Can actuaries be expected to fully meet the requirements placed on them by both management and regulators? asks Nigel Allen

In recent years the actuary has been lauded as the saviour of the insurance and reinsurance industry for introducing a much greater level of discipline into the reserving process, while in equal measure has been lambasted as the root cause of the deluge of reserve strengthening announcements which continue to plague the market. That the industry has over the past several years been in a state of perpetually topping up reserves that were woefully inaccurate has called into question the credibility of the international actuarial profession and led to increasing demands for more stringent regulation of the industry and further refinement of the actuarial methodologies employed.

REVIEWING THE ACTUARIAL REVIEWS

The Casualty Actuarial Society, in response to the growing criticism being levelled at the actuarial profession, undertook a "critical examination of current practice" in relation to the property/casualty sector. In September 2004, the CAS board met to consider the underlying factors for the credibility gap which had developed and to consider how this could be bridged. The US Task Force on Actuarial Credibility was set up and charged with refining the board's observations and putting in place a framework for re-establishing the good name of the actuarial industry. In May, the Task Force released the findings of an extensive report examining potential strategies for "enhancing the perceived credibility of the actuarial profession" and setting up a plan of action for the implementation of such strategies.

While the main focus of this article is on those studies conducted in the US it is also interesting to examine some of the conclusions which emerged from the UK Morris Review of the Actuarial Profession, released in March 2005. The review began in March 2004, and was set against the backdrop of the report conducted by Lord Penrose into the Equitable Life debacle which raised a number of concerns regarding the actuarial profession.

Sir Derek Morris, then chairman of the Competition Commission, focused the review on levels of choice and competition for actuarial services, the regulatory framework governing the profession, and the role of the Government Actuaries Department.

ASKING TOO MUCH?

"The role of appointed actuary has introduced a discipline in the reserve-setting process that has been and continues to be critical to the protection of policyholders and to the stability of the property/casualty industry itself," states the Task Force report. To be charged with ensuring the stability of an industry which is founded on the ability to ascertain the likelihood of a future event occurring is a heavy burden to bear.

The expectations placed on the actuary are great, with management expecting a degree of certainty which is often beyond the scientific rigours of even the most sophisticated of actuaries. That the terminology surrounding the actuarial statement is dotted with words and phrases such as "adequate", "reasonableness standard", "best estimate", "opinion" reflects the fact that any attempt to ascertain a future liability based on current information is inherently uncertain, and therefore all that can be expected of the actuary is that they help companies cope with this degree of uncertainty which underlies the industry which they are part of. As Sir Derek Morris, author of the Morris Review of the Actuarial Profession, explains, "Actuarial expertise must not be confused with an ability always to forecast the future accurately."

This call for the opinions provided by the actuary to be seen as exactly that, opinions, is also taken up by Robert Wilcox, president of the American Academy of Actuaries, in a letter to Morris in which he commented on the interim findings of the Morris Review in February of this year. Mr Wilcox urges, "In making your final recommendations, please recognise that, in most instances, actuaries serve as advisors, not decision makers ... Actuaries can and should be held responsible for the quality of their advice, but they should not be held accountable for solvency beyond their authority to implement policy decisions, nor should they be made a scapegoat for bad management decisions."

A DUAL ROLE

One issue which emerges in both the Task Force report and the Morris Review is the difficult task faced by the actuary in serving two masters, employer and regulator. Beholden to both, the actuary can be said to be suffering from divided responsibilities, fulfilling the demands placed on them by their employers to produce "accurate" forecasts of their liabilities while also meeting the requirements of their role as protector of public interest imposed on them by the regulatory authorities to inform them of any deviations in management's recorded reserves and the actuary's best estimates. This is perhaps best summarised by the US report, "The role of appointed actuary reflects the delicate balance between the responsibility of the actuary to his or her principal in estimating loss and loss adjustment expense reserves, and the responsibility to assist the regulator in protecting the public interest by providing an opinion on the reserves set by management."

BRIDGING THE UNDERSTANDING GAP

It is clearly crucial if the actuary is to successfully meet the requirements of this dual role that all parties to the actuarial report understand the advice which they are being given. However, both Morris and the Task Force reports highlight the fact that there exists an "understanding gap" which must be bridged to ensure the effectiveness of the actuarial report.

