway or Bag Borrow or Steal. The sky is the limit in the present on-demand economy.
Home-sharing companies such as Airbnb, VRBO, HomeAway, and TripAdvisor Rental are becoming more popular as alternative lodging options for both vacationers and business travelers. An article in Forbes states Airbnb had “nearly 5 million lodging options across 81,000 cities in the world” and “Airbnb is worth at least $38 billion now.”1 According to a 2017 article in Recode, a technology news website, Airbnb’s “growth rate remains impressive,” showing a growth of approximately 200% in guest arrivals between 2015 and 2016 and a predicted growth of 25% between 2016 and 2017.2 Clearly, home sharing is big business—and getting even bigger.
With the rise of vacation rentals and the risks they pose, insurance for hosts is an opportunity insurance companies should be looking into. Can insurers create new policy types to help hosts who cannot get insurance through their home-sharing brokers? Is there an endorsement that can be added to cover home-sharing rentals? Should insurers look into collaborating with home-sharing companies like Airbnb to help insure all hosts while rentals are active? What on-demand insurance products are available for hosts?
Because they might not rent their homes 365 days a year, hosts may want to look into homeowners policies for part of the year and non-owner-occupied policies for when they are away and rent their homes. Insurance companies could work with hosts to create unique policies that switch policy forms based on when a rental is taking place, thus tailoring policies to a host’s specifications. This would help hosts who only rent their place on occasion or only rent out part of their home instead of the entire home.
An alternative option is for insurance companies to add home-sharing endorsements to homeowners policies. According to an article published by Gen Re, “Two national writers have developed endorsements for their insureds to add coverages for home-sharing onto their homeowners policies.”3 An article in Insurance Journal discussed how the Insurance Services Office (ISO) has started to tackle the issue of home-sharing insurance by introducing new “options to address exposures that policyholders may face when renting out all or parts of their home.” The new ISO insurance options “address a number of exposures faced by home sharing hosts including: liability, theft, vandalism, and damage to guests’ property.”4 These are just a few of the options that are starting to develop to help protect hosts in the growing on-demand economy.
In 2015, according to a Casualty Actuarial Society article by Dion Oryzak and Amit Verma, several insurers started offering a business owners policy (BOP) for hosts renting their homes for short terms on home-sharing websites. The BOP coverage was “designed to replace [the] homeowners or renters policy that an occupant would normally have.” However, the problem with this coverage is the flat premium, which frequently made the rentals financially impractical for the part-time hosts.5
Insurance for home-sharing brokers can easily be compared to ride-sharing companies such as Uber and Lyft. They have run into a similar issue with how auto insurance policies would turn on and off depending on whether a car is in use for business or personal use.
The 2015 Oryzak and Verma article discusses the dilemma of whether insurance coverage for the sharing industry should be considered personal lines policies or commercial lines policies. It is an interesting quandary and one that poses many problems for insurance companies writing policies for these new lines of business. It will take more time and data to determine whether the risks are closer to personal line policies or commercial lines, which could lead to changes in selected industry benchmarks. Oryzak and Verma suggest creating a hybrid policy that switches between personal and commercial, which creates the challenge of pricing accordingly for this new type of coverage.6
One company that has started offering on-demand insurance for home rentals is Slice. It offers home-sharing insurance in the United States that can be turned on and off as needed and covers a host's house, contents, and any additional buildings on the property for replacement costs. The coverage also includes living expenses incurred during repairs.7 In a way similar to how Uber provides insurance, Slice structures its coverage to turn on during home rental. If a home-sharing broker’s insurance is insufficient, or a broker does not offer any, insurance companies like Slice can help fill that gap. Slice is in the process of developing insurance for ride sharing and hopes to launch that coverage soon.
