Chad C. Wischmeyer, FCAS, MAAA, CFA Mercer Risk, Finance and Insurance ConsultingCara M. Blank, FCAS, MAAAOneBeacon Insurance CompaniesMary D. Miller, FCAS, MAAAOhio Department of InsuranceThomas M. Mount, ACAS, MAAAA.M. Best Company
Actuaries’ Responsibility to Users of Their Work Products CAS Spring Meeting
May 19, 2003
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Actuaries and Actuarial Reports are Under Increased Scrutiny
WHY?WHY?
Increased concern over companies financials
More people discover actuaries and the benefits they can offer
Less cushion for adverse reserve development
Litigiousness
– Society at large
– Plaintiffs bar has found the actuarial profession
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Speakers
Cara M. Blank, FCAS, MAAAVice President and Regional ActuaryOneBeacon Insurance Companies
Mary D. Miller, FCAS, MAAAActuaryOhio Department of Insurance
Thomas M. Mount, ACAS, MAAAManaging Senior Financial Analyst/ActuaryA.M. Best Company
The Actuary’s Relationships with Users of a Work Product Discussion Paper Prepared by Committee on Professional Responsibility
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Scope
Code of Professional Conduct Prevails
– Offers explicit guidance concerning principals
– Less explicit with regard to third parties’ interests
Not binding – intended to generate discussion
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Code of Professional Conduct
“The purpose of [the code] is to require Actuaries to adhere to the
high standards of conduct, practice, and qualifications of the actuarial
profession, thereby supporting the actuarial profession in fulfilling its
responsibility to the public”
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Precept 1 –Professional Integrity
“An Actuary shall act honestly, with integrity and competence, and in a manner to fulfill the profession’s responsibility to the public and uphold the reputation of the actuarial profession”
– Use skill and care
– Refuse services to those that may use services to avoid the law or damage actuarial profession
– Shall not improperly use relationships with third parties
– Shall not engage in any professional conduct involving dishonesty, fraud, deceit, or misrepresentation
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Components of the Code
Professional Integrity
Qualification Standards
Standards of Practice
Communications and Disclosure
Conflict of Interest
Control of Work Product
Confidentiality
Courtesy and Cooperation
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Myths
Code of Professional Conduct is only important for actuaries who:
– Set reserves
– Testify under oath
– Advise policymakers
– Consult
Only actuaries engage in the above activities
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Complex Situations
Stockholders
InsuranceProvider
Consulting InsuranceFirm Customers
Actuary BusinessesIndividualsGovernments
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Actuarial Roles in Practice
Operations Research & Development
– Creating new rating or product plans
Financial Accounting/Reporting
– Reserving, public reporting, company valuations
Regulatory/Statutory Compliance
– Filings, solvency exams
Regulatory/Statutory Influence
– Policy or standard setting
General Management
– General business practices
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Changes in Landscape
Senior management accountability
Increasing number of public companies
Organizational structures have changed
– New players
– Higher educational levels
Rate and product deregulation in certain state markets increases
actuary’s accountability for results
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Less Complex Situations
Insurance Company
Employee Auto InsuringActuary Public
Self InsuredEntity
Consulting MunicipalitiesFirm
Actuary
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Situations
Are all services performed by actuaries “actuarial”?
What if users do not understand the work or understand it
differently than intended?
Can I change my approach depending on the principal’s needs?
What if the law conflicts with the standards of practice?
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Implications of the Code
Benefits
– Provides process of self-
regulation
– Provides guidance on
numerous practice areas
– Provides sound guidance
on means of ensuring
proper use and
interpretation by users
Consequences
– Focuses on actuarial
science; expanding
credentials may require
additional sources of
accreditation
– Not all actuaries qualify for
the same types of practice
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Actuarial Opinions: Whose fault is it?
“Not I!” said the CEO, “I had a ‘clean’ reserve opinion so I thought
everything was OK.”
“Not I!” said the Insurance Commissioner, “their actuary gave them a
‘clean’ opinion so I thought everything was OK.”
“Not I!” said the Actuary, “I relied on management to give me good
data and to tell me whether their reinsurance was collectible or not. I
also relied on the auditors and the state regulators to find any
problems. It’s not my fault. I did the best with what I had.”
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Actuarial Opinions: A look back in time
Statutory opinions born out of insolvencies of the 1980’s.
Originally said reserves made ‘good and sufficient’ provision for
reserves. (Life and Health opinions still do)
Now they make a ‘reasonable’ provision – Is that enough?
Yes, as long as reasonable does not mean “I can make the numbers
come out that way if I try hard enough.”
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Actuarial Opinions: To whom do we owe a responsibility?
All things being equal, everyone’s best interests are served when
companies are solvent and reserves are adequate.
Actuary needs to report the results of his/her review thoroughly and
honestly to the company’s Board and management, identifying risks
and areas of concern.
Management books their best estimate and the actuary
communicates their evaluation of that estimate to the domiciliary
Commissioner by way of their opinion.
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Actuarial Opinions: How do we fulfill our responsibility?
Communication to the Board, management and domiciliary state must
be forthright.
Reasonable must mean more than “if all the most optimistic
assumptions come through.”
A healthy dose of skepticism is essential – more reserves develop
adversely than redundantly.
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Actuarial Opinions: Where can we go for Guidance?
