eAcuaft ial UpdateVOLUME 20 NUMBER 12

In

2

this issue

Editor's Notebook

3 Standards Outlook

AICPA Seeks4 to Apply SFAS 106

to Multiemployer Plans

5 Changes on the Horizonat A.M. Best

5 Checklist of Statements

6Annual Meeting Report:Practice Councils

8ASB Clarifies IssuesRegarding Statementon Cash Flow Testing

EnclosuresIncluded in this month's issue ofThe Update are the following:• Government Relations Watch• In Search Of . . .• ASB Boxscore• Exposure Draft of RevisedVersion of ASOP No. 10Exposure Draft of ActuarialCompliance Guidelinefor SFAS 106

AMERICAN ACADEMY OF ACTUARIES

House Energy and Commerce Sub-committee on Oversight and Invest-igations. Over the past year, this sub-committee, chaired by RepresentativeJohn Dingell (D-MI), has held hearingson life insurer solvency . According toAcademy Executive Vice President JimMurphy, who had accompanied Daykinto the day's meetings on Capitol Hill,Chesson wants to learn more about theappointed actuary system In the U .K.-in particular the clause that requires theappointed actuary to report to theregulator if company management is

The U.K. Government Actuary'sDay in Washingtonby Jeanne Casey

In late October, Chris Daykin came toWashington, D .C . to talk to con-gressional staff about the appointedactuary system in the United Kingdom-something he knows a lot about. Heheads the Government ActuaryDepartment, which in the U .K. isidentified as part of the regulatorysystem .

"We have a written agreement withthe Department of Trade and Industry,the actual regulators, whereby weundertake to carry out the financialmonitoring of companies. That's ourjob," said Daykinin an informal inter-view at the Shera-ton Carlton Hotel inWashington .

And a big partof that job iskeeping in touchwith appointedactuaries through-out the U .K. "Weencourage an in-formal relation-ship," said Daykin ."They ring us upand we ring themup." When thereare financial prob-lems within acompany, the com-

DECEMBER 1991

not heeding theactuary's warningor recommend-ations .

Over the courseof the day. Daykinalso met withsenior staff for theCongressionalResearch Serviceand Moses Boyd,counsel for theSenate EnergyandCommerce Sub-committee on Con-sumer. In each ofthese informalmeetings, Daykintalked about theU.K.'s appointed

Daykin, Hendricks, and Murphy relaxafter theday's "skirmish on the HILL "

pany's actuary may be under pressurenot to talk. DaykIn noted that actuariesin such straits "are really on theirprofessional mettle-they have got todecide at what stage they're no longerable to do their job because of the waymanagement is or isn't responding ."

It is just this relationship betweenthe appointed actuary and the regul-ator, or "supervisor" as the role is calledin the U.K., that congressional staffersin the United States are interested inlearning about .

Earlier that afternoon, Daykin hadmet with Jack Chesson, counsel for the

actuary system, a system that hasexisted in its present form for the pasteighteen years .

For this interview, however, AcademyDirector of Government InformationGary Hendricks wanted to take adifferent tack: "I've heard now-for anevening and a day about the glories ofthe U.K.'s appointed actuary system .What's wrong with it? What doesn'twork so well?"

Without much hesitation, Daykinmentioned four ways in which the U .K.system could be improved upon .

(continued on page 4)

2

of Actuarics

PresidentHarry D. Garber

President-ElectJohn H. Harding

Vice PresidentsRobert H. DobsonR. Stephen RadcliffeRichard H. SnaderMichael A. WaltersLarry D. Zimpleman

SecretaryPrreasurerThomas D. Levy

Executive Vice PresidentJames J . Murphy

Executive Office17201 Street, N.W. 7th FloorWashington, D.C. 20006(202) 223-8196FAX (202) 872-1948

Membership AdministrationWoodfield Corporate Center475 N. Martingale RoadSchaumburg, Illinois 60173-2226(708) 706-3513

ChairpersonCommittee on PublicationsRoland E . KingEditorE. Toni MulderExecutive EditorErich ParkerAssociate EditorsGary D. LakeStephen A. MeskinCharles Barry H. WatsonManaging EditorJeanne CaseyContributing EditorKen KrehbielProduction ManagerRenee Cox

American Academy of Actuaries1720 I Street, N .W. 7th FloorWashington, D.C. 20006Statements of fact and opinion in this publication,including editorials and letters to the editor, are madeon the responsibility of the authors alone and do notnecessarily imply or represent the position of theAmerican Academy of Actuariesm the editors, or themembers of the Academy.

by Charles Barry H. Watson

Notes froman Actuarial Tourist

In caseyou had not noticed, the actuarialprofession in the United States is takingon a decidedly international look .

By this is meant something muchlarger than the long-standing liaisonwith our Canadian actuarial colleagues .Look at what has happened over thepast few years, almost without ourknowing it .

An organization has been set up .First, the Society of Actuariesestablished a Committee on Inter-national Relations . Not to be outdone,the Academy set up a Committee onInternational Issues . Raising the ante,the Society has just authorized theestablishment of an InternationalSection .

