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

Introduction

3

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

4

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

6

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

7

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”

8

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

9

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

10

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

11

Complex Situations

Stockholders

InsuranceProvider

Consulting InsuranceFirm Customers

Actuary BusinessesIndividualsGovernments

12

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

13

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

14

Less Complex Situations

Insurance Company

Employee Auto InsuringActuary Public

Self InsuredEntity

Consulting MunicipalitiesFirm

Actuary

15

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?

16

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

Observations of an Insurance Regulator Actuarial Opinions

18

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.”

19

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.”

20

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.

21

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.

22

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.

24

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.

Using Actuarial Work Products in the Rating ProcessReliance on Actuarial Reports

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Outline

Impact of Reserve Deficiencies

What products used

Why or why not used

How products used

Helpful exhibits

Pitfalls

Conclusions

27

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

29

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

31

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

35

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

36

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

37

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

38

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

39

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.