Actuaries: Let Conscience Guide You

This type of finger pointing has been raised to an art form in recent years, but I think it would be hard for actuariesor anyone in the industry, for that matterto argue with the fact that rating agencies havent more than adjusted for any past failings with lightning fast actions today.

As a member of the AAA, a fellow of the CASand someone who has a clear "understanding of reserve estimates and the nature of risk"Im going to try to offer what is probably as close to an alternative insider view on the S&P report as you can get in a national magazine. Assigning reporters to interview working actuaries only serves to produce the Academy response. And I have to say I am disappointed by that response.

I am even more disappointed when I see multibillion-dollar reserve charges hitting the books of some companies, with no clue that they were coming.

(Admittedly, its been years since I signed a reserve opinion, but I think my "clear understanding of reserves estimates" is well demonstrated by my experience and qualifies me to express some opinions. During my career, I reviewed the reserve positions of at least 80 different companies with multiple types of business, including everything from personal auto to excess-of-loss reinsurance, to high-layer directors and officers, to medical malpractice.)

When I saw the S&P report, I applauded it. In a sense, the S&P analysts beat me to the punch. No, I wouldnt have used some of the more explosive language of the report, but they did ask the very same relevant questions I thought of each time I grabbed onto the desk to steady myself when I heard those $2- and $3 billion charge numbersquestions that every actuary, and indeed every participant in this industry should ask.

How can we explain our "abysmal track record?" How can we explain the fact that actuaries have "signed off" on reserves that turn out to be "wildly inaccurate" in S&Ps words. And what can be done to enhance disclosure, monitor results and stem the tide of reserving surprises that seemingly have no end in sight?

Does anyone really believe that drastically different workers compensation, excess casualty, directors and officers liability, and contractors liability loss development patterns all became evident in 2003? Isnt it more likely that the pressures to ignore those trends have eased up, allowing models to be adjusted.

Is Bowing To Pressure Fraud? No, But Its Still Not Excusable.

S&P wrote: "Whether by na?vet? or knavery, the property-casualty industrys ongoing parade of reserving additions has undermined confidence in the estimates given by insurance actuaries."

The second part of that sentence is unarguable. And while I realize that actuaries were reacting to the first partbecause they interpreted it as accusing them of outright fraudlike S&P, I believe that the need for actuaries to account for the discrepancies is more critical now than its ever been. A defensive posture isnt called for.

Im hoping that internally, within the actuarial societies, members are investigating the possible merits in the warning sign S&P flashed in front of them. If recent history is any guide, they are. Actuaries organized sessions at two of their annual conferences to debate some issues I raised in a column about the actuarial credibility gap over two-and-a-half years ago.

But I was not even the first to raise the issues. Back in August 1996, Kenneth Gorman, then chairman and chief executive officer of The Atlantic Mutual Companies, asked the question: "Is $40 billion irrelevant?" referring to a reserve shortfall that some analysts had estimated for the industry at that time.

"The role of actuaries in financial statement credibility has been elevated in recent years, not only because of their academic technical training and professional independence, but also by statute to certify loss reserve positions. A $40 billion deficiency number is a disconnect that is difficult to reconcile," Mr. Gorman wrote in NU.

In my April 29, 2001, column, with the Enron collapse as a backdrop, I tried to shed some light on one possible reason for the "disconnect," in essence telling our readers that I didnt believe underreserving could be totally explained away by actuarial mistakes or overlooked loss development trends. Instead, I explored the situations where actuaries might cave in to pressures by management and other constituents, but stopped short of accusing the profession of blatant manipulation or knavery.

Heres an excerpt from that column:

I have not presented these examples to suggest that a collapse the size of Enron is imminent in the insurance industry or to suggest that actuaries and auditors are to blame for decisions by insurance company managements to carry inadequate reserves. What is relevant to consider here is the fact that pressures facing the professionals who review the financial statements of this industry are very real.

Reading my own words years later, Im bothered, in particular, by my willingness to excuse actuaries for "the decisions by insurance company managements." In recent weeks, some actuaries have been privately using that same excuse to explain away the problems that S&P resurfaced like a cold slap in the face. The common refrain is "actuaries recommend reserves. Managements set them."

The words of that excuse are beginning to sound like the weasel words that pepper actuarial statements of opinion. And they no longer wash with me.

My thinking on this issue now is that if actuaries dont stand their ground when faced with tough decisions, then they have failed to live up to their designationsand all the studying to pass all those exams was an incredible waste of time. (In the interest of full disclosure, Ill reveal that one reason I chose to stop working as an actuary was that I didnt have the maturity or backbone nearly a decade ago to do exactly that.)

More Actuaries Weigh In.