Meetings have proliferated . Almostevery program held by an actuarialbody in the United States during thelast five years has featured one ormore sessions devoted to international(non-Canadian) issues, even the augustand normally inward-focused EnrolledActuaries Meeting. This flurry wascapped off by the devotion of the 1990Society of Actuaries Annual Meeting toan exploration of internationalopportunities (for life insurancecompanies and their actuaries, asmight be expected) .

The publication of material hasfollowed apace-articles in TheActuarialUpdate and The Actuary, and aspasmodically regular "ForeignCorrespondence" department inContingencies. Even a collection ofactuarial international experiencesentitled "Letters from Abroad" appearedas part of the support mechanism forthe 1990 Society Annual Meeting .

Attention should also be given toeducational activities. The Society ofActuaries has gradually assumed theburdens of actuarial empire from theInstitute of Actuaries and the Faculty ofActuaries, particularly in the PacificRim countries, and has even granted"most favored nation" status tomainland China by sponsoring anactuarial training program in thatcountry.

The Actuarial Update

All this activity Is impressive and,viewed from this writer's perspective ofover twenty years' involvement iInternational actuarial practice, Ionoverdue . (Of course . I am an employeebenefits consultant and so find therelatively single-minded. concentrationon life-company issues somewhatannoying, but something is better thannothing.)

However, what does it all add up to?What inspires it, and what does itportend for the future?

Why have the Academy, the Societyof Actuaries, the Casualty ActuarialSociety, and the other North Americansocieties-none of them (with thepossible exception of the CanadianInstitute) previously noted for theirinternationalist fervor decided to diptheir toes (no, entire legs) in foreignwaters?

There appear to be a number ofreasons: some professional, somepersonal , and some profitable ; somereactive , and some (to use anunfortunate turn of phrase) proactive .

Look first at the profit-relatedmotives. (Actuaries are, after all.employees/consultants of businessorganizations .)

∎ Business opportunities abouabroad, for both insurance organ-izations and consulting firms. NorthAmerican know-how is an advantage,but knowledge of the local scene isessential. Involvement by the pro-fessional societies can help .∎ Competition from overseas businessentities is growing (the reverse side ofthe coin), through increased productsales, purchases of domestic organ-izations, and mergers . In combatingthis challenge, you have to know theenemy to fight him .∎ Competitive position vis-a-vis NorthAmerican rivals for overseas businessis strengthened by multinationalalliances-insurance networks andconsultancy chains .

Turn next to professional issues.These are more up-front, but areactually more subtle in theirimplications.∎ Our profession is small ; cooperationwith foreign societies strengthens us,and them.∎ We can learn from other societies(better to put our backs to the wlthan to re-invent it.) The valuaactuary concept was not "made in NorthAmerica."∎ As economic blocs develop (EC 1992,Pacific Rim, free-trade zones), we desireaccess on equal terms with our foreign

December 1991

counterparts (i.e., another level playingfield) . This requires cooperation .

Certain matters of turf intrude . Toblunt, we tend to view ourselves ase imperial successors to the Institute

and Faculty and wish to positionourselves to achieve this . (Oddly, thisis not an uncontested notion .)∎ Certain philosophical issues dividethe actuarial societies. One line ofdemarcation is found in the control ofeducation/accreditation : professionalsociety or academia? Another lies inhow the products of our professionalwork are controlled : governmentregulation or professional respon-sibility? The divisions are country-specific and are in large measure linked:academia-based societies are usuallygovernment regulated . (The system inthe United States, however, is a hybrid .)Theseareimportantissues, andweshouldtake a proactive (i) position on them .

Finally, personalities do matter.Certain presidents and other influentialactuaries, by inclination orwork habits,have advanced the cause of inter-nationalism .

Well, there we have it: a significantand growing international involvementby the North American bodies . This ispositive development, and it shouldencouraged. There are, however,

certain areas where caution needs to beexercised .∎ Our experience and traditions shouldbe presented for evaluation, not rammeddown the throats ofothers. There shouldbe no PaxAmericana, or new (American)global order, in the actuarial profession .∎ We need to seek, and practice,reciprocity. The ability to carry on ourcraft freely in other countries, subjectonly to demonstrated knowledge of thelocal environment, is the goal that we,as a profession, should pursue .∎ As a corollary, we belong to a growingfree trade bloc, in which services willinevitably be affected . Extension ofactuarial free trade to Canada haspresented no problems. However,extension to Mexico will require careful,considerate statesmanship on ourpart .∎ Finally, we must shoulder ourresponsibility as world citizens . Theactuarial profession has much of valueto offer to developing countries, and weshould be willing to offer educationaland training facilities, as well as thee_nefits ofour experience in these areas .But gently, and in all humility.

