Our chief risk officer Jan-Hendrik Erasmus discusses with David Walker from Insurance ERM how the Dutch insurer is positioned for M&A, why Solvency II does not need to change, longevity risk hedging and today’s technology and cyber challenges.
Jan-Hendrik Erasmus has been the chief risk officer at Dutch insurance and pensions group NN for just over a year – “and it has been a very exciting year, not least because of the acquisition of Delta Lloyd”, he says.
In this interview, he discusses aspects of the Delta Lloyd merger process, such as how the internal model is being restructured, and the situation in the Dutch market as regards further M&A and life product guarantees.
Technology and cyber risk have risen to the top of the CRO’s agenda, he says. But genetic testing is also a major concern for the firm, which earned roughly 82% of its gross premiums in 2016 from life insurance.
He also explains how Solvency II has changed the business – and how he doesn’t want Solvency II to change.
The Netherlands has seen M&A between insurers. Is consolidation inevitable in the Dutch market?
Consolidation in the Dutch market has always been on the cards and we are seeing it now. The life market is a shrinking one and there are many benefits from scale. Also, with the move from DB (defined benefit) pensions to DC (defined contribution) pensions, scale is becoming increasingly important.
At NN we focus on improving earnings, generating cash and making free cash-flow available for shareholders. We found an opportunity with Delta Lloyd, moved to acquire the group, and the integration process is now well underway.
Various aspects of Solvency II face review in the coming years. What do you hope for most?
I am very keen to see stability in the Solvency II framework. It is relatively new – still only one or two years old – after the industry spent 13 years or more developing it.
Having stability in the framework and to have a level playing field across Europe [in applying it] is perhaps more important than to change any specific aspect of the framework we have today.
There are areas where we see slight differences in interpretation. For example, the matching adjustment (MA) is applied predominantly in the UK and volatility adjustment (VA) is used more elsewhere in Europe. In some cases the VA is dynamic, in some cases it is not. Also in some cases government bonds are treated differently in the standard formula to their treatment in internal models.
NN does not make use of the matching adjustment. Why, and have you any plans to do so?
We do not have plans to at the moment. We do not use the MA because our liability profile fits less well to using it than would be the case for, say, a UK annuity writer. But it is certainly not impossible for us to explore and does not mean we won’t look into this in the future.
How do you see the function of an insurer’s CRO changing?
If you look at the CRO space in our industry, the key issue is how to embrace technology and the modernisation of the business. In the risk function, then, this is about IT tasks and technology, and how to manage the risks. Robotics and artificial intelligence are becoming a part of how the operations work in insurance.
One forward-looking example is customers taking smartphone pictures of damage at the scene of a car accident and immediately uploading that to a claims handling application. These pictures could be reviewed by ‘trained’ machines so only a small proportion goes to real life claims processors.
In the risk function, you are second line of defence, you have to challenge the business and make sure it operates in a controlled way. You need to be a challenger.
We understand we have to invest in people with skills around cyber risk and robotics, to play that role effectively.
What do you see as the main emerging risks?
Cyber risk is clearly a big one. Another area we have been thinking about is around genetic testing and genome mapping. It is a bit like cyber, in that both pose risks to our current business but they are opportunities as well.
With genetic testing it is an anti-selection type risk, if the customer has information that you do not have, about the likelihood of illnesses that you do not know about.
On the other hand I could see it becoming a standard part of our underwriting procedure for large policies.
What is NN doing to guard against cyber risk?
There is no way I can sit here and promise that we are completely immune to the risks of cyber, but we are taking all the necessary steps to protect the data we have.
We focus on trying to keep cyber attackers out, but that is not always going to be possible. So our secondary focus is on time to detection: in other words, can we limit the amount of data they can see, and what they can achieve?
We are focusing a lot on hiring the right people and also on developing existing personnel. We have a CISO [chief information security officer] in all business units and a group CISO.
What is the size of the combined risk function of Delta Lloyd and NN, and can it stay at this size as the integration of the two groups progresses?
The joint risk function is approximately 400 staff, which includes head office risk and dedicated staff in all our business units.
