Readers Sound Off On Actuarial Buzz

Readers Sound Off On Actuarial Buzz

To The Editor:

Bravo to Susanne Sclafane for her recent column about the controversy over actuarial opinions on reserves. (See “Actuaries: Let Conscience Guide You,” Jan. 19.) I, too, agree that the initial response from the profession was a little too defensive relative to the actual adverse runoff we are observing.

As a practical matter, if rating agencies, investors, agents, consumers, etc. don't have a material level of confidence in our Statements of Actuarial Opinion pronouncements, then we as a profession DO have a material problem.

I compiled some data for a presentation I did last summer for the Society of Financial Examiners and found that the all-lines runoff for the top-10 workers compensation writers (excluding two of the top-10 that are already gone, Kemper and Legion) was roughly as adverse for accident-years 1998-2000 (as of Dec. 31, 2002) as the full industry runoff for accident-years 1982-1985 (as of Dec. 31, 1990).

The deficiency statistics I presented were relative to accident-year reserves set at first report. For example, the accident-year 1999 reserves that had been set (by the eight insurers) at first report (Dec. 31, 1999) had already proven to be 20 percent deficient as of Dec. 31, 2002. The accident-year 1998 workers comp deficiency was 17 percent, and the accident-year 2000 deficiency was already 12 percent as of Dec. 31, 2002.

The corresponding older-year deficiencies for the industry were 21 percent for accident-year 1984, 18 percent for accident-year 1983, 12 percent for accident-year 1985, and 11 percent for accident-year 1982.

I doubt that the runoff for accident-years 1998-2000 will improve when we have the Dec. 31, 2003 data.

Keep up the good work!

Susan Szkoda
President
Szkoda Actuarial Services,
Marietta, Ga

To The Editor:

Susanne Sclafanes column concerning actuaries and their need to let their conscience be their guide was very much appreciated. I have spent much of my career “fixing things” within insurance and related entities ranging from branch office departments to entire national carriers. Ms. Sclafanes comments resonated very loudly as I reflected upon my own attempts to undo the mismanagement of others.

It has been my experience that such misbehavior is not generally limited to the actuarial discipline. The management of many of these organizations is often involved with manipulating other critical areas like accounting, claims and underwriting to one degree or another.

In one instance, I actually dealt with a national company where disingenuous behavior by many of the mid- and lower-level managers seemed to be the norm as opposed to the exception. I could only conclude that the corporate culture of the organization had been infected to its core. Suffice to say, the best possible outcome in this instance was to place the entire organization into voluntary runoff.

My father was an attorney from the late 1930s into the 1970s. He taught me that his oath and position as an officer of the court meant that he and his peers were to be held to a higher standard than the rest of society in general. Over the last 30 years, society has witnessed too many instances in which professional standards appear to have fallen by the wayside. Regrettably, groups like the bar associations and medical societies have been less than aggressive in their insistence that their members be held to high professional standards.

As a result, many in our country have come to accept that there is little reason to expect a higher standard of behavior from professionals. It is my belief that actuaries in general have also been caught in this quicksand of compromise and rationalization of standards.

The Casualty Actuarial Society needs to be leading the charge for change, as opposed to defending this unacceptable behavior. Maybe the implementation of some strict discipline (including possible expulsion) could provide a real wake-up call.

Ms. Sclafane raised the question whether bowing to pressure was fraud. She says no, and she is probably correct in the strictest legal sense. On the other hand, I believe that it may well be fraud within the concept of professional standards that an individual accepts when they receive their designation as a “fellow.”

Please keep this subject toward the top of your pile of things to share with the industry. If we are to improve things, we need to re-invigorate our industry with a sense that professionalism and standards represent more than just words and feel-good concepts.

John W. Cowley
Cowley & Associates
Insurance and Reinsurance Consulting
New Orleans, La.

To The Editor:

Although I am a research analyst, I have not been distributing my research to the media, having decided awhile back that it was for clients first and foremost. I still am willing to discuss the industry overall, but most reporters seem to want stock tips, and they certainly aren't very interested in proper, detailed analysis, by and large.