Home sharing and ride sharing are just two new insurance exposures that have resulted from the sharing economy. Another new exposure the on-demand economy is imposing on the insurance industry is fashion rentals. Fashion rental companies such as Rent the Runway, Bag Borrow or Steal, and ArmGem are on the rise because of the high expense of designer clothes and the desire to wear the latest fashions. According to a Business Insider article, Rent the Runway subscription business “is already up 150% year-over-year—and it now represents over 50% of the company’s total revenue.” The same Business Insider article also mentions how CNBC has named Rent the Runway “the ninth most disruptive company in the world, right alongside Uber, Airbnb, and SpaceX.”8 With these rental companies growing, is there a need for insurance?
For perspective, look at how insurance works for rental cars. If someone wanted to rent a car for a few days, that person can easily buy coverage through the rental company or have coverage through a personal auto policy. Using this logic, one might wonder whether coverage could be obtained under a homeowners policy, perhaps as “liability damage to property of others,” or possibly an additional endorsement could be purchased. This might be something homeowners companies could consider if they do not already offer the coverage.
This lack of insurance raises a plethora of questions. Should homeowners policies start offering customers optional endorsements to cover rental items? Should rental companies start offering more expansive add-on insurance to their rentals? Is there an opportunity for insurance companies to start writing this coverage and selling it directly to renters? Is it possible this insurance could be used for other types of items in the new rental and sharing economy?
Recently insurers have begun to cover couture clothes and accessories for owners of high-end fashion. According to an article in Forbes, these policies would cover individual items listed on the policy with an option to use blanket coverage for less expensive items.9 If insurers are writing insurance for owners of high-end designer clothes, why not start writing insurance for renters of these same items?
Given all these new insurance exposures, what challenges do actuaries face when trying to reserve for these risks? Are there credibility issues or problems creating homogenous reserving groups? What about difficulties finding industry benchmarks? Actuaries face different problems in the analysis of any insurance exposure during the reserving process. New exposures bring additional uncertainty and therefore additional risks and challenges. Credibility, homogeneity, and finding suitable industry benchmarks are just a few of the challenges actuaries face when reserving for new exposures in the sharing economy.
Two problems with the unique insurance exposures created by the sharing economy are credibility and homogeneity. These challenges go hand in hand and one is often a trade-off with the other. There is a fine balance between creating homogenous groups to analyze the data and having enough credible data. When separating data into homogenous groups the actuary should focus on key characteristics such as consistency of coverage, the lag between when an insured event occurs and when it is reported, the length of time to close a claim, and the average severity of claims.
The actuary should not split the data too thin because it will lose credibility. Data for new exposures caused by the sharing economy is still limited. It is recommended to group similar claims together to increase credibility rather than splitting data into small homogenous groups. The goal is to create “sufficiently homogenous groupings without compromising the credibility of the data.” Credibility is based on two components, the homogeneity of the group of data and the volume of data in the group. These two components need to be balanced because increasing one will decrease the other.10
Another issue with new insurance exposures is finding industry benchmarks. With thin data or short histories, or both, it can help to use industry benchmarks for judgmental selections such as loss development factors or expected loss ratios. Finding industry benchmarks can be difficult in situations of innovation (new product types or expansions into new areas) or in new situations (shocks or changes such as regulatory action or stock market crashes). The on-demand economy is a perfect example of a situation of innovation in which industry benchmarks are difficult to find. In this case, it might be helpful to look at similar lines of business for benchmarks.11
For home sharing, homeowners insurance might be a good starting point to look for benchmarks. For ride sharing, personal auto insurance, and fashion rental insurance, it might be renters insurance. The established benchmarks found in those places are likely to have similar risk characteristics in terms of reporting lag, average claim severity, length of time to close a claim, and similar coverages. It is possible to use other sharing economy benchmarks as well, such as, for example, a home-sharing benchmark for clothing rental insurance. Using other sharing economy benchmarks can be appropriate when the two lines of business have characteristics in common. For example, home sharing and ride sharing are both short-tail lines. The feature of providing the insurance only when it is needed is also seen in both.
Another source for benchmarks could be the initial pricing information used for home sharing, ride sharing, or rental fashion. The original pricing work could provide a reasonable expected loss ratio that can be used in the reserving work as an a priori.
