Reserving Standards

1
Reserving Standards

• Professional Issues

2
Overview

• Professional Issues affecting
• Advice to a UK general insurance company on its
  reserves for financial reporting
• Professional Guidance
• Summary

3
Company Reserves

• Issues to be covered
• Who is responsible for setting reserves?
• What is the role of the actuary in this context?
• What is an acceptable range of reserves?
• What actions can an actuary take when their
  opinion is that the solvency of the company is
  imperilled?

4
Overall Framework

• Directors are responsible for setting reserves.
• Auditors provide independent verification and
  sign off of published financial statements.
• Company Actuary is an officer acting as an
  adviser.
• In the Lloyds Market, the actuary signs off the
  held reserves if they exceed his best estimate.
• Regulator wants to ensure that policyholders
  interests are not jeopardised.
• Other interested parties include Market analysts
  and rating agencies.

5
Directors

• Directors are expected to set reasonable
  reserves.
• Process of setting the reserves has to be
  rigorous and documented.
• Directors may use a professional to assist in the
  process of setting reserves.
• Directors view will be formally audited by
  accountants.

6
Directors Duties

• Case law lays down the following general
  obligations
• to comply with the constitution and use their
  powers under it for proper purposes
• to run the undertaking for the benefit of the
  company (ie, generally speaking for the benefit
  of its members as a whole) and not for any other
  purpose
• to maintain their independence of judgement
• to avoid profiting personally from their position
  and to avoid conflicts of interest without the
  consent of the members or the authority of the
  constitution
• to act fairly between the members and
• to apply reasonable care and skill in exercising
  all their functions.

7
Draft Statutory Statement of Directors Duties

• Summary of responsibilities
• Compliance and Loyalty.
• Independence of Judgement.
• Conflict of Interest.
• Fairness.
• Care, Skill and Diligence.
• Source Modern Company Law for a Competitive
  Economy - Developing the Framework A
  Consultation Document form the Company Law
  Review Steering Group (March 2000).

8
Draft Statutory Statement of Directors Duties

• Care, Skill and Diligence
• A director must exercise the care, skill and
  diligence which would be exercised by a
  reasonably diligent person with both the
  knowledge, skill and experience which may
  reasonably be expected of a director in his
  position and any additional knowledge skill and
  experience which he has.
• Case law in older cases the standard was an
  ordinary prudent person.
• Section 214 of the Insolvency Act - now based on
  the reasonable skill and care of a reasonable
  person with the skill and knowledge of the
  director.

9
Draft Statutory Statement of Directors Duties

• Business Judgement
• Accepted that Directors are expected to take
  risks, often without the ability to fully examine
  the relevant factors.
• Accepted that the companys success or failure
  depends on the directors not being unduly
  cautious as well as avoiding fool-hardiness.
• Appropriateness of risk depends on the ethos of
  the company and the character of its business and
  markets.

10
Draft Statutory Statement of Directors Duties

• Delegation and Reliance
• No express provision requiring directors to
  acquire and accept proper professional advice in
  areas where they lack competence.
• It is felt by the Steering Group that this is
  covered by the proper selection of advisers and
  subordinates and the scrutiny of their advice in
  accordance with the standard as it applies to
  each director.

11
Summary of Directors Obligations

• In setting the reserves the Directors are obliged
  not to
• Deliberately under-reserve.
• Be deliberately over-optimistic in setting
  reserves or over-conservative.
• Knowingly conceal information that will have a
  material effect on the conclusions of a reserve
  review.
• But they are allowed to
• Exercise business judgement and take risks taking
  account of the ethos of the company and the
  character of its business and markets.

12
Auditors

• Audit the process of setting the reserve.
• Since the 1995 year end they sign off accounts as
  true and fair.
• Are not allowed to recommend a specific reserve
  figure but can advise the directors on the range
  of reserves that they regard as reasonable.
• Will not sign off the reserves and accounts
  unless they feel that the reserves fall within a
  reasonable range.
• Ultimately the auditors opinion on the
  reasonableness of the reserves will determine
  whether or not the reserves are adequate for
  financial reporting.

13
Auditors

• What is reasonable in this context?
• Anything that cannot be described as unduly
  cautious or over-optimistic.
• Consider the ethos of the company.
• Consider general market practice.
• Consider prudence, consistency and materiality.

14
Role of Company Actuary

• To provide supporting evidence for the directors
  reserves usually in the form of a report.
• To assist the auditor in understanding the
  factors affecting the business and the basis
  underlying the reserves set by the Directors.
• Actuary is principally in role of providing
  advice to the directors in setting the reserves
  and communicating the basis of those reserves to
  the auditor.

15
Role of Company Actuary

• How to manage differences of opinion?
• Reconsider factors likely to have affected the
  data with relevant staff from claims,
  underwriting, IT and customer service.
• Consider alternative methods.
• Identify your opinion of the best estimate and
  the range of results that you regard as
  reasonable.
• Identify the range of assumptions that you regard
  as reasonable.
• Carry out sufficient investigations to support
  your conclusions and key assumptions.
• If necessary identify further changes to produce
  an illustrative range which includes the
  proposed reserves.

16
Role of Company Actuary

• How to manage differences of opinion?
• If the report includes illustrations that the
  actuary does not believe are appropriate, this
  should be clearly stated in the report.
• Produce report showing position of the proposed
  reserves highlighting key assumptions.
• Comment on any particular areas of uncertainty.
• Consider the results in the context of market
  practice.
• Consider the materiality of the issue in the
  context of the audit and solvency.
• Note that the actuary may not be reviewing the
  totality of the business.

