The Top Ten Casualty Actuarial Stories of 2008
By Christina Gwilliam and Michael Christian
Our CAS thought leaders were surveyed to identify the top ten stories affecting casualty actuaries in 2008. Three major themes came from the survey:
The financial crisis has led and will continue to lead to a very challenging environment for actuaries.
As surplus has shrunk and capital has been squeezed, focus on underwriting profit through actuarial pricing and the allocation of capital through modeling will be crucial to the survival of a company.
The contraction of the economy and its impact on claim frequencies and severities must be monitored closely.
Economic recession will lead to fewer employment prospects, possibly affecting the actuarial profession.
Regulatory processes and agencies have failed to maintain the stability of the financial markets.
The collapse of Bear Stearns and Lehman Brothers and the growing outrage over the $50 billion investment fraud by Bernie Madoff will lead to many changes in the regulatory environment, both at the state and federal levels. This could include either more regulation of insurance holding companies or federal regulation of insurers, or both. Actuaries should be able to expand their area of influence into new directions. For example, if credit default swaps are considered insurance products in the future, actuaries will certainly be asked for their opinion on the value of such instruments.
Catastrophe and financial models failed because of over-reliance on them, inclusion of unrealistic assumptions, or a combination of the two.
Actuaries must continue to take leadership positions in enterprise risk management (ERM) so that this field can continue to develop.
How the Stories Ranked and Why
The collapse of American International Group (AIG) was identified as the top news story for 2008 affecting casualty actuaries, with about half of the respondents naming this as their number one story. Respondents noted the far-reaching effects of AIG’s fall: the need for risk modeling of extreme events, turmoil in the industry from a market price standpoint, turmoil in the industry concerning market share, possible sell off of AIG businesses, and job security.
The economic downturn accounted for the second- and fourth-ranked news stories. The fact that the Dow lost 35% of its value during 2008 was our second-ranked story. A related story, the shrinkage in property/casualty (P/C) insurer surplus due to investments and catastrophe losses, was ranked fourth based on a survey question noting the decrease in half of the year. Through nine months of 2008, P/C insurer surplus declined $39 billion, or 7.6%.
The sentencing of Ron Ferguson to two years in prison was news story number three based on our weighting system. Ron Ferguson, a name known by virtually every actuary as the co-creator of the widely used Bornheutter-Ferguson loss reserving technique, and Christopher Garand, another CAS member, were found guilty of conspiracy, fraud, and mail fraud as well as making false statements to the Securities and Exchange Commission (SEC) related to an arrangement between General Re and AIG. In remarks about this story, respondents expressed the continued need for professional standards and commented that the actions of a few can have a lasting effect on the whole. As actuaries move into management roles, they may be presented with ethical dilemmas not envisioned in typical actuarial roles.
The failure of regulation to prevent the current financial crisis was story number five. Respondents cited the lack of regulation of credit default swaps that led to AIG’s solvency crunch and the SEC’s apparent lax regulation of Bernie Madoff’s funds as prime examples of the regulatory system’s failure.
Speculation on whether better models could have averted the financial crisis was the sixth-ranked story. As mentioned above, actuaries have the opportunity to influence what should be considered in the models, e.g., the correlation of risks that were considered to have little or no correlation and extreme event scenarios. Additionally, all modelers need to ensure that assumptions based on historical data sets have predictive value.
Coming in at number seven again this year is the topic of accounting. Last fall, the U.S. Financial Accounting Standards Board (FASB) announced it was joining the International Accounting Standards Board (IASB)’s Insurance Project. If the project comes to fruition, the treatment of insurance contracts will be largely, if not totally, identical in U.S. GAAP accounting (promulgated by FASB) and International Financial Reporting Standards (IFRS, promulgated by the IASB). The specifics are still being determined, though the IASB has determined that some form of discounted value with risk margins is the preferred loss reserve treatment. Actuaries in the U.S. need to stay abreast of the accounting rule changes.
President Barack Obama’s reform of the regulatory process and the economic stimulus package was story number eight. Mr. Obama has been quoted as saying, “We have been asleep at the switch. Not just some of the regulatory agencies, but some of the congressional committees.…” He also said he might try to consolidate some regulatory agencies. With the expected growth in regulations, standards, and disclosures, actuarial involvement should increase. There will be a need for more or different insurance products if the stimulus package is approved.
The ninth-ranked story is the failure of the catastrophe models to accurately predict losses from Hurricane Ike.
After making landfall in the Galveston Bay of Texas as a Category 2 storm, Ike continued to move north and caused significant wind and rain damage in ten Midwestern states. ISO’s Property Claim Service estimates the insured losses over $10 billion, making it one of the costliest storms in history. The destruction caused by this wide storm with low wind speed and high storm surge is forcing modelers to revisit their model assumptions and insurers/reinsurers to revisit their catastrophe risk management plans.
The continued softening of the P/C market, our number two story from last year, ranked tenth this year.
Nearly all lines of business experienced rate declines through most of 2008. Because of the financial crisis and large catastrophe losses, however, there are some signs of rates leveling off in the casualty sector and some hardening in the property arena. Low investment returns and underwriting losses should put upward pressure on rates in the future, but this may be offset by low demand for insurance from a contracting economy. The continuing challenge for actuaries is to exert their influence in pricing discipline, balancing the need for growth with the need for profitability.
The accompanying chart summarizes the results of the survey. As in prior years, the survey was compiled by the authors and sent to members of the CAS Board of Directors and Executive Council, current CAS committee chairs and vice-chairs, Regional Affiliate presidents, and others. Participants were asked to rank the top 10 stories, writing in any stories we missed, and to explain the significance of the stories. Fifteen points are awarded to a story receiving a first place vote, down to six points awarded to a story for a tenth place vote.
Continuing this year are the prizes for the best predictors of the consensus of all participants. Mr./Ms. Anonymous came in first in this process by selecting nine of the top 10 stories as well as selecting rankings most closely aligned with the final rankings of the top 10 stories. Thomas Myers, Ted Wagner, and Clive Keatinge all selected eight out of the top 10 stories and came in second, third, and fourth places, respectively.
Thanks to all of those who participated in this year’s survey!