An important aspect of reserving is understanding how claims are handled. An actuary must understand when a claim is reported as well as the lag time between incident date and report date, how case reserves are set for claims, how long it takes to settle a claim, and any changes in claim handling over time. These are important questions for reserving actuaries to discuss with the claim department before deciding what benchmarks to use and which reserving techniques to utilize in their analyses.
It is well known that there are different approaches to setting case reserves for claims. Claim handlers can set case reserves by selecting their beliefs of the ultimate settlement value, set all case reserves to maximum values such as a policy limit, or use another statistic such as the mode or an expected value method. It is important for the reserving actuary to know what method the claim department is using and if the method has changed over time. For a new exposure, it is unlikely to have a large history of data with changes in case reserving but it is important to know which method is used in order to select benchmarks that use similar case reserve philosophies.12
An additional question a reserving actuary might want to ask is if the company uses a third-party administrator (TPA) for claims or has its own internal claim department. This would impact the loss adjustment expenses in a reserve analysis because TPAs typically have higher expenses.
As the sharing economy continues to grow, new risks will continue to emerge. This innovative industry creates unique opportunities for insurance companies and actuaries. With any new risk actuaries face different reserving problems such as credibility, homogeneity, and obtaining industry benchmarks. Once the reserving complexities are determined and considered, actuaries can ascertain the best approaches to address these problems and weigh the advantages and disadvantages of different reserving techniques for the new exposures.
1 Forbes (May 11, 2018). As a rare profitable unicorn, Airbnb appears to be worth at least $38 billion. Retrieved July 26, 2019, from https://www.forbes.com/sites/greatspeculations/2018/05/11/as-a-rare-profitable-unicorn-airbnb-appears-to-be-worth-at-least-38-billion/#4c1dabe92741.
2Molla, Rani (July 19, 2017). Airbnb is on track to rack up more than 100 million stays this year – and that’s only the beginning of its threat to the industry. Recode. Retrieved July 26, 2019, from https://www.recode.net/2017/7/19/15949782/airbnb-100-million-stays-2017-threat-business-hotel-industry.
3Unger, Christine (December 2016). The home-sharing economy and upcoming coverage options in the U.S. Gen Re. Retrieved July 26, 2019, from http://www.genre.com/knowledge/publications/pwm1612-36-en.html.
4Insurance Journal (November 16, 2016). ISO files homesharing coverage options for homeowners' policies. Insurance Journal. Retrieved July 26, 2019, from https://www.insurancejournal.com/news/national/2016/11/16/432335.htm.
5Oryzak, Dion & Verma, Amit (2015). Insurance 2.0: Insuring the Sharing Economy & Sharing the Insurance Economy. CAS E-Forum. pp. 10-13. Retrieved July 26, 2019 from https://www.casact.org/pubs/forum/15sumforum/Oryzak-Verma.pdf.
7Slice. Homeshare Policy Summary. Retrieved July 26, 2019, from https://slice.is/homeshare-policy-summary/.
8Leighton, Mara (August 7, 2018). How Rent the Runway is changing the way women get dressed – and why it’s been called one of the most disruptive companies in the world, alongside Uber, Airbnb, and Space X. Business Insider. Retrieved July 26, 2019, from https://www.businessinsider.com/rent-the-runway-membership-2018-8.
9Huen, Eustacia (September 23, 2015). AIG launches couture insurance for clothes and shoes. Forbes. Retrieved July 26, 2019, from https://www.forbes.com/sites/eustaciahuen/2015/09/23/aig-launches-couture-insurance-for-clothes-and-shoes/#3ff1e4de5294.
10Friedland, Jacqueline (July 23, 2010). Estimating Unpaid Claims Using Basic Techniques. Casualty Actuarial Society. pp. 29-328. Retrieved July 26, 2019, from https://www.casact.org/library/studynotes/friedland_estimating.pdf.
11Paris, Timothy (2018). When is your own data not enough? The Actuary. Retrieved July 26, 2019, from https://theactuarymagazine.org/when-is-your-own-data-not-enough/.