Watson is associate editor of TheActuarial Update. He is a consultingactuary with The Wyatt Company inWashington, D.C,

3

C Standards Outlook∎"M by Christine Nickerson

The Actuarial Standards Board (ASB)reviewed a lengthy list of projects at Itsfinal 1991 quarterly meeting. Meetingon October 8-9 in Dallas, the ASBconsidered several proposed standardsand various administrative Items.

New Board and Committee Members

As a first item of business, the boardapproved members of the operatingcommittees for 1992 . Operatingcommittee chairpersons for 1992 are :Michael J . Miller, Casualty Committee ;Robert W. Haver, Retiree Health CareCommittee; Paul F. Kolkman, LifeCommittee; Stephen G. Kellison,Specialty Committee ; Mary HardimanAdams, Pension Committee; Jerome A .Scheibl, Editorial Advisory Committee ;Ted A. Lyle. Health Committee; andBartley L. Munson, Long-term CareTaskForce .

The ASB also welcomed RichardRobertson to the board . Robertson wasappointed to replace Walter N . Miller,whose second term on the board expiresin December 1991 . Willard Hartmanand P. Adger Williams. whose first termsexpire at the end of 1991 . were bothappointed to a second three-year termon the board. JackTumquist will replaceWalter Miller as ASB chairperson ; vicechairpersons for 1992 are JamesHickman and P. Adger Williams.

Life InsuranceHarold Ingraham, outgoing chairpersonof the Life Committee, presented arevised version of Actuarial Standard ofPractice (ASOP) No. 10, Methods andAssumptions for Use in Stock LifeInsurance Company Financial StatementsPrepared in Accordance with GAAP. Therevised version of ASOP No . 10incorporates material previouslycontained in Financial ReportingRecommendations 1, 5, and 6 and theiraccompanying Interpretations andwould fully replace these documents .Because the material taken from thefinancial reporting recommendationswas condensed and paraphrased whenit was added to ASOP No . 10. the LifeCommittee recommended the revisedversion of the standard be exposed. Theboard agreed with this recommendationand approved release of the documentas an exposure draft .

Ingraham also updated the ASB onrevisions to Financial ReportingRecommendation 7. Statement ofActuarial Opinion for Life InsuranceCompany Statutory Annual Statements .This document is being revised toprovide guidance for meeting therequirements of the new StandardValuation Law-particularly withrespect to asset -adequacy analysis. Aspecial task force within the LifeCommittee has been formed toundertake this revision . The task forcehopes to complete its work early in1992 and to have an exposure draftready for the ASB to review at its Aprilmeeting .

Actuarial AppraisalsThe ASB voted to adopt the proposedstandard of practice for actuarialappraisals. It was presented to theboard by the chair of the ActuarialAppraisal Task Force, Robert Shapiro.The purpose of the standard is todescribe the considerations that bearon the actuary's professional work whenperforming actuarial appraisals . Itprescribes appropriate procedures forperforming actuarial appraisals and fordocumenting assumptions andmethodologies in an actuarial report.The board suggested various changesto the document, including clarifyingthe definition of the term "actuarialappraisal" in order that it not be limitedonly to statutory appraisals . Thestandard is scheduled to be distributedwith the January 1992 Actuarial Update.

. (continued on page 8 )

4

DAY IN WASHINGTON(continued from page 1)

First of all, there is no processwhereby the profession can screen foractuaries who are best suited to beappointed actuaries . The present lawallows any fellow of the Institute ofActuaries (in England) or the Faculty ofActuaries (in Scotland) to become anappointed actuary. But, as Daykinpoints out, "the primary quality onewould want in an appointed actuaryisn't technical skill , but the ability tostand up to aggressive managementand to be a presence in the board room .

"Not every actuary has that," heacknowledged, and "there is no processwhereby the profession can decidewhich actuaries are best suited or not .It's almost a process of trial and error ."

But according to Daykin, there isnow an agreement between theDepartment of Trade and Industry and

the professional bodies to introduce anappointed actuary practicing certificate.Daykin noted that the profession wouldthen be able to remove an appointedactuary from the position, simply byremoving the practice certificate, leavingthe actuary free to practice in otherareas.

A second drawback being addressedis the fact that "the law really doesn'tsay anything about what the appointedactuary has to do, other than to producean annualvaluation." Daykin explainedthat the agreement reached in 1973called on the profession to fill in thegaps with professional guidance .

To date, professional guidance hasincluded such things as, "The actuaryhas responsibility to ensure that theboard receives the report."

"What's now to he done," said Daykin,"is that the actuary is going to have tocertify . . . to the supervisor [regulator]

AICPA Seeks to Apply SFAS 106to Multiemployer Plansby Stephen Meskin

On September 5, the American Institute of Certified Public Accountants (AICPA)issued an exposure draft of a proposed statement of position (SOP) that could havea significant impact on multiemployer health and welfare funds . The SOP,"Accounting and Reporting by Health and Welfare Benefit Plans," would requireplans to measure their accumulated postretirement benefit obligation (APBO) inaccordance with Statement of Financial Accounting Standards (SFAS) 106 .

