Guest View: Accounting for Pricing Risk
Given the volatility in the capital markets over recent years, and the consequent adverse developments across the financial services industry, the calls have been raised for more sophisticated risk management techniques.
Experience has shown that much of the fundamental exposure facing life insurers stems from a failure to adequately understand the risks that are assumed, which can lead to incorrect pricing of products.
We have seen, for example, that pricing risk relates directly to the long-term nature of a life insurance or annuity policy. Compare this situation to a candy bar manufacturer, which presumably knows or can ascertain all of the costs associated with the development, manufacture, and distribution of its product when setting the price of the candy bar.
But unlike a candy bar manufacturer, "the cost of goods sold" inherent to a life insurance policy will probably not be known with certainty for many years, and must be projected over a long period of time when setting the policy prices.
It's really as simple as this: pricing must be recognized as a key component in any effective enterprise risk management strategy. Insurers that not only assess risks accurately but also incorporate them in their pricing are more likely to succeed.
Given the current sophistication of the market for life insurance, the more underpriced that a product is, the more policies of it a company may sell. In the long term, this is not really good news.
Our article last year for Best's Review, "The Big Picture: Enterprise Risk Management Can Reveal Key Pricing Concerns to Insurers That May Help Prevent Losses," examines the multitude of risks facing today's life insurer and draws connections between these risks and effective pricing.
Click here for a free download of "The Big Picture: Enterprise Risk Management Can Reveal Key Pricing Concerns to Insurers That May Help Prevent Losses".