Taking Care of Business?

Editor’s Note: This article is part of a series written by members of the CAS Committee on Professionalism Education (COPE) and the Actuarial Board of Counseling and Discipline (ABCD). The opinions expressed by readers and authors are for discussion purposes only and should not be used to prejudge the disposition of any actual case or modify published professional standards as they may apply in real-life situations.

Freddie Flexible, FCAS, MAAA, is a consulting actuary who serves as the appointed actuary for Products Liability Insurance Company (PLIC). PLIC has been writing insurance coverage since the early 1970s and has a specific niche market and expertise in the agriculture industry. Freddie has been working with PLIC and its current CFO for the last 15 years. In addition to providing the year-end actuarial opinion and corresponding actuarial report, Freddie also completes a comprehensive loss (including loss adjustment expense) reserve analysis each quarter. PLIC relies heavily on the reserve analysis completed by Freddie as demonstrated by the fact that the company books a reserve number each quarter exactly equal to the projected reserve in the actuarial report. 

Historically the management of PLIC, particularly the CFO, has wanted to book a conservative loss reserve so that future calendar years never reflected adverse development. In fact, the company reacted quite strongly the two times in the last 15 years when the actual came in higher than Freddie’s projections. Given the company management’s strong desire to book a conservative loss reserve and the high severity nature of products liability claims, Freddie has selected assumptions and projected reserves in his reports that were at the very upper end of what in his opinion was reasonable. However, none of Freddie’s actuarial reports (or year-end opinions) have included any mention of his conservative approach. 

After completing his June 30, 2004 actuarial reserve report, but before the quarterly financial statements were finalized, the CFO informs Freddie that PLIC is up for sale. The CFO asks Freddie to complete a separate report using the same June 30, 2004 data with much more aggressive assumptions and selections so that the resulting reserve is at the low end of Freddie’s reasonable range. The CFO tells Freddie that he is anticipating a reserve number that is 25% less than the number in the original June 30 actuarial report.  The CFO would like to show as much surplus as possible in the June 30 quarterly financials because he believes that this will maximize the sale price of the company. Freddie tells the CFO that he can revise his original report to include a reasonable range of reserve estimates. The CFO tells Freddie that the range approach is not acceptable. He wants a stand-alone report that can be shared with third parties interested in acquiring the company and this report is not to include any mention of the aggressive approach utilized. The CFO tells Freddie that he understands the likely loss of future revenue to his firm if PLIC is acquired and assures Freddie that he will “be taken care of” if the company is sold.

Is Freddie in violation of any of the applicable professional standards by completing this alternative “aggressive” actuarial report? 

YES
While Freddie can serve as an advocate for PLIC, through his professional actuarial credentials he has accepted the requirement to act with integrity and in a manner to uphold the reputation of the actuarial profession as stated in Precept 1 of the Code of Professional Conduct. The dramatic change from a very conservative to a very aggressive approach undermines the public credibility of the profession and gives appearance that insurance companies can manipulate the results of the actuarial report to fit the situation at hand. This claim could certainly damage the reputation of the profession. Further, Precept 8 requires that “An Actuary who performs Actuarial Services shall take reasonable steps to ensure that such services are not used to mislead other parties.”

With respect to the documentation issue, Section 5.2 of Actuarial Standard of Practice 8 requires that the Actuary disclose any material change in assumptions from prior reports. The aggressive report represents a very material change from the prior report.

NO
The concept of companies encouraging actuaries to provide conservative or aggressive projections is quite common and is not in violation of any of our professional guidelines. As stated in the Statement of Principles Relating to Loss and Loss Adjustment Expense Reserves, “The uncertainty inherent in the estimation of required provisions for unpaid losses and loss adjustment expenses implies that a range of reserves can be actuarially sound.” This Statement also goes on to say, “The most appropriate reserve within a range of actuarially sound estimates depends on both the relative likelihood of estimates within the range and the financial reporting context in which the reserve is presented.”   

With respect to the documentation issue, the aggressive report is being completed for the first time for potential buyers (remember the conservative report is still being completed for management) so as long as prior reports are not distributed to potential buyers, there is not a prior report from which to have material assumption changes. While it may have been preferable to discuss the conservative nature of the historical reports and the aggressive nature of this report, there is no professional obligation for Freddie to make such a disclosure.