Currently, SFAS 106 applies to employers rather than to plans ; plans do nothave to accrue an annual expense forpostretirement benefits, and no portion of theAPBO appears on the plan's balance sheet as a liability. Plans merely have todisclose the APBO in a note accompanying the financial statements .

"Clarification" or Significant Change?In a separate but related matter, the SOP also clarifies that all benefit obligations,including claims due and payable, premiums due, claims incurred but notreported, and accumulated eligibility credits are not plan liabilities . Even so, theseobligations must all be measured and disclosed in the same note as the APBO .

Some would say that this "clarification" of SFAS 106 constitutes a significantchange in plan accounting .

If a plan does not follow the SOP, then the financial statement does not satisfygenerally accepted accounting principles (GAAP), and the accountant has to say soin a qualification to his or her opinion .

The proposed effective date of the SOP is for plan years beginning after December15, 1992, with a two-year extension for small plans . The time table is the same forcomplying with SFAS 106 . However, "financial statements of prior plan years arerequired to be restated . . . if presented together with financial statements for planyears beginning after December 15, 1992 ." (See SOP, page 20 .) Thus, for acalendar-year plan that presents the immediate prioryear in Its financial statements,a measurement of the APBO will be required for December 31 . 1992 .

The Academy's Committee on Health and Welfare Plans submitted comments tothe AICPA, which will be reviewed, along with other comments, by the AICPA'sEmployee Benefits Committee, November 15 .

Meskin is associate editorforThe Actuarial Update. He is v cepresident and actuarywith Martin E. Segal Company in Washington. D.C .

The Actuarial Update

that the guidance notes have beencompiled with by the company ."

Thirdly, although the appointedactuary system is well established, "n-0all boards of directors, not all non-actuarial management , are fully awareof the appointed actuary's role." Daykinnoted that the Institute of Actuarieshas created a small booklet outliningthe role of the appointed actuary fordistribution to CEOs as well as everyappointed actuary in the U.K.

The fourth and final Improvement tothe present system involves theGovernment Actuary Departmentitself, said Daykin. "We decided toadopt a much more proactive super-visory role . . . not just looking at[financial] statements, which Inevitablygive a rather out-of-date picture, butvisiting the company and talking withthe CEO and senior management staff,and with the appointed actuary andactuarial staff, about the strategicdirection of the company . . . where thecompany is going, what its strengthsand weaknesses are . . . and how theactuary ensures that the necessarychecks and balances are in place ."

Daykin is optimistic, althoughtentatively so, as to how much currencythe U.K.'s appointed actuary systewill gain with the advent of the EuropeaiCommunity. '

"It is probably foolish of us toanticipate that everyone else will adoptour system, but we do believe that wehave developed a very good system . Itworks in the competitive market whichmost of the other countries haven't had .They've had much more closed, very .protected markets. If we can buildsomething similar on the property/casualty side, I would feel verycomfortable with our regulation beingapplied throughout Europe," saidDaykin .

In closing, Hendricks asked Daykinif he had any particular impressionsabout the U.S. system from "today'ssmall skirmish on the Hill ."

Daykin responded, "I have beencoming to grips with an understandingof the American system for a number ofyears now. I feel that I am beginning tounderstand certain elements of it. Itinevitably remains something of amystery to an outsider .

"I was appreciative of the interest ofsome of the people we met today, and Imkthink most challenged by Jac.Chesson's throwing down the gauntlet -a challenge to the profession to helpthem come upwith aworking solution."

Casey is Update managing editor.

December 1991

Changes on the41orizon at A X Best

by Jeanne Casey

"A.M. Best Is going to be tightening itsbelt a notch or so," said Larry Mayewski,vice president of the company's life-health division . Although the ratingcompany has always looked at insurers'assets and liabilities under normalmaturation and even stress cycles, neverhas Best evaluated companies' abilityto withstand "nuts on the bank."

Recent developments In the lifeinsurance Industry, specifically theregulatory takeovers of Executive Life,First Capital Life, Fidelity Bankers Life,and Mutual Benefit, have spurred A .M .Best to alter its approach to ratinganalysis. Best's ratings for thesecompanies were A, A-, [A+c, and A+respectively one year before regulatorstook them into conservatorship toforestall large numbers ofpolicyholderscashing out their policies .

Some analysts fau]tA.M. Bestfornothaving given policyholders adequatewarning of these company failures .There are really two issues involved in

is charge. What were the underlyingrisks associated with each company'sassets, which precipitated the declinein confidence in the company? and,Should A.M. Best have been able tosignal that a company was in troublebefore public confidence declined?

A statistical analysis of Best's ratings,"Life Insurance Company Ratings; HowReliable Is A.M. Best?" by Lee Slavutin(Financial & Estate Planning, August1991). is critical of the predictive valueof Best's ratings as compared withMoody's and Standard & Poor's (S&P)bond ratings. Slavutin observes that ofthe 269 companies rated A+ in 1981, 7companies failed within 10 years . Bondswith Moody's and S&P's highest rat-ings for that period never approachedthat failure rate of 2 .6%. "A.M. Best hasnot discriminated among A+ companiesin very different financial conditionsand gives out its A+ rating to the largercarriers more easily than Moody's, S&P.and Duff and Phelps give out their topratings," Slavutin concludes . (Heacknowledges that this comparison isbased on the premise that insurance

npany and bond ratings areequivalent.)