A number of participants in the Morris Review acknowledged that actuarial advice tended to be taken at face value and that no attempts were made to scrutinise the methods employed to produce this advice. As Morris stated, "Many have regarded actuarial advice as having the characteristics of 'black box' analysis with the methodology and calculations lying behind the output and even the input assumptions being quite opaque."

It is the responsibility of the actuary to make clear not only the findings and conclusions of his or her report, but also the methods by which these conclusions were reached. According to the requirements laid down in the Statements of Actuarial Opinion on P&C Loss Reserves as of 31 December 2004 in the US, the "narrative component" should clearly explain to both management and regulator the findings and recommendations in the report, while the technical element should provide "sufficient documentation and disclosure for another actuary practicing in the same field to evaluate the work." In fact, the Casualty Actuarial Task Force sees the Relevant Comments section of the narrative component, which places the actuarial advice or opinion in its "context for interpretation", as the most valuable information in the document for the regulator.

However, the onus does not lie solely with the actuary, as both reports call in unison for the implementation of education and training for all parties to the actuarial report, whether internal or external, with the Task Force claiming that the SEC, rating agencies and regulators "are among the highest priority constituents for targeted education on what is meant by an actuarial estimate."

DIFFERENCE OF OPINION

However, if the actuary is to effectively serve two masters, then the potential for conflict surely comes into play. According to the NAIC note of December 2004 on Statements of Actuarial Opinion on P&C Loss Reserves, the statement of actuarial opinion must include either a Determination of Reasonable Provision, stating that the stated reserve amount is considered within their "range of reasonable reserve estimates", or if the actuary believes that the reserve amount is insufficient and below the "reasonable" minimum amount, a Determination of Deficient or Inadequate Provision.

The actuary can also opt for a No Opinion if they believe that limited or deficient data prevents them from making a reasonable assessment, and must state the reasons for this.

The Task Force report recommends broader disclosure within the actuarial opinion of any deviation in either direction between management's recorded reserves and the actuary's "best estimate". However, the report notes that there may be occasions when management, in order to minimise this difference, put pressure on the appointed actuary to adjust their estimate, but adds that sufficient guidance on how the actuary is to proceed in such circumstances is provided by the Actuarial Code of Conduct. It should be noted that if an appointed actuary is replaced, the actuary is required to provide the regulator with a letter highlighting any disagreements which they may have had with the company in the past twenty four months.

This therefore provides them with a means of informing the regulator of any wrongdoing on the part of management.

This raises the rather thorny issue of "whistle blowing". If the actuary is to fulfill the requirements of their role as guardian of the public interest then they must be prepared to whistle blow on their employer.

Turning once again to the findings of the Morris Review, in its interim assessment, it reported that a number of commentators believed that "actuaries face multiple and often conflicting responsibilities." To overcome this it concluded that there was a need for clarity as to who actuaries are accountable to and for what, and a need to establish "a clear hierarchy of accountabilities."

By choosing to whistle blow, the actuary runs the risk of damaging his or her relationship with their employer and also tarnishing their professional reputation. There is also the danger of breaching client confidentiality.

While the Morris Review demands that the UK government and the regulatory authorities clarify the reporting and whistle-blowing requirements, "to ensure that the actuaries understand when they have a duty to report and that they have an appropriate degree of legal protection when they do so", the issue of whistle blowing is not one that is effectively dealt with in the US.

According to the Regulatory Review Framework Recommendations from the American Academy of Actuaries' SVL II Work Group presented to the NAIC's Life and Health Actuarial Task Force, when considering the requirements placed on the reviewing actuary, "The role of the reviewing actuary in the process could be defined to include whistle blowing and reporting requirements to the regulators to protect public interest." The report goes on to add that such whistle-blowing and reporting requirements to the regulator should be subject to legal protections, "such as relief from confidentiality requirements and protection against unfair treatment, including retaliation."

CONCLUSION

However, no matter which side of the fence you are on - and few can be accused of sitting on the fence on this issue - whether you consider actuary saint or sinner, one thing is clear, the continued stability of the industry rests squarely on the shoulders of the actuary.

- Nigel Allen is editor of Global Reinsurance.