ASOP No. 36 gives us several excellent tools for communicating through the Opinion
Defines 5 Types of Opinions
Significant Risks and Uncertainties Paragraph – Minimal boilerplate,
PLEASE!!!!!
Risk of Material Adverse Deviation
Gross vs. Net Reserves
Range of Reasonable Reserve Estimates
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Actuarial Opinions: How can the regulator help?
We are trying to see that the mechanisms and protections are in place
to help you succeed.
New Audit Instructions will require communication with the actuary
and testing of the data he/she relies on.
New opinion and report instructions will try to protect confidentiality of
regulatory communications.
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Actuarial Opinions: What do they expect an Actuary to do?
Take responsibility for your work product
Decline the appointment if you are expected to be less than honest.
Sarbanes-Oxley makes today the best time to get off the slippery
slope and onto solid ground.
Actuarial knowledge and judgment are valuable tools – use them to
strengthen the profession one actuary at a time.
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Outline
Impact of Reserve Deficiencies
What products used
Why or why not used
How products used
Helpful exhibits
Pitfalls
Conclusions
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Impact of Deficiency on Rating Process
Materiality
– ASOP 36 - Statement of Actuarial Opinion regarding P/C loss &
LAE reserves
– Consider purpose and intended use
– Ratio to surplus
– Ratio to premiums
– Ratio to carried reserves
– Ratio to net income
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Impact of Deficiency on Rating Process
Should we consider impact on Financial Strength Rating in
materiality?
– Yes
Deficiencies are extremely important
– Even small deficiencies can contribute to downgrade
– Can be compounded by growth charges
– Deficiencies funded from surplus have impact on economic surplus
and required capital
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Documents used to Estimate Deficiency
Schedule P
Reserve Opinion
Actuarial Report supporting Opinion
Quarterly Financial Statement - Part 3
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Why or Why Not Used
Schedule P
– Readily available source of data for development
Reserve Opinion
– Opinion stating “reasonable provision” not Used
– Used to gain other info about the company’s reserves
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How are we doing?
One Year Development vs. Original Reserve
9%
10%
17%
16%
19%
16%
6%
8%
GT 25% Favorable
15% to 25% Favorable
5% to 15% Favorable
0% to 5% Favorable
0% to 5% Adverse
5% to 15% Adverse
15% to 25% Adverse
GT 25% Adverse
Percent of 876 Rating Groups
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How are we doing?
One Year Development vs. Original ReserveCos. With Original Reserve > $100M
0%
2%
13%
23%
31%
21%
6%
3%
GT 25% Favorable
15% to 25% Favorable
5% to 15% Favorable
0% to 5% Favorable
0% to 5% Adverse
5% to 15% Adverse
15% to 25% Adverse
GT 25% Adverse
Percent of 209 Rating Groups
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How are we doing?
One Year Development vs. Original ReserveCos. With Original Reserve < $100M
11%
13%
18%
13%
16%
14%
6%
10%
GT 25% Favorable
15% to 25% Favorable
5% to 15% Favorable
0% to 5% Favorable
0% to 5% Adverse
5% to 15% Adverse
15% to 25% Adverse
GT 25% Adverse
Percent of 667 Rating Groups
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Why or Why Not Used
Actuarial Report
– More detailed Commentary
– More detailed Analysis
– Greater understanding of trends
– Shows assumptions used
Quarterly Financial Statement
– Part 3 gives quarterly updates on prior year reserve development
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How are Documents used?
Schedule P
– Used to generate A.M. Best’s indicated ultimates
– Used to generate deficiencies
– Used to generate credibility
– Used to calculate reserve discount factors
– Report card of company’s ability to reserve adequately
Reserve Opinion
– Relevant comments used, including discounting, retroactive reinsurance, salvage/subro treatment, major risk factors, change in methods/assumptions
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How are Documents used?
Actuarial Report– Commentary may provide reasons why Sched P not appropriate
Case reserve strengthening Change in settlement rates
– Review Analysis for LDF selections Ultimate selections Pd/Pd selections ELRs used Freq/Severity Trend and other Assumptions Methods used
Quarterly Statement – Part 3– Watch prior year development
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Helpful Exhibits in Actuarial Report
Historical Selected Ultimates/Runoff by AY
Historical Net Retentions by AY
Calculation of ELR
– Show earned rate changes
– Show freq/severity trend selections/support
Average Severity - selected & reported triangle format
Average Case reserves – triangle format
Closing Rates – triangle format
Pure Premiums
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Pitfalls in Actuarial Reports
Trends in LDF’s – responsive vs stability
– 1.10, 1.15, 1.20, 1.25, 1.30
– Should select 1.35, but reports using 5 yr ex hi,lo , 3 yr avg, 5 yr
avg understate ultimates
Curve fitting severities – responsive vs stability
Using Accid Qtr data when Accid Yr available and growth not an issue
Using ILFs when credible total limit data available
Selecting based on “judgment” without stating reason
When using/citing industry data, show it
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Summary
Reserving is a corporate philosophy
Reserve deficiencies are material to rating process
Amount and extent of adverse development is too high
Only saw 2 adverse Opinions – one high, one low
Need to reduce the number of companies with adverse development
and reduce the extent of adverse development to maintain
profession’s credibility
Even though filed Actuarial Opinion is ignored, our interactive rating
process does value the actuary’s expertise and is considered in the
rating process.