In fairness to A.M. Best, the dataSlavutin compiles also show that only5% of the 98 rated companies thatfailed between 1975-1991 had had a

rating above B- one year before theyfailed. (Half of all failed companieswere not rated.) The question remainswhether a downgrade one year or lessbefore a company fails is adequatewarning .

Perhaps to debunk the notion thatBest's ratings are Inflated whencompared to S&P's and Moody's. A.M .Best Vice PresidentJackSnyder pointedout that Mutual Benefit had invest-ment-grade ratings (BBB or better)from all three rating agencies at thetime it went into receivership.

"We're not rating on a bell-shapedcurve." said Mayewski . "Why do wehave so many A and A+ ratings? We setstandards that companies have workedhard to achieve ." He suggests thatrating downgrades reflect the toughereconomic environment in which thesecompanies are operating and investing.

In the current environment, It seemsthat a company's long-term viabilitydepends, at least in part, upon its quickliquidity-its ability to satisfy cash-value surrenders. Liquidity has alwaysbeen considered for purposes of ratinga company, according to Mayewskt .Now, A.M. Best plans to add a newfactor to its qualitative rating analysisto better measure a company's quickliquidity, its ability to respond to quickcalls on its assets .

Policyholder Confidence Factor

An August 2 press release reported thatA.M. Best's "policyholder confidencefactor will be used to closely evaluatethe potential Impact ofdemand-deposittype products, such as annuities andguaranteed investment contracts(GICs), on an insurer's financialstability."

To determine this factor for eachcompany, A.M. Best will be solicitingadditional information for thecompany's qualitative review. For onething, "companies will have to providemore specific data about the processthey go through in coming up withmarket-value adjustments," notedMayewski. This information now comesup In Best's interviews with companymanagement. Additional informationon the level of business in surrender-able liabilities is gathered from financialstatements and interrogatories : Whatare the sizes of the annuities andcontracts? How are the contractsdistributed-through brokers? Whatare the risk features of the products?How many ways are there to cash themout? What are the penalties?

5

F------------November 1991

I Checklist of AcademyStatementsa PS-91C-11 Summary of Meet-ing of Academy, AICPA, and NAICon P/C Blank Instruction 12

U PS-91L-4 Life FinancialReporting Committee Commentson Present Value- based Mea-surements In Accounting

U PS-91P-3 Comments to DOLon Fiduciary Standards forSelecting Pension AnnuityProviders

U PS-91H-7 Comments onAICPA Statement of Position onAccounting/Reporting for Health I

I and Welfare Plans I

L------------- 1When asked what effect this new

confidence factor would have oncompany ratings, Mayewski comment-ed, "Right now, we do not expect manyor dramatic rating downgrades due tothis qualitative factor." He emphasizedthat A.M. Best had no intention todivide the industry into two types ofcompanies : "those that can withstanda run and those that can't."

Insurance companies are "inbusiness to handle long-term oblig-ations," observed Mayewski. To assumethat an insurer is sound only if It cansatisfy an immediate, significant call onits assets runs contrary to the role ofthe industry, he said. The new factorwouldn't be applied "in a fashion thatcreates an image that this companycan't withstand a run," he emphasized .

When asked how Best would ensurethat downgrading a company's ratingdidn't become a "self-fulflllingprophecy"by prompting a drop in policyholderconfidence, Mayewski said that there"has to be public acceptance that [forBest] to downgrade a company from A+to A doesn't mean it's not a strong com-pany." He said that A . M . Best would tryto articulate reasons for the downgradeso as not to incite undo concern .

The potential for media attentiontriggering a decline in policyholderconfidence will also be weighed In thenew ratings, according to Snyder andMayewski. Best's rationale for includingthis as part of the new policyholderconfidence factor is that if a company

(continued on page 71

6

1991 Annual Meeting Report:Practice Councils

Two committees report to the Life Prac-tice Council: the Committee on LifeInsurance, which is chaired by PhilPolkinghorn, and the Committee onLife Insurance Financial Reporting, nowchaired by Arnold Dicke. The JointCommittee on the Valuation Actuarywill be terminated this fall. Issuesregarding the valuation actuary will betransferred to the Committee on LifeInsurance Financial Reporting .

Committee on Life Insurance

The Committee on Life Insurancemonitors legislative and regulatoryactivities in the life insurance area. Thecommittee may prepare statements onlife insurance issues for disseminationto the membership or for submission toappropriate organizations, bothgovernmental and private . Issues oncertain specialty subjects, such asfinancial reporting and risk class-ification, are generally referred to thosecommittees for action .