Our guidance on cost synergies has not changed since our disclosure on 23 December 2016, when we said we expected €150m ($176m) of cost synergies by 2020, on top of existing savings for both companies, from a cost base of €2bn.
There will be some element of duplication at head office, and you do not need two head offices. The exact numbers are not something I can comment on because we are still working through these plans and discussing them with important stakeholders.
Could you update us on the situation with internal models at NN and Delta Lloyd?
Before the transaction with NN Group, Delta Lloyd was applying for a partial internal model (Pim). We stopped that process and our plan is to expand NN Group’s approved Pim to include the larger Dutch entities of Delta Lloyd. We have a project “major model change” running with our regulator [the Dutch National Bank], and we hope to have that done by the end of next year.
We are currently planning to apply for this expansion of scope for Delta Lloyd Leven and Delta Lloyd [non-life]. For the ABN Amro Insurance joint venture and the Belgian entities, we would consider the costs versus the benefits at a later stage.
What is your stance on longevity risk and how to handle it at NN?
After the acquisition of Delta Lloyd we have the biggest DB [pensions] exposure of any insurer in the Netherlands. When you look at the components of our SCR [solvency capital requirement], longevity is one of our biggest risks and we do have a concentration that we are looking to manage down over time.
It is safe to say that we would actively look to reinsurance and longevity swap markets in the coming months and years. We are not in a hurry because longevity takes a lot of time to show itself and reinsurance and longevity swaps markets are not always liquid.
At NN Group we have not yet completed a longevity transaction so it would be something new for NN Group, Delta Lloyd had two longevity derivative contracts on their books.
How do you view the various perspectives that stakeholders can take when viewing insurers, from Solvency II and financial reporting angles?
Insurance reporting and accounting has long been a challenge for the industry of communicating how a business is run.
We normally give guidance on how we run the business by focusing on free cash capital at group level by taking dividends from the units and deducting things like group expenses.
We try to simplify it in that way and our stakeholders appreciate that we take complexity out of insurance accounting and regulatory reporting. I do believe Solvency II will align further with accounting principles under IFRS 17.
In the long run, they come out in the same way, so it’s really a timing issue. Solvency II is a market value framework and I do see quite a lot of quarter-to-quarter volatility coming through. But if you look at it over a year you expect to see less volatility than in any single quarter so it is important for stakeholders to get used to this volatility.
If you fiddle with the framework too much you risk confusing them. Searching for a perfect framework is a fool’s errand, it does not exist.
Is the volatility adjustment, which NN uses, working as you hoped or intended?
For me it is not about being happy with how it is working, it is about finding a metric that accurately reflects the risks that we are exposed to. We do think the volatility adjustment (Vola) provides a more accurate representation than without it.
Our investment portfolio is more defensive than the Vola reference portfolio, in that we have a larger allocation to government bonds.
We are selectively looking at moving to higher yielding assets in our portfolio where it makes sense to do so.
But it is important that any asset allocation decision you make is done rationally and in a balanced way, considering risk and return. We would always want to be comfortable with the underlying investment.
We have NN Bank in our group, which has been very useful as an originator of mortgages and last week we issued out first covered bond [with a fixed coupon] of 50 basis points. It demonstrates that mortgages remain an attractive asset class for us which we are able to fund efficiently.
We are very cognisant of our asset allocation overall and the proportion of our general account that we wish to invest in mortgages – and you have always to look at risk and return.
Do you think the life insurance industry should be making promises to policyholders, given the current environment for investing?
We care a lot that our customers are happy. If you look at the future, the shift from DB pensions to DC is clear and, if you are still offering guarantees, there will be a shift towards more affordable guarantees and towards no guarantees.
Making promises around the future almost goes straight to the raison d’etre of insurers. They help people to manage the volatility of their personal outcomes. You would always want insurance to ensure your children are looked after if you pass away early.
In terms of saving for retirement, I think insurers have a key role to play whether through longevity insurance or through some other form of guarantee.
In many of our units we sell some guarantee. It is not the case that you should not sell them at all, but you should price them accurately.