After having read Susanne Sclafanes Jan. 19 opinion on the actuarial controversy, National Underwriter has unfortunately done nothing to convince me that I was wrong. She really took the low road here, drawing very predictable and non-analytical conclusions to the two main issues surrounding this controversy: 1) how much should actuaries stand up to management, and 2) how difficult is it to estimate liabilities? Let's take each one in turn.

On the first point, of course actuaries and all sorts of advisers should have stood up to corrupt managements. They should have stood up to basically decent but overoptimistic managements, too. The point is that they don't, quite predictably throughout history. The proximate cause of the problem is management, not the advisers, unless the advisers actually believe things are bad and help management conceal this.

Already, managements are whining about the new rules before they've even had a chance to take effect. At an economic forum, executives stated that higher ethics were needed, not more rules. If human beings had higher ethics, there wouldn't be nearly as many of these problems.

So prosecute those who break the law, but if you want actuaries and other advisers to exhibit higher ethics, the standards need teeth. Make it impossible for a certain time period to fire an adviser who issues a negative opinion, for example. This would cause problems, too (for example, lax standards), but would it be worse than what we have now? Thats debatable.

All Ms. Sclafanes suggestion does is to discourage anyone from becoming an expert adviser. I wish most people had the courage to stand on principles and risk their careers to do what's right, but most don't, and those who do too often get punished by those in power until we reach corrective periods like now.

On the second point, what really bugs me is actuaries like Ms. Sclafane not understanding the risk inherent in their own industry. In a detailed piece of research on this issue, I make several key points related to this issue:

Liability uncertainty has stayed about constant over the last five years, and it's highabout five points of loss ratio equals one standard deviation for the INDUSTRY. It's obviously higher at the line-of-business and company level. From the standpoint of reported earnings, this is huge. But it's realityinsurance liabilities are probably the hardest balance sheet estimate of ANY industry.

Reserve inadequacy at the end of 2002 was about the same as at the end of the mid-1980s hard market. Excluding asbestos and environmental (which makes the mid-1980s look even worse if included, like to the point of insolvency), the average bias in loss reserve adequacy is about zero over the last 25 years.

So like most statistical processes, loss reserves go through a predictable cycle of over- and under-reaction which cannot easily be controlled But most people can't be bothered with what happened last year, let alone two decades ago

Unless we allow companies to carry large redundancies or deficiencies for long periods of time, it is impossible to manage results to a tight range, meaning that large blowups and releases are inevitable. This is a function of the loss process, not estimation. Basically, to avoid the problem of reserve inadequacy, companies would need to be able to carry very large redundancies. This is on top of the fact that they cannot book a risk-free discount on loss reserves

The answer is not “greater precision” of estimates. As noted above, this is an impossible goal. As fast as we figure out one kind of risk, we add new ones we don't understand. But greater conservatism means lower reported results (at least initially), and this runs smack into the issues with management again.

What actuaries SHOULD do is be much more consistent with their estimates over time and incorporate sufficient conservatism, reacting less to short-term favorable results.

Finally, while greater disclosure is definitely needed, and I would not be adverse to some kind of uncertainty disclosure (such as ranges or their equivalent), surely you must understand that non-experts in statistics will misinterpret or abuse this information. Ranges are not a choice of equally likely outcomesthey are a completely separate statistic from the point estimate. And Ms. Sclafane should have gone with her initial impulses from her April 2001 columnranges SHOULD be bigger, not smaller.

Yes, I'm pretty burned by the column, mostly because I'm harsh on actuaries, who should know better. I have no problem criticizing the profession. I always strive to improve my own methodologies and disclose my track record.

But you should understand that recent commentary by rating agencies and sell-side analysts is mostly a means of covering their mistakes, and they are simply looking to see which other professions have avoided the scrutiny they have received.

Unfortunately for them, both rating agencies and sell-side analysts deserve more scrutiny, given their much higher profiles and market influence. When actuaries reach that stature, I'll certainty call them to even higher standards than I do now.

As I lay out the above, most of the criticism is unjustified, in my view. But because it is complex to rebut, it seems easier to join in the bashing. Very disappointing.

Todd R. Bault, FCAS

Research Analyst
Sanford C. Bernstein LLC
New York City

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, February 20, 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.