Issues to be discussed at upcomingmeetings include :

∎ Monitoring regulatory activity : Itemsdiscussed in the past have includedGuideline XXX on deficiency reservesand special state requirements that havearisen .∎ Examining sales illustrationpractices: There will be continued exam-ination of the smoothness test containedin the Standard Nonforfeiture Law.∎ Miscellaneous Commissioners'Annuity Reserve Valuation Method(CARVM) issues: This includes lookinginto cliff surrender charges, variableannuities, index annuities, change-in-fund methodology, and interest rateclassification .

Committee on Life InsuranceFinancial Reporting

The Committee on Life InsuranceFinancial Reporting monitors financialreporting activities related to life andhealth insurance. It reviews proposalsmade by various governmental andnongovernmental organizations thatcould affect accounting practices vis-a-vis life and health insurance companies .The committee prepares analysis andrecommendations that are presented

either in written form, or as oraltestimony , as appropriate .

Current issues of concern to thecommittee include:∎ Development of risk -based capitalformulas and asset valuation reserve .Any new model Standard ValuationLaw needs to be coordinated with therisk-based capital approach. (Look formore on the risk-based capital conceptin The Update in the months ahead .)∎ The F inancialAccounting StandardsBoard's efforts to mark asset values tomarket values will be monitored . It willbe important to tie assets to liabilities inthis process .∎ The Actuarial Standards Board maydevelop additional standards for thevaluation actuary. A new version ofFinancial Reporting RecommendationNo. 7: Statement of Actuarial Opinionfor Life Insurance Company Statutory

The Casualty Practice Council, whichmet during the Annual Meeting,reviewed Its present qualificationsprocess and discussed how to fine-tunethe application form. As assessed byAcademy Vice President MichaelWalters, the key problem is that manyapplicants do not fill out the formproperly. In order to approve an actuaryas qualified to sign loss reserve opinions,the council must determine whetherthe applicant has learned what he orshe needs to know to assess loss re-serves properly. In particular, canapplicants show that they haveunderstudied for three years with aqualified actuary?

In reviewing the form and process,the council also took a global perspective .For example, if a European actuaryapplies to the Academy for membershipand seeks qualification from theCasualty Practice Council . should thesame requirements apply? And if theAcademy denies a foreign actuaryqualification, how might that bode forU.S. actuaries applying to work in thenew European community? Althoughan extremely tough issue, councilmembers were cognizant of its ramifica-tions, since European countries have adifferent set of environmental problemsthan the United States, -which means

The Actuarial Update

Annual Statements will include theconcept of asset adequacy.∎ The committee will provide morspecific information on solvency anliquidity Issues to the Forecast 2040program in 1992 .∎ The Pension Benefit GuarantyCorporation's brightlining for pensionplans is another issue. One question iswhether the valuation actuary shouldoffer an opinion to pension-plansponsors .∎ Regarding FASB's thoughts oninterest methods for discounting, thereneeds to be consistency betweencasualty and life insurance practices.

In the past, the Committee on LifeInsurance Financial Reporting hasprimarily addressed generally acceptedaccounting principles (GAAP) issues andtherefore has been oriented toward stockcompanies. With the current concernabout solvency and liquidity In the indust-ry, the committee will be concerned withissues that are important to both stockand mutual companies. Q

different loss reserve considerations (i .e .,Britain does not have a serious asbestosproblem, and France's manufacturinregulations and requirements are mucfeless stringent) . One council membernoted that the International RelationsCommittee of the Casualty ActuarialSociety is looking into these kinds ofquestions as well .

Investigate insolvencies

In a report from David Hartman. chairof the Committee on Property andLiability Financial Reporting, the councillearned ofa pending update to the 1990study of effectiveness of casualty lossreserve opinions. Hartman was pleasedto advise the council that, unlike thefirst survey in which not all stateinsurance departments responded, allstates responded to the committee'srequests for information this time . Healso said that this survey appears tosupport the initial one's findings thatactuaries are Involved in less that one-third of all insurance companyInsolvencies .

The discussion of the survey led thecouncil to Informally approve arecommendation that the new ActuarialBoard for Counseling and Discipliinvestigate all Insurance companyinsolvencies, effective with 1991insolvencies . Council members said theAcademy and the profession have anobligation to follow up on Insolvencies .

December 1991

Other BusinessIn other business, the councilscussed the need to develop and

4egularly update a database of statelaws and regulations that affectinsurance in general and loss reservesin particular .The council also discussed

developing standard wording for non-standard opinions, which could bepromulgated through the same processthat theActuarial Standards Board usesfor its materials.

Walters also noted that councilmembers need to be aware of the factthat . the National Association ofInsurance Commissioners' profitliability formula for 1989 is notcalculated properly, but he added thatthe miscalculation is more of aratemaking issue .

Academy Vice President LarryZimpleman was ringleader for a free-wheeling discussion of the myriad is-sues facing actuaries involved inension practice and social insurance .e dozen actuaries in attendanceeluded Rowland Cross from the

Internal Revenue Service (IRS) and thenewvisiting actuary at IRS, Joan Weiss;JoeApplebaum from the Department ofLabor; and representatives from thevarious pension committees: MaryRiebold (Conference of ConsultingActuaries) and Bob Guarnera (AmericanSociety of Pension Actuaries) . JimTurpin represented the Academy'sPension Committee .

