From the President: Are You Part of the Solution?
by Mary Frances Miller
On November 19, 2003, two ratings agencies issued press releases that held casualty actuaries accountable for the recent increases in property/casualty loss reserves in the United States. Fitch Ratings pointed out that while the industry had seen favorable reserve development for a number of years in the 1990's, in 2001 and 2002 the development was decidedly unfavorable. Although the Fitch report gave a number of reasons for the bad news, including strengthening of asbestos reserves and "a significant upward shift in critical loss cost drivers," Fitch placed blame for the upward development on a failure in the actuarial process. Standard and Poors was even more blunt in its criticism, suggesting that actuaries had played at best a passive and perhaps an active role in companies' suppression of their actual results.
In addition to insulting the integrity of the profession in the United States, the S&P report contained a number of factual inaccuracies. When negative press about the actuarial profession appears, the American Academy's crisis communication plan is triggered. The first step is to get a short press release out as soon as possible. The purpose of this first step is twofold—first, to put a damper on any tendency for the media to accept the negative press as factual and therefore to quote it as such, and, second, to steer media inquiries to the Academy for further information. The initial press release is designed to be fairly hard hitting so that it will draw the desired media response. The expectation is that the first release will serve temporarily while the Academy composes a longer, more thoughtful response. The Academy's response was developed very quickly and made available late on November 21. Although the tone of the press release was a bit harsher than some of us might have preferred, it did have the desired effect, and there were no further reports covering only the S&P article.
There has been significant follow up since that initial press release. More balanced articles by Morgan Stanley and the National Underwriter quoted the Academy press release and Bob Anker (former president of both the CAS and the AAA), Rade Musulin (CAS Media Relations Committee chair and AAA Communications Review Committee chair), and others. The Academy followed up with letters to S&P and to Morgan Stanley. Bob Anker, Dave Hartman, and I had a productive face-to-face visit at S&P that led to both a better understanding by S&P of the casualty actuary's role and some pointed feedback to us on how dependent S&P and the other rating agencies really are on our analyses.
The Academy was able to release its issue brief, Actuarial Opinions in Property-Casualty Insurance, at the NAIC winter meeting during the second week in December. The article discussing the role of the actuary in developing loss reserves, developed by the CAS Committee on Reserves, will be published over Gail Ross's and my names in the near future.
So, we have responded to the media quickly and effectively. But how well have we addressed the underlying issues that brought the attention in the first place? The CAS and the Academy have not been asleep at the switch. In addition to the issue brief mentioned above, the Casualty Practice Council of the Academy has formed a task force to address Financial Soundness and Risk Management. Within the CAS, the Committee on Reserves has formed a subcommittee specifically to address the link between under-reserving and insolvency. A working party of more than 40 members is currently compiling the existing literature on reserve ranges, with the intention of aiding practicing actuaries looking for the most up-to-date methods. The NAIC's new model law calls for disclosure of the relationship between the carried reserve and the actuary's estimate or range.
All of these efforts should improve our work. But I see two fundamental questions remaining for us to address as a profession in our research and practice, questions that will be critical to our credibility in the next century.
(1) Leaving aside questions on asbestos, other mass torts, and unpredictable judicial decisions, the Fitch report, I think rightly, complains that actuarial techniques, dependent principally on historical data from within the insurance industry, are least accurate when external conditions such as the overall economic climate change. Bob Anker has characterized insurance companies' data as miniature barometers of the economy. Admittedly, economists are also not the greatest predictors of the very changes that we actuaries tend to reflect only in hindsight. Where is our research on how to anticipate and reflect changing economic conditions in our pricing and reserving? What are we doing as a profession to improve the accuracy of our calculations for standard lines of insurance?
(2) Actuaries opine in the United States that reserves are reasonable. That is, they fall within a range of estimates calculated using reasonable assumptions. When results deteriorate, we are more often called upon to opine on reserves that fall well within our range of reasonable estimates but nevertheless somewhat short of our best estimate. We end up with a collection of reasonable estimates, the sum of which is not a reasonable estimate of the whole. Even when every one of its claim reserves has been set at a reasonable amount, a single insurer needs to reserve for IBNR that is not assignable to individual claims. Similarly, the insurance industry as a whole has IBNR that may not be assignable to individual insurers. How do we communicate this concept to our critics—regulators and rating agencies in particular—and how do we distinguish between unreasonable company estimates (parallel lousy case reserving) and truly unassignable IBNR?
I challenge all of us to respond to these questions.
For pricing actuaries—how are you changing your ratemaking calculations to be more responsive? How are you improving your ability to predict the loss ratio? Is that even part of your job? Should it be?
For reserving actuaries—how do you take economic conditions into account? How reasonable are your assumptions? How are you reacting to what the underwriters are doing and what the pricing actuaries are telling you?
For all of us—are you a part of the solution?