Jeff Post, CEO of Firemans Fund, is also a fellow of the CAS. At a Society meeting in May 2001, he said: "This industry has a track record of consistent financial underperformance. That should make everyone in this room madder than hell [because] we are the financial conscience of the insurance industry. We need to step up as actuaries, act professionally and get this industry back to a level that makes it sustainable going forward."

More recently, Mr. Post shared his perspective on the S&P report with me.

"I do believe actuaries are the financial conscience of this industry, so we carry a responsibility on our shoulders to make sure that we are setting reserves appropriately; we are looking at loss trends appropriately; were pricing the products appropriately; were monitoring the schedule credits that the underwriters are giving out to make sure that overall our companies are adequately priced in the marketplace.

"Because we shoulder that burden, that means that we need to ensure that our voices are heard. And that means that we cant besitting in a corner with a green eyeshade. Weve got to be out there, talking to senior management, helping to drive the decisions.If [actuaries are] not doing that, then I would agree with S&P that actuaries are not doing their jobs."

Mr. Post did, however, point to aspects of the S&P report he felt were unfair. He noted that with recent years of unanticipated mold losses, runaway asbestos losses and "a tort environment [that] has really swung to the liberal view of paying people for outrageous things," S&P cant pin a failure to see the future on actuaries. "There are always going to be curve balls that no matter how good you are, youre not going to see coming," he said.

How Big Is A Reasonable Range?

Im a little less forgiving on this point, as is another actuary who recently wrote a report on this subject, William Wilt of Morgan Stanleynot so much for the failure to pick up some of the trends in the data, but for dismissal, denial, and lack of ownership and disclosure when those curve balls begin to reach the plate.

Mr. Wilt draws his conclusions from several insider perspectives, having worked as a consulting actuary for a Big Five firm and as a rating agency analyst. In his Dec. 4 report for Morgan Stanley, he reacted to a portion of the Academy statement that said: "Actuaries have estimated reserves within reasonable ranges, but recent adverse events have caused losses that exceeded reasonable expectations.Fraud should not be inferred from misfortune."

Mr. Wilt writes: "To characterize the massive reserve restatementsas simply exceeding reasonable expectations or a matter of misfortune seems to us na?ve at best." He added: "It seems to us a real stretch for the actuarial profession to assume the high ground in this debate. At last count, some $22 billion of adverse development was recognized in 2002Can [that] fit any reasonable definition of an acceptable record of accomplishment?"

Like S&P, I dont believe the reserve shortfalls of the astounding magnitude that were revealed last year can happen overnight. And like Mr. Wilt, I dont think we can dismiss them easily with vague references to ranges of reasonableness.

The latest estimate of industrywide reserve deficiencies, put forth not by actuaries but by rating agencies, is in the range of $30-to-$60 billion for nonasbestos losses. Even if the low end of that range is close to being rightand if only half of it relates to years prior to 2001 (a stretch of the imagination)then that prior-year deficiency, added to the more than $33 billion thats already been accounted for, represents more than 13 percent of total industry reserves carried in mid-2001 (about $350 billion, including asbestos reserves). And its 16 percent of surplus. Can we really justify these numbers as reasonable?

I can remember a time when 5 percent of carried reserves was an unwritten threshold that auditors used as a guidepost, refusing to sign off on a company if their reserve shortfalls were larger.

I am also reminded of a bit of actuarial news I reported in May 2002that actuaries opposed an NAIC proposal that would have required them to put best estimates and ranges in their actuarial opinionsinstead of just stating that reserves are "reasonable." They also objected to a proposed instruction that would have required them "to state whether or not there is a significant risk of adverse material deviation" in items they opined on.

They had some reasons for this, such as not wanting two estimates (managements and the actuarys) in the public domain. But I couldnt help thinking at the time that the real goal of an actuarial statement of opinion should be to offer true clarity and guidance to regulatorsa goal that would certainly be achieved by the very things the actuaries opposed.

In the end, a compromise was reached, relegating best estimates and ranges to supplemental reports and allowing actuaries to caveat the material deviation risk with the words "reasonably believes."

Referring to opinion language, the recent S&P report observes that "deciding what is reasonable or material leaves a lot of room to maneuver."

Can actuaries financial consciences really be clear if we havent effectively and clearly communicated our opinions?

While S&Ps report puts actuaries alone in the firing line over the loss reserve issue, more broadly, actuaries, underwriters, agents and other industry participants all have professional standards to uphold in the areas of risk selection and pricing. As the market changes in 2004, let your conscience be your guide.

NU Managing Editor Susanne Sclafane is a fellow of the Casualty Actuarial Society and a member of the American Academy of Actuaries.

Reproduced from National Underwriter Edition, January 16, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.