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In My Opinion

Actuarial Credibility

by Walter C. Wright

Enron, Global Crossing, WorldCom, and on and on. It seems as though the first years of the 21st century may be remembered more for financial fraud than for the war on terrorism. Actuaries should give serious thought to these financial fiascoes, and ask themselves what they can do to avoid getting caught up in similar situations.

About 30 years ago the major scandals, as I recall, were Equity Funding and Watergate. The Equity Funding scandal was memorialized by the movie Billion Dollar Bubble, starring James Woods in the role of the actuary. The CAS shows this movie as part of the Professionalism Course, so many of our members are probably familiar with the case. For those who are not familiar with it, suffice it to say that Equity Funding was an egregious attempt to pump up earnings reports by recording fictitious life insurance policies. It began with the recording of a small amount of life insurance premiums that had not actually been written, and snowballed so that in each successive quarter more and more fake policies were added to the reported financial results. A special team of employees would even meet to create hard copies of underwriting files whenever the auditors requested policies that did not actually exist. When the bubble burst about 64,000 policies, roughly half of the company's business, were found to be fake.

For the young actuary in the early 1970's, the lessons of Equity Funding were fairly simple: Don't falsify records. Don't yield to peer pressure to become part of a conspiracy. But the world has become more complicated, and one wonders how much protection these lessons offer to the actuary of the 21st century.

Consider the column "Ethical Issues Forum" in this issue of The Actuarial Review (see article). The dilemma posed to readers is straightforward, and undoubtedly a common one. An actuary is instructed by his or her boss, who is also an actuary, to prepare a rate filing using assumptions with which he or she disagrees. Should the subordinate refuse to do so, even though the filing will go out with the boss's signature?

My immediate response was "the subordinate should do what the boss requests." I think that was definitely the right response in the world of the 1970's and I think it is still right in 2002, but I am no longer quite so sure. What about the company accountants at WorldCom who accepted their boss's judgment that certain line expenses should be considered as capital investments? Should they have blown the whistle? Were there any lower-level employees at Arthur Andersen's Houston office who should have balked at the audit partner's instruction to shred Enron documents?

Or consider the fact that Arthur Andersen was found guilty because one of the firm's lawyers recommended deleting a remark that was critical of Enron's accounting practices. The public may easily accept the conclusion that this is evidence of collusion. But how many consulting actuaries have revised actuarial reports so as not to offend a client? And how many company actuaries have revised an internal report so as not to upset the CFO or CEO? I bet an honest show of hands would indicate that virtually all of us have. Will this change in the current environment? Should it change?

One lesson of Watergate was: If you are the president and get caught at something, don't lie about it to the public. A politician as shrewd as Nixon failed to realize this, and about 25 years later Clinton repeated this mistake. Political scandals do not appear to have changed much over time. By contrast, some would argue, financial scandals have become more complicated and more difficult for today's actuaries to avoid.

Adherence to actuarial best practices and statements of principles will go a long way in keeping us out of trouble. But the best advice, as always, is simply to "do the right thing, not the easy thing." This is what Dennis Kozlowski, the former CEO of Tyco, told recent college graduates shortly before he was indicted on charges of tax evasion. Recognizing the right thing is easy; doing the right thing is the challenge.

We should take pride in the fact that the actuarial profession is guided by broad principles rather than by numerous rules. This forces us to rely more on asking, "What is right?" than "What will the rules allow, and how much can we stretch them?" This gives us all an obligation, to our profession no less than to ourselves and our clients, to do the right thing.