Actuarial Accountability in a Changing World

1. Actuarial Accountabilityin a Changing World The UK Morris Review and its Implications for the US

2. Panel Participants • Lauren Bloom • Mary Frances Miller • Karen Terry

3. Background • From Equitable • To Penrose • To Morris

4. Equitable • Near Collapse of Equitable Life • the UK’s oldest Life Insurer • Questionable actuarial and accounting practices related to individual pensions • Illustrations and current payments “promised” a better return than guaranteed • Reserves were only for guaranteed benefits • Actuarial methods were questioned by others within the profession • Dominant chief actuary was also the CEO

5. Penrose • Lord Penrose led the UK government’s inquiry into Equitable • Many parties had responsibility • Actuaries particularly singled out • Vague, self-serving standards • Poor self-regulation • Anti-competitive behavior? • Recommended a further review • Hence the Morris Review of the Actuarial Profession

6. Sir Derek Morris • PhD Economist • Head of House at Oriel College (Oxford) • Extensive academic & government credentials • Chair of the UK Competition Commission • The review took a little over a year and involved extensive input from inside & outside the profession, inside & outside the UK

7. The Morris Review: 3 Charges • Competition and Choice for Actuarial Services in the UK • Regulatory Framework of the Actuarial Profession in the UK • Review of the UK Government Actuary’s Department • Peculiar to the UK and not covered today

8. Competition & Choice • Focused on pension consulting & insurance • Found recent significant entry by smaller firms: reasonable provider choice • But – significant concentration for the large pension plans • Combined bidding for actuarial and other services is common (such as the fund manager) • Recommended separate tenders for actuarial consulting & other services

9. Competition & Choice • Recommended separate tenders for actuarial consulting & other services • Is this similar to Sarb-Ox requirements?

10. Competition & Choice • Not much switching of actuarial provider • Difficult to review the quality of advice • Client-specific knowledge is important • Full service contracts including actuarial • Marketing is costly • Best practices for pension plans • Evaluate annually • More formal evaluation triennially • Remarket at least every 6 years

11. Competition & Choice • Best practices for pension plans • Evaluate annually • More formal evaluation triennially • Remarket at least every 6 years • Is the US situation analogous? • Are the suggestions good (best) practice here?

12. Competition & Choice • Significant “understanding gap” for users of actuarial advice • Many just trust their actuary • Pension trustees & non-executive directors of insurers need better education, training & guidance • A Standard on Communication is needed • Information & advice users typically need • How to convey in a manageable form so users can understand, scrutinize & probe

13. Competition & Choice • Better education, training & guidance for users • A Standard on Communication is needed • Do we have a similar understanding gap?

14. Morris criticized actuaries’ communications skills: • “too much has been expected of actuaries and, explicitly or otherwise, too much has been promised by them.” • “clients have looked to actuaries to provide certainty, and actuaries have often appeared to provide it.”

15. Morris continues: • “many have regarded actuarial advice as having the characteristics of a ‘black box’ analysis with methodology … calculations…and even the input assumptions being quite opaque.”

16. In pensions, Morris observes that actuaries have been criticized for: • Failing to allow for the downward path of inflation and interest rates in the 1990s • Failing to allow for the subsequent stock market drop • Not questioning the “prevailing orthodoxy” that equities could be expected to provide healthy long-term returns

17. Morris called for a standard of practice on communications: • Disclosure of assumptions and extent to which professional judgment was exercised • What methodologies were chosen and why • Sensitivity analysis of outcomes to changed assumptions and methodologies • Probabilistic analyses of key variables or indicators under particular scenarios • Concerns the client should have, bearing in mind the client’s capacity to cope with various types and levels of risk.

18. In the U.S.: • Do the ASB’s standards address all of the areas Morris identified? • Should they? • Do the profession’s Code and standards provide sufficient guidance on communications?

19. Regulation of the Profession • UK specific findings • Professional standards are weak, ambiguous or too limited in range – and perceived as influenced by commercial interests • Absence of proactive monitoring of members’ compliance with standards • Profession is too introspective, not forward-looking enough, slow to modernize

20. Regulation of the Profession • Professional standards are weak, ambiguous or too limited in range – and perceived as influenced by commercial interests • Absence of proactive monitoring of members’ compliance with standards • Profession is too introspective, not forward-looking enough, slow to modernize • To what extent are these weaknesses of the US profession?

21. Regulation of the Profession • Conclusion: the current self-regulatory framework is inadequate to protect the public interest • Three possibilities: • Continue self-regulation • Independent oversight of self-regulation • Full statutory regulation • Middle route is chosen

22. Oversight of Self-Regulation • Recommended that the Financial Reporting Council (FRC) take on oversight of the actuarial profession • Note that FRC already oversees accounting profession in the UK • Five areas of oversight • Education and Continuing Ed requirements • Reserved (statutory) roles for actuaries • Professional & ethical standards • Monitoring compliance • Discipline

23. Education • Concerns with the current system • Encourages narrow application of actuarial skills rather than broader appreciation of actuarial principles • Not open to new ideas from outside the actuarial profession (financial economics particularly cited)

24. Education (cont’d) • Inadequate oversight of quality assurance • And lack of confidence among candidates • Existing apprenticeship program discourages employment of actuaries outside traditional roles • Long travel time discourages the best candidates • They can be investment bankers much faster

25. Education (cont’d) • Concerns with the current system • Skills vs principles • Not open to new ideas • Inadequate oversight of quality • Discourages employment outside traditional roles • Long travel time discourages the best candidates • Are these valid criticisms of the CAS system?

