Code of Professional Conduct and Relevant Actuarial Standards of Practice

1. Code of Professional Conduct and Relevant Actuarial Standards of Practice March, 18, 2008 Ratemaking Seminar Boston

2. Agenda • Code of Conduct/Code of Professional Ethics • Relevant Actuarial Standards of Practice • Case Studies

3. Code of Professional Conduct

4. Code of Professional Conduct • Definitions • Precepts & Annotations • Canadian Issues • Code of Ethics for Students

5. Key Definitions within Code • Actuarial Communication • Actuarial Services • Actuary • Confidential Information • Law • Principal • Recognized Actuarial Organization

6. Precepts and Annotations • Professional Integrity • Qualification Standards • Standards of Practice • Communications and Disclosures • Conflict of Interest • Control of Work Product • Confidentiality • Courtesy and Cooperation • Advertising • Titles and Designations • Violations of the Code of Professional Conduct

7. Professional Integrity • PRECEPT 1: An Actuary shall act honestly, with integrity and competence, and in a manner to fulfill the profession's responsibility to the public and to uphold the reputation of the actuarial profession.

8. Qualification Standards • PRECEPT 2: An Actuary shall perform Actuarial Services only when the Actuary is qualified to do so on the basis of basic and continuing education and experience and only when the Actuary satisfies applicable qualification standards.

9. Standards of Practice • PRECEPT 3: An Actuary shall ensure that Actuarial Services performed by or under the direction of the Actuary satisfy applicable standards of practice.

10. Communications and Disclosure • PRECEPT 4: An Actuary who issues an Actuarial Communication shall take appropriate steps to ensure that the Actuarial Communication is clear and appropriate to the circumstances and its intended audience and satisfies applicable standards of practice.

11. Communications and Disclosure • PRECEPT 5: An Actuary who issues an Actuarial Communication shall, as appropriate, identify the Principal(s) for whom the Actuarial Communication is issued and describe the capacity in which the Actuary serves.

12. Communications and Disclosure • PRECEPT 6: An Actuary shall make appropriate and timely disclosure to a present or prospective Principal of the sources of all direct and indirect material compensation that the Actuary or the Actuary's firm has received, or may receive, from another party in relation to an assignment for which the Actuary has provided, or will provide, Actuarial Services for that Principal. The disclosure of sources of material compensation that the Actuary's firm has received, or may receive, is limited to those sources known to, or reasonably ascertainable by, the Actuary.

13. Conflict of Interest • PRECEPT 7: An Actuary shall not knowingly perform Actuarial Services involving an actual or potential conflict of interest unless: • the Actuary’s ability to act fairly is unimpaired; • there has been disclosure of the conflict to all present and known prospective Principals whose interests would be affected by the conflict; and • all such Principals have expressly agreed to the performance of the Actuarial Services by the Actuary.

14. Control of Work Product • PRECEPT 8:An Actuary who performs Actuarial Services shall take reasonable steps to ensure that such services are not used to mislead other parties.

15. Confidentiality • PRECEPT 9:An Actuary shall not disclose to another party any Confidential Information unless authorized to do so by the Principal or required to do so by Law.

16. Courtesy and Cooperation • PRECEPT 10:An Actuary shall perform Actuarial Services with courtesy and professional respect and shall cooperate with others in the Principal's interest.

17. Advertising • PRECEPT 11:An Actuary shall not engage in any advertising or business solicitation activities with respect to Actuarial Services that the Actuary knows or should know are false or misleading.

18. Titles and Designations • PRECEPT 12: An Actuary shall make use of membership titles and designations of a Recognized Actuarial Organization only in a manner that conforms to the practices authorized by that organization.

19. Violations of the Code of Professional Conduct • PRECEPT 13:An Actuary with knowledge of an apparent, unresolved, material violation of the Code by another Actuary should consider discussing the situation with the other Actuary and attempt to resolve the apparent violation. If such discussion is not attempted or is not successful, the Actuary shall disclose such violation to the appropriate counseling and discipline body of the profession, except where the disclosure would be contrary to Law or would divulge Confidential Information.