Steve Kellison, chairperson of theAcademy's Social Insurance Committee,was first up. He outlined his committee'sactivities briefly, acknowledging that at-tendees were probably more interestedin pension topics . The committee's projectsover the past year included work onproposals for Medicare (Part B) costprojections, review of the three SocialSecurity Advisory Reports, and thedrafting of a proposed standard ofpractice on social insurance for theActuarial Standards Board (ASB) .

Several in attendance were eager todiscuss the fact that the chief actuaryAL r the Health Care Financing

iniitratinn, Guy King, had qualifieds opinion and that the public trustees

for Social Security had taken issuewithhis doing so. Kellison noted that it was

unprecedented for the public trusteesto come out against the chief actuary inthis way. Weiss commented that it maybe important to clarify what' s at issuein this matter for the public . Turpinpointed to the value of havingstandards .of practice that couldalleviate pressure on actuaries to usedictated assumptions .

Riebold reported that the pensioncommittee for the Conference ofConsulting Actuaries had decided todivide in two-with half its members"infiltrating" the Academy's publicinterface committees, and the otherhalf planning the Conference' s annualmeeting . She referred to the Council ofPresidents' Working Agreement, whichlimits the scope of the Conference andSociety of Actuaries in dealing withissues external to the profession-arole delegated to the Academy in theUnited States. The Conference'scommittee will continue to focus oneducation and research .

Guarnera, president-elect of ASPA,reported thatASPAhad given testimonyon pension simplification . Thetestimony argued for eliminatingInternal Revenue Code Section 415(e)on the grounds that the Section 404and Section 415 limits make 415(e)duplicative. In addition, ASPA isdeveloping criteria for certification ofdefined-contribution plan practitioners,akin to the enrolled actuary certification .This work is deemed important becauseof the explosion of 401(k) plans andage-based profit-sharing plans .

Reporting on the Academy's PensionCommittee, Turpin outlined thecommittee's activities: work on pensionsimplification, joint testimony withASPA (by Ed Burrows) on proposedseparate-line-of-business regulations,a survey on plan terminations,testimony before the IRS and Treasuryon the 401(a)(4) proposed regulations,and testimony at the ASB hearing onshutdown benefits. The committee hasalso been monitoring the small-planaudit program. Turpin said that thereason the Pension Committee has notissued a statement on the small-planaudit is because its members have notreached consensus concerningSchedule B assumptions .

Zimpleman identified a new issue forthe Pension Practice Council to followup on in the coming year: the issue ofguidance for pension plans investingin insurance company annuities, givenrecent Insurer insolvencies .

Reports on the Health Practice Council and the Council on Professionalism willappear in the next Update .

7

CHANGES ON THE HORIZONATA.M. BEST(continued from page 5)

has a high media profile and isexperiencing difficulty, that in itselfcan expedite a run .

Asked whether making the actualrating media-sensitive might not makethe rating more reactive than predictive,Mayewski answered that Best's analysiswould consider that question-apparently on a case by case basis. Insuch cases, the rating agency wouldask "Has media exposure gone to thepoint where no matter what happens toa rating, the company is still in adownward spiral?" in other words,Best would hesitate to downgrade acompany precipitously on the basis ofits media profile alone .

Risk-Based Capital Model

Risk-based capital models are designedto evaluate the relative risks associatedwith a company's investments andproducts. A. M. Best Is developing arisk-based capital model, which, alongwith the policyholder confidence factor,will be incorporated into Best's year-end ratings. Among other things, A.M .Best's risk-based capital model looks atthe size of a company's individual Invest-ments. their diversification, and charac-teristics of Its loans and mortgages(e .g., the geographical spread of loans,whether or not mortgages are FHA-secured) .The National Association of

Insurance Commissioners (NAIL) andits industry advisory groups aredeveloping a risk-based formula also.Although aware of the NAIC's and otherorganizations' efforts to develop risk-based measures for evaluating aninsurance company's asset mix(Moody's has already developed such aformula), Mayewski believes analystsat A.M . Best "can bring more to theplaying field from our experience."

At this time, A.M. Best has no plan togo public with its model . Mayewskicommented, "We're hesitant to just slapa formula out there . We haven't crossedthe bridge as to whether we'll make [it]public. But we will discuss It withcompany management during acompany's qualitative review ."

The real question for actuaries andpolicyholders is whether these changeswill enhance A.M. Best's ratings aspredictive measures of a company'slong-term financial strength in thecurrent economic environment. Intruth, only time will tell. 6

8

ASB Clarifies Issues Regarding Statement onCash Flow Testing in Actuarial Opinion

by Walter N. Miller and Jack M. Turnquist

Two important questions have arisenon interpretation of Actuarial Standardof Practice No. 14, When to Do CashFlow Testing for Life and HealthInsurance Companies.