17
Role of Company Actuary

• Actuarial Report
• State the purpose and scope of the report clearly
  - state restrictions on use, specific limitations
  and unsuitability for outside parties as
  appropriate.
• It is essential to distinguish between your
  comfort zone for the reserves and the range of
  outcomes that may be considered reasonable.
• Objective is to provide a basis to enable the
  directors to understand the context of their
  reserving policy and enable the auditor to form
  an independent judgement about the reasonableness
  of the proposed reserves.
• Full documentation of the conclusions and the
  supporting analysis should be produced and filed.

18
Role of Company Actuary

• GN12
• The report should outline and discuss the key
  assumptions made including those as to the legal
  and claims environment.
• If the report includes illustrations based on
  assumptions that the actuary does not regard as
  appropriate, this should be made clear in the
  report.

19
Role of Company Actuary

• How to Manage Solvency Concerns?
• Project Companys 3 year Trading performance and
  cash flows on a number of scenarios having regard
  to the business plan.
• Update the projections regularly for emerging
  experience.
• Communicate the results to senior management and
  discuss solutions to identified issues.
• Establish systems to identify the quality of new
  business and compare the results to market
  benchmarks.
• Monitor claim development to test the assumptions
  underlying the reserving basis.
• Recommend independent advice as appropriate.

20
Role of Company Actuary

• Points to bear in mind
• The actuary is not a director in this situation,
  but an adviser.
• Distinguish between the financial management of
  the business and the companys financial
  reporting philosophy.
• Advise management to commission an independent
  review if there is an irreconcilable difference
  or if you feel that solvency is threatened.
• Duty of client confidentiality.

21
Role of Company Actuary

• Client confidentiality
• PCS
• 4.1 An actuary has a duty to the profession and
  responsibility to any client must be consistent
  with that duty. An actuarys responsibilities
  are personal and, in advising or otherwise acting
  for each client, the actuary must have proper
  regard to the trust and confidence which that
  implies. In particular, unless disclosure is
  required under statutory or judicial authority or
  Guidance Notes, the actuary must make no
  disclosure of the clients affairs unless
  authorised by the client.

22
Role of Actuary

• Criticism of another actuarys work
• Be clear in distinguishing differences of
  opinion.
• Acknowledge that others may quite properly hold
  different professional opinions.
• Acceptable if it is reasoned and felt to be
  justified.
• Identify structural differences in methodology if
  appropriate.
• High level explanation of difference in
  conclusions.

23
Role of Company Actuary

• Professional Conduct Standards, PCS
• The actuarial profession has an obligation to
  serve the public interest. Individually
  members must maintain and observe the highest
  standards of conduct.
• An actuary who has any doubt as to the attitude
  which should be adopted or the action which
  should be taken in a particular circumstance must
  seek guidance from the professional body. An
  actuary should normally seek guidance from a
  senior actuary.

24
Regulator

• May request discussion with the Company Actuary
  or presence may be required at Regulators
  meetings.
• Client confidentiality principle still applies
  but should discuss matters as authorised by your
  employer.
• If in doubt, you can ask for the points to raised
  to be sent in writing by the Regulator for a
  formal response.

25
FSA Code of Practice

• Principle 1
• Individuals must act with integrity in carrying
  out their controlled function.
• Principle 2
• Individuals must act with due skill, care and
  diligence in carrying out their controlled
  function.
• Principle 3
• Individuals must observe proper standards of
  market conduct.
• Principle 4
• Individuals must deal with the FSA and with other
  relevant regulators in an open and co-operative
  way.

26
FSA Code of Practice

• Principle 5
• Senior managers must take reasonable steps to
  ensure that the regulated business of their firm
  for which they are responsible is organized so
  that it can be controlled effectively.
• Principle 6
• Senior managers must exercise due skill, care and
  diligence in managing the regulated business of
  their firm for which they are responsible.
• Principle 7
• Senior managers must take reasonable steps to
  ensure that the regulated business of their firm
  for which they are responsible complies with the
  regulatory requirements imposed on that business.

27
Summary

• Overall comments on operating environment
• Designed to give directors freedom to act subject
  to constraints of regulation and Company Law.
• Fit and proper person supervision for insurers.
• Regulator has authority to request additional
  information.
• Actuarys role in this context is as an adviser.

28
Relationship diagram
Company Law
Accounting Standards
Company
Directors
Company Officers including
Institute of Actuaries
Auditors
Actuary
Regulator
Shareholders
Policyholders
29
Relevant Professional Guidance

• Professional Conduct Standards
• GN12 General Insurance - Actuarial Reports
• GN18 Actuarial Reporting for UK General Insurance
  Companies writing US Regulated Business
• GN20 Actuaries Reporting Under the Lloyds
  Valuation of Liabilities Rules
• GN32 Actuaries and Friendly Societies General
  Insurance Business
• GN33 Actuarial Reporting for Lloyds Syndicate
  writing US Business

30
Causes of Reserving Uncertainty
Statistical Variation
Management and operating Changes
Data Quality
External Changes
Reserving Uncertainty
Underwriting
Claim Management
Processing Backlogs
31
Summary of Reserving Indications
Actuarys best estimate
Company Market, GN18
GN20, GN33
Range of reasonable results
Illustrative Range
Notes1. Opinion as to where the points lie will
vary 2. Lloyds requirements are more strict than
Company Market