20. Violations of the Code of Professional Conduct • PRECEPT 14:An Actuary shall respond promptly, truthfully, and fully to any request for information by, and cooperate fully with, an appropriate counseling and disciplinary body of the profession in connection with any disciplinary, counseling or other proceeding of such body relating to the Code. The Actuary's responsibility to respond shall be subject to applicable restrictions on Confidential Information and those imposed by Law.

21. Canadian Rules of Professional Conduct • The Rules of Professional Conduct in Canada require that certain procedures must be followed when a member is aware of a violation of the Rules. • Affirmative responsibility to act to correct violation • No confidentiality agreement or employment protections exist

22. Code of Professional Ethics

23. Code of Professional Ethics for Candidates • Effective with the May 2008 exams • Similar to Code of Conduct for members • CAS now consistent with other societies (e.g. CPCU and CFA Institute) in requiring candidates to abide by ethical standards

24. Code of Professional Ethics for Candidates • Rules 1 & 2 = Precept 1: Integrity • Rule 3 = Precept 10: Courtesy • Rule 4: Exam discipline • Rule 5 = Precept 12: Titles/Designations • Rule 6 = Precept 9: Confidentiality • Rule 7 = Precept 14: Respond promptly/cooperate

25. Code of Professional Ethics for Candidates • Precepts not addressed by Candidate Code • Precept 2: Qualification Standards • Precept 3: Standards of Practice • Precepts 4-6: Actuarial Communications • Precept 7: Conflict of Interest • Precept 8: Control of Work Product • Precept 11: Advertising • Precept 13: Discussing/Disclosing Violations

26. Actuarial Standards of Practice

27. Actuarial Standards of Practice and Ratemaking • Actuaries need to be aware of the applicability of the different ASOPs to the work that they perform • The Council on Professionalism of the AAA has developed the “Applicability Guidelines for Actuarial Standards of Practice”

28. Applicability Guidelines • These guidelines are not meant to be exhaustive and only provide “non authoritative” guidance • Ultimately, it remains the actuary’s responsibility to identify the standards that apply to each assignment and to appropriately apply such requirements • These are updated periodically and it is the actuary’s responsibility to keep current with changes to ASOPs • The guidelines are not standards of practice • These were not promulgated by the Actuarial Standards Board

29. ASOPs Applicable to Ratemaking • Up to 10 ASOPs may apply to the different actuarial tasks related to product development/ratemaking/pricing • # 9 Documentation and Disclosure • # 12 Risk Classification • # 13 Trending Procedures • # 23 Data Quality • # 25 Credibility Procedures • # 29 Expense Provisions • # 30 Treatment of Profit and Contingency Provisions and Cost of Capital • # 38 Using Model’s Outside Actuary’s Area of Expertise • # 39 Treatment of Catastrophe Losses • # 41 Actuarial Communications

30. ASOP #9: Documentation and Disclosure in P/C Insurance Ratemaking, Loss Reserving and Valuations • Defines documentation and disclosure required • Issues addressed and recommended practices • Extent of documentation • Required whether or not there is legal or regulatory requirement for documentation • Describe sources of data, material assumptions, methods and changes • Sufficient for another actuary practicing in the same field to evaluate the work • Prevention of misuse • Take reasonable steps to ensure that an actuarial work product is presented fairly, clearly, and identify the actuary as the source of actuarial aspects • Who should have access to documentation? • Actuary’s client or employer, or other if requested by client/employer • Signing of work product • If required by law or regulation or by client/employer to provide documentation, should provide in writing • Be sure to meet qualification standards • Disclosure of reliance on others’ work • Repeal pending

31. ASOP #12: Risk Classification(for All Practice Areas) • Provides guidance with respect to designing, reviewing, or changing risk classification systems • Appropriate to exercise considerable professional judgment when providing such services, including making appropriate use of statistical tools • Issues addressed and recommended practices • Selection of risk characteristics • Related to expected outcomes • Rates would be considered equitable if differences in rates reflect material differences in expected cost for risk characteristics • Establishing risk classes • Based on results of measuring or observing risk characteristics • Testing risk classification system • Reliance on data provided by other