Should Disclosure Regarding CashFlow Testing Appear in the ActuarialOpinion?

The Actuarial Standards Board (ASB)was asked whether Section 6 .1 of thestandard requires the actuarial opinionaccompanying the statutory annualstatement to include disclosure as towhether cash flow testing wasperformed, and if not, the reason for notdoing so.

The requirement for such disclosurefor reserve testing is obvious and is notat issue. The question is whether thedisclosure is to be made a part of theactuarial opinion itself or is requiredonly to be included in the actuarialreport or memorandum that supportsthe actuarial opinion .

While a strict and narrow reading ofSection 6.1 of the standard mightsupport the latter approach, it was theintent of the ASB to require suchdisclosure in the actuarial opinion itself,as well as in any actuarial reportdocumenting the work done in supportof the opinion .

In December 1990, the NationalAssociation of Insurance Com-missioners (NAIC) modified theinstructions for the annual statementto require the actuary to statecompliance with the applicablestandards of practice promulgated bythe ASB. This change was made tobridge the gap until the more extensiveresponsibilities of the appointedactuary, defined by the 1990amendments to the Standard ValuationLaw, become effective in the variousstates. The insurance regulatorsassumed that the revisions to theinstructions would require the opiningactuary to disclose what cash flowtesting had been done in support ofactuarial opinions prepared inaccordance with the current provisionsof the Standard Valuation Law .

Two drafts ofa reformatted version ofexisting Financial ReportingRecommendation 7 dealing with theactuarial opinion for the statutory lifeand health annual statement have

previously been submitted to the ASB .However, the amendments to theStandard Valuation Law andmodifications to the instructions havedemonstrated the need for a morecomprehensive and encompassingstandard .

Accordingly . a special task force hasbeen created by the Life Committee ofthe ASB to develop a new and expandedstandard that will address the actuary'sresponsibilities under both the currentand pending versions of the StandardValuation Law. This standard-will.address more specifically the wordingand disclosures for the various versionsof the actuarial opinion to be required .It is anticipated that the first draft ofthis new standard will be presented tothe ASB at its January meeting .

Until then, it is the recommendationof the ASB that the actuarial opinion forthe 1991 statutory statement make fulldisclosure as to whether cash flowtesting was used, and If not, state thereason why not .

What Are the Consequences of NotPerforming Cash Flow TestingBecause of a Lack of Time orResources?

As previously mentioned, ASOP No . 14requires disclosure of why cash flowtesting was not performed, if that is thecase. Consequently, when cash flowtesting has not been performed becauseof lack of time or resources, a qualifiedopinion must be rendered, perhapsusing language such as the following :

Scope paragraph addition : "Enaddition, my examination consideredthe need for cash flow testing, but nonewas performed because of time andresource limitations associated withthe issuance of this opinion ."

Inserted paragraph : "The followingopinion is based on the assumptionthat the reserves of the company aresupported by valid assets which havesuitable scheduled maturities ormarketvalue and sufficient liquidity to meetthe company's cash flow requirements .However, because cash flow testingwasnot performed, this assumption maynot be valid .

Opinion Paragraph insert: "In myopinion, except for the matter referredto In the preceding paragraph, theamounts carried in the balance sheet

The Actuarial Update

on account of the actuarial itemsidentified above . . ."

The ASB believes that a qualifiedopinion relating only to time or resourlimitations could be insufficient. Fexample, it would not excuse thevaluation actuary from the requirementto perform cash flow testing if he or shereasonably should have known that asignificant portion of the company'sassets were impaired or that a materialdisintermediation of assets andliabilities existed .

The valuation actuary should also beaware that an opinion qualified as totime or resource limitations may beunacceptable to insurance regulators .

Miller is the outgoing chairperson of theASB, and TLmquist is the incomingchairperson.

STANDARDS OUTLOOK(continued from page 3)

Pension Assumptions

The ASB reviewed the proposedexposure draft ofa standard on selectingeconomic assumptions for measuringpension obligations . The board decidedthat the standard needed further wto improve consistency and clarity .revised version of the proposal will bereviewed at the January 1992 ASBmeeting.

Retiree Health CareRobert Haver, chairperson of the RetireeHealth Care Committee, presented aproposed exposure draft ofan actuarialcompliance guideline for Statement ofFinancialAccounting Standards (SFAS)106, Employers' Accounting for Post-retirement BenefitsOtherTan Pensions .This proposed compliance guidelinewould provide guidance to actuarieswith respect to actuarial calculationsrequired under SFAS 106 . As stated inthe proposal, the "guideline is believedto accurately represent currentunderstanding of SFAS 106 as itpertains to actuarial calculations; theguideline is not an actuarial standardof practice.' The primary emphasis inthe guideline is on health care benefits .The board reviewed the proposal andapproved its release as an exposuredraft .

The next meeting of the ActuaStandards Board is scheduled*January 8-9, 1992, in Washington, D.C.ASB meetings are open to the public .

Ntckerson is director of the standardsprogram.