November 2000 Actuarial Review - Should Reserves Reflect Anticipated Savings?

Ethical Issues Forum
Should Reserves Reflect Anticipated Savings?
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.
Jane Smith, FCAS, MAAA is a consulting actuary. Jane has been asked to complete an actuarial analysis of Widget Incorporated's (Widget) self-insured workers compensation program. Widget has been self-insured for workers compensation for the past 20 years but has never staffed a risk management or safety department. As might be expected, Widget's self-insured losses are approximately 50 percent higher than losses that would be expected based on industry rates and Widget's level of payroll by job class. Claim frequency is approximately 20 percent higher than the expected level.
Jane has just completed her loss reserve analysis, projecting a required retained loss reserve of $50 million for past accidents and $10 million for the prospective accident period.
Widget has just hired Betty McCormick to fill the newly created position of Risk and Safety Manager. Betty joins Widget from Trinkets, Incorporated (Trinkets), Widget's main competitor. During Betty's tenure at Trinkets, workers compensation costs and claim frequencies were reduced by 75 percent and 50 percent, respectively. Jane provided actuarial consulting services to Trinkets and was able to see firsthand the reduction in losses and claim frequency achieved during Betty's tenure.
Betty has briefly studied the situation at Widget and believes that the programs implemented at Trinkets can also be effective at Widget. She is beginning to implement at Widget the programs that were so successful at Trinkets and feels very strongly that it is appropriate for Jane to reduce her loss reserve and prospective period estimates to incorporate the likely impact of these programs. Betty thinks that it is reasonable to expect a 33 percent drop in the cost associated with historical accidents and a 50 percent reduction in the prospective period. Betty's compensation is partially tied to the reduction in losses that she can achieve.
In addition to the company financial statement accrual, Jane is also required to issue a statement of opinion regarding Widget's loss reserves to the self-insurance regulators.
Can Jane produce a report and corresponding actuarial opinion that incorporates Betty's estimates of the likely impact of these new programs?
Yes

It is appropriate for actuaries to consider operational changes in the loss projection process. At least two specific professional statements/standards give us guidance in this area.

The Considerations section of the Statement of Principles Regarding Property and Casualty Loss and Loss Adjustment Expense Reserves, the Operational Changes paragraph states: "The computation of the reserves should reflect the impact of such (operational) changes."
Paragraph 3.5.2 of Actuarial Standard of Practice No. 36 Statement of Actuarial Opinion Regarding Property/Casualty Loss and Loss Adjustment Expense Reserves states: "The actuary should consider whether there have been significant changes in conditions particularly with regard to claims, losses, or exposures that are new or unusual and that are likely to be insufficiently reflected in the experience data or in the assumptions used to estimate loss and loss adjustment expense reserves." However, Jane should remember to disclose this change as required by paragraph 4.5 in the same Standard.

No

It would be inappropriate for Jane to reduce her figures without any hard evidence of the impact of these new programs. This is particularly true since Betty's compensation is tied to loss experience. It is very common for new risk managers to feel that the changes that they implement will produce significant savings. While incorporating operational changes is appropriate, the statement of principles and the standard of practice do not require the actuary to use an unsubstantiated figure.