32. ASOP #13: Trending Procedures in P/C Insurance Ratemaking • Provides a basis for assessing procedures appropriate for estimating future expected values by analyzing historical data and other relevant information • Proceedings and Syllabus provide extensive information on alternative procedures • Issues addressed and recommended practices • Historical insurance data • Data from book of business being priced • Other insurance data • Non-insurance data • Be familiar with and consider various methods for measuring trends • Select trending procedures with appropriate consideration to the analysis of historical insurance data • Economic and social influences • Criteria for determining trending period • Actuarial judgment • ASB has released a revision exposure draft for this ASOP • Comment deadline is May 1, 2008

33. ASOP #23: Data Quality • Provides guidance regarding: • Selection of data • Understand intended use and consider desired and possible alternative data elements • Review of data • Informal examination of obvious characteristics of the data • Review for reasonableness and consistency, unless deemed not necessary or not practical • Reliance on data supplied by others • Accuracy is responsibility of those supplying the data • Actuary should disclose such reliance • Use of Data • Is the data adequate to satisfy analysis purpose? • Disclosures with regard to data quality • Accuracy and validity of actuarial analyses are dependent on the quality of data used • An actuary performs an analysis with available data and sufficiently discloses material data limitations, and their implications • This standard does not require audit of data

34. ASOP #25: Credibility Procedures Applicable to Accident, Health, Group Term Life and P/C • Provides guidance in the selection of a credibility procedure and the assignment of credibility value to sets of data including subject experience and related experience • Credibility blends information from subject experience with other related experience to improve estimates of expected values • Issues addressed and recommended practices • Selection of credibility procedure • Be familiar with and consider various methods • Select procedures that do the following: • Produce results that are reasonable • Do not tend to bias the results in any material way • Are practical to implement • Give consideration to the need to balance responsiveness and stability • Choice of related experience • Similar frequency and severity characteristics • Homogeneity of data

35. ASOP #29: Expense Provision in P/C Insurance Ratemaking • Provides guidance in estimating costs for P/C insurance ratemaking other than • Incurred losses • Provision for profit and contingencies • Investment expenses • Federal and foreign expenses • Issues addressed and recommended practices • Categorization of expenses • Determination of expense provisions • Policyholder dividends • Classified as an expense to operations • Residual market and statutory assessments • Provision for reinsurance • Depends on State regulations

36. ASOP #30: Treatment of Profit and Contingency Provisions and the Cost of Capital in P/C Insurance Ratemaking • Provides guidance in estimating the cost of capital and evaluating underwriting profit and contingency provisions • Rates should provide for all expected costs, including cost of capital associated with the risk transfer • Issues addressed and recommended practices • Basis for cost of capital estimates • Consider the relationship between risk and return • Cost of capital likely to vary from one insurer to another • Capital needed to support risk transfer has an opportunity cost • Investment income from insurance operations and on capital • Investment risk can result in a significantly different yield than the stated yield • Several approaches can be used to estimate investment income • Contingency provision • Include if assumptions used in the ratemaking process produce cost estimates that are not expected to equal average actual costs, and if difference cannot be eliminated otherwise • Not intended to measure variability of results, and not expected to be earned as profit • Different bases to express cost of capital

37. ASOP #38: Using Models Outside of the Actuary’s Area of Expertise (P/C) • Provides guidance in using models that incorporate specialized knowledge outside the actuary’s own area of expertise when developing work product • Actuary’s level of effort in understanding and evaluating a model should be consistent with the intended use of the model and its materiality to the results of the actuarial analysis • Issues addressed and recommended practices • Determine appropriate reliance on experts • May rely on experts if needed • Basic understanding of models • Understand basic components, user input and output • Evaluate whether the model is appropriate for intended application • Consider limitations, modifications and assumptions needed • Determine that appropriate validation has occurred • User input: Review ASOP #23 “Data Quality” • User output: Compare with alternate models, historical results and review sensitivity • Determine the appropriate use of the model