26. Education Recommendations • Greater academic & non-actuarial syllabus input • Improve quality control on exams • Involve external experts • Expand university education of actuaries • More exam exemptions • Accredit departments rather than individual courses • Allow for innovation • Fast track graduate programs to cover the technical parts

27. Education Recommendations • Greater Academic & non-actuarial syllabus input • Improve quality control on exams • Expand university education of actuaries • Do these recommendations have relevance in the North American environment?

28. Continuing Ed • Existing UK scheme is too complicated • No assurance of adequate monitoring or professional “revalidation” • Not comparable to other professions’ requirements

29. Current UK Cont Ed Initiative • Minimum CPD syllabus for statutory roles • Practicing certificates for other actuaries (voluntary at first – future mandatory?) • Basic CPD required for all actuaries • Compliance monitoring • Annually for statutory roles • Triennially for certificate holders • Spot checks for other (10%)

30. Current US Requirements • “Statutory” = NAIC opinion signers • 12 hours / 6 in “organized” activities • Must be relevant to the opinion • Other “prescribed” statements • 12 hours / 6 “organized” • No provision for monitoring except at ABCD level

31. Under Consideration • Require 30 hours for virtually all actuaries • Actuary determines relevance • Maintain 12 / 6 in reserving for NAIC opinion signers • Continue with no monitoring except at ABCD level

32. US Continuing Ed • Is the current system sufficient? • Will the proposal improve US practice? • What about assurance to the public that the profession is up to date? • Should there be compliance monitoring?

33. Roles Reserved for Actuaries • Current life and pensions roles in the UK should be retained • But if others prove able to do it, the government should consider letting them! • There is no current p/c reserved role except for Llyods syndicates • FSA (like NAIC) should consider requirement that management consult with an approved person with relevant skills • Who may or may not be an actuary

34. Standard Setting • Current UK system has standards set by equivalent of AAA practice councils • Current standards • have at times been weak and ambiguous; • have failed to resolve contentious issues; • have lacked consistency across practice areas; • have in some cases been dominated by commercial interests; and • there has been insufficient independent and lay input into the standard setting process.

35. Standard Setting Options • Profession proposed a semi-independent Actuarial Standards Board • Review notes that this works outside the UK! • UK version would have representation from outside the profession • Intermediate – put the ASB under the oversight of the regulator • Draconian – have the regulator set the standards

36. Standards: Recommendations • Intermediate choice – Standards of practice set by the outside oversight board • Majority UK practicing actuaries • Overseas actuaries or academics • Users of actuarial advice • Consumers & regulators • Profession maintains ethical standards (Code of Conduct) • But the ASB could also create standards

37. Standards in the US • Is the US Actuarial Standards Board sufficiently independent? • In reality? • In perception? • Membership? • Process? • Susceptible to large employer influence?

38. Compliance with Standards • Lack of scrutiny was a major factor in the Equitable’s problems. Penrose cited: • the complexity of the work of actuaries; • the specialist nature of the actuarial profession; • the existence of reserved roles; and • the emergence of professional norms which discouraged critical assessment of one actuary by another. • No current method for monitoring & ensuring compliance with standards

39. P/C Recommendations • Consider introducing a requirement for actuarial advice as part of the audit for general insurers; • the Financial Reporting Council, working closely with the FSA and the Profession, should – within 2-3 years – satisfy itself that appropriate monitoring of actuaries’ compliance with professional standards and independent scrutiny of actuarial advice is occurring through either direct supervision by the regulator, audit or external peer review.

40. P/C Compliance Monitoring • actuarial advice as part of the audit • appropriate monitoring of actuaries’ compliance with professional standards and independent scrutiny of actuarial advice is occurring through either direct supervision by the regulator, audit or external peer review. • Should there be compliance review in the US? • If so, how and by whom?

41. Discipline • Lack of public confidence in the profession’s ability to police itself • Recognized by the Institute/Faculty prior to Morris Review • New discipline process adopted 2005

42. UK Discipline • Independent disciplinary Board • Separate from the Institute/Faculty Councils • Lay participation at all stages of the process • Morris also recommended closer links with regulators

43. Discipline in the US • Is the ABCD sufficiently independent? • Is there confidence in the process within the profession? • Is there public confidence in the actuarial discipline process? • Where does the counseling function fit in?

44. The U.S. is not the U.K. • There are significant differences in: • Law and structure of government • Regulation of industries actuaries serve • Cultural expectations • The U.S. profession is very active in addressing public interest through public policy involvement. • The U.S. standard-setting and discipline processes directly address public interest.

45. Academy activities: • Survey of membership on professionalism topics • Council on Professionalism Task Force on Independence • Continued work to address public interest in dealings with policy makers

46. Morris’ Review is limited to the U.K.: • Many of his observations may be irrelevant here. • His review provides a basis for self-evaluation here and elsewhere. • Ultimately, any changes the U.S. profession makes should be appropriate to the U.S. environment.

47. Questions and Comments?