38. ASOP #39: Treatment of Catastrophe Losses in P/C Ratemaking • Provides guidance in evaluating catastrophe exposure and in determining a provision for catastrophe losses and LAE • Issues addressed and recommended practices • Identification of catastrophe perils or events that differ materially from the expected losses • Identification of catastrophe losses in historical data • Use of historical insurance and noninsurance data in determination of provision • Determine the extent to which available data is fully representative of long-term frequency and severity • Adjust to reflect future conditions (e.g., changes in exposure to loss, trends, etc.) • Review relationship between LAE and incurred losses

39. ASOP #41: Actuarial Communications(for All Practice Areas) • Provides guidance for written, electronic or oral actuarial communications • Applies to all actuarial communications, with some exceptions (e.g. testimony), between an actuary and a principal • Guidance applies to the extent practicable in the particular circumstances • Issues addressed and recommended practices • General Requirements (as appropriate) • Identify Principal, clearly state scope and any limitations or constraints • Form and content clear and appropriate to audience • ASOP #41 establishes minimum requirements, other ASOPs may supersede • Requirements for Specific Communication Types • Significant findings should be in writing or electronic form • Compliance with Other Standards • Compliance with law, regulation, or another profession's standards may be sufficient to deem compliance with this standard • Responsibility to Other Users • Take reasonable steps to ensure the communication is clear and presented fairly • No obligation to communicate with any person other than the intended audience • Revisions currently considered by the ASB

40. CAS Statement of Principles for Ratemaking, Loss Reserving and Valuations • Ratemaking Principles • 1: A rate is an estimate of the expected value of future costs • 2: A rate provides for all costs associated with the transfer of risk • 3: A rate provides for the costs associated with an individual risk transfer • 4: A rate is reasonable and not excessive, inadequate, or unfairly discriminatory if it is an actuarially sound estimate of the expected value of all future costs associated with an individual risk transfer • Ratemaking – Considerations • Data – relevance, organization, homogeneity, credibility • Loss development, trends, catastrophes, policy provisions, mix of business • Reinsurance, operational changes, external factors • Class plans, individual risk rating • Actuarial judgment

41. Case Studies

42. Assume that you filed a rate change of +10% and it is sitting in the Department of Insurance for quite a while (Prior Approval state/province). A new analyst decides to run a more current indication which utilizes two additional quarters of data that is not included in the 10% change waiting for approval. This new indication shows a -2.0% need. The new analyst shares this information with you and you have seen the answer. What do you do? Case Study #1

43. Case Study #2 Suppose your marketing department is really pushing a new business discount in order to get a boost in growth. You have no actuarial support for the discount because you do not collect data on it. The competition does not have this discount either. As an actuary, would you file a discount that has no known support? What would you do?

44. Case Study #3 You are an ACAS in the ratemaking department of ABC insurance company. Your boss, an FCAS, asks you to put together a homeowners rate filing that he intends to sign. Your analysis results in a rate increase indication of 2.0%. Your boss reviews your work and says that management wants a 5.0% increase and asks you to make some changes to some assumptions that will get the desired rate increase. You think these changes are somewhat arbitrary and that they result in a rate indication that is at, if not above, the very high end of a reasonable range. Your boss is the only actuary signing the rate filing report. What do you do?

45. Case Study #4 You are doing the final review of a personal auto rate filing when you discover an error that not only was made in this filing, but also the prior filing which was approved by the Insurance Department and implemented. Your prior indication was 17%, and you implemented the entire indication. Had this error been found the corrected indication would have been 4.5%. What would you do?

46. Case Study #5 You are the actuary for a reinsurance company trying to set an excess auto reinsurance rate for a small domestic company that does not have credible data. You also reinsure a larger company, which writes basically the same business in the same state, and who has supplied you with ample data that could be used to set the rates for the smaller company. Do you use the data, as a collateral source, to develop rates for the smaller company?