The Current Role of the Appointed Actuary Function in Life Offices A paper prepared by the Actuarial Governance Working Party of the Life Board The table on the following pages sets out 11 key aspects of the current appointed actuary role in life offices, indicating the primary purpose of the work involved and how it might fit in the framework outlined in the FSA s With-Profits Review May 2002 Feedback Paper Future Role of Actuaries in the Governance of Life Insurers. Further detail of the work involved is included in section 2 of the Actuarial Governance Working Party s report Actuarial Governance - A Discussion Paper of February 2002. In some cases, it is only professional guidance that gives the current appointed actuary responsibility in the area described. However, unless otherwise stated, it is assumed below that the responsibility will be retained by either the new Appointed Actuary or Actuarial Function under the FSA s proposed new framework (either through FSA rules or professional guidance). The following categories of actuarial work, while often performed under the direction of the individual who is the appointed actuary, are not part of the function of the appointed actuary and are not discussed in detail: Profit reporting and accounting support (potentially including Modified Statutory, Achieved Profits, Embedded Value, US GAAP, Fair-value accounting of shareholder profits) Realistic assessment of product / channel profitability Advice to shareholders on restructuring, capital raising and M&A transactions Services to other customers not related to the financial management of the life office. Page 1 24/10/02
1 Statutory Valuation Customer Protection. The statutory valuation acts as the primary control to ensure adequacy of funds to meet obligations to customers. This valuation determines whether the firm can transfer money out of its Long Term Fund; it is questionable whether the Board of Directors should have primary control over this gateway because of the direct conflict of interest between shareholder and policyholders. The valuation could develop into an assessment of risk-based capital. The actuarial function will need to allow for the exercise of discretion that can affect the valuation result. If the policy adopted by the Board (following advice from the Appointed Actuary) is not sufficiently clear, the appointed actuary may need to be 2 Solvency Projections and Solvency Management and Customer Protection. Ideally an integrated part of business planning. The outcome will typically include: constraints on new business and investment strategy capital needs going forwards actions that can be taken in a range of circumstances This activity would largely become an integrated part of (1) above with a move to risk-based capital assessment. In financial models requiring investment and bonus algorithms or assumptions, there will need to be to be consultation with the person responsible for advising the firm on the exercise of discretion. consulted. However performing this function requires assumptions as to how the firm will exercise discretion in the operation of with-profits business. Interaction with the appointed actuary would probably be required. Further, the Appointed Actuary would need to understand future solvency implications to identify constraints on discretion. This area, therefore, will require very close liaison between the Appointed Actuary and Actuarial Function. Page 2 24/10/02
3 Premium Rates certify adequacy taking into account other resources and Customer Protection Certification of adequacy as required by current FSA rules is retrospective. This could be better-tackled by a requirement for appropriate internal governance around the premium-rating process. Implications of the level of premium rates should be apparent from (2) above. A process is required to trigger a change in product terms when necessary because of changing financial conditions. The Appointed Actuary would need to monitor the position to understand (a) any issues of equity between generations, and (b) the effects of new business on the limits of future discretion. 4 Manage Insurance This would include reinsurance management, alignment of Actuarial Function Risk 5 Preparation and/or monitoring of material including illustrations and literature that will influence customer expectations 6 Advise on Bonus Policy for With-Profits Business Fairness to Customers premium rates and underwriting standards (as well as 3 above) This material will influence customer expectations and as such would have to be reviewed by the actuary responsible for advising the Board on the exercise of discretion. This would include presale disclosure of the effect of expenses (as opposed to commission-equivalent disclosure which does not usefully inform expectations - and appears to add little value). Professional guidance is provided to the current Appointed Actuary on the appropriateness and consistency of the expense assumptions to be used for this purpose. As well as affordability of bonus policy (impact on solvency and investment constraints), this will include advising the Board on what customers might reasonably expect taking into account statements previously made and, in the light of this, fairness both between different policyholders and between policyholders and shareholders. This will include advice to the Board on creating statements of Principles and Practices of Financial Management of with-profits business. (Subsequently reviewed by the Appointed Actuary when advising on the exercise of discretion the firm would probably wish to receive advice from the Appointed Actuary pre-issue.) Appointed Actuary Page 3 24/10/02
7 Advise on Encashment Terms Fairness to Customers This is necessary for all policy types for which the company has discretion over benefit payments, including the setting of Market Value Reductions on unitised with-profits policies and surrender value scales for conventional with-profits and some nonparticipating policies. Appointed Actuary (with-profits) Actuarial Function (other) 8 Preparation or review of material reviewing the operation of with-profits business. 9 Investment policy and Asset / Liability Matching Openness to Customers (and therefore customer protection) Customer Protection Typically surrender bases are maintained with the objective of providing payments that are fair both relative to underlying asset values and other policy classes. This would include the preparation of the proposed new realistic balance sheet for with-profits business and the statement of compliance with principles of financial management. Taking the FSA model at face value, the actuarial function would be responsible for advising on investment policy for non-profit business and for the with-profits business from an overall solvency standpoint, whereas the appointed actuary would advise on investment mix for the with-profits fund from a customer expectations standpoint. Different constraints may apply for one part of the business depending on the decisions made for another (e.g. the constraints on the investment of shareholder-owned assets within the long-term fund can depend on the investment policy in the with-profits fund). The advice clearly needs to be coordinated. The practical way forward may be for the advice to be formulated by the actuarial function in consultation with the discretionary function actuary. (However the Appointed Actuary would have responsibility for advising the Board on interpretation of the Principles and Practice of Financial Management.) Appointed Actuary (with-profits customer expectations) Actuarial Function (other) Page 4 24/10/02
10 Advise on Fairness to Examples include: interpretation of what Customers equity in unit-linked unit pricing (where the Appointed Actuary customers might reasonably expect and the corresponding operation of business (other than with-profits business) is currently responsible for some of the function performed by the Trustees for unit trusts). There is much discretion in unit pricing (e.g. determining allowances for tax charges and whether the unit price should be based on the buying or selling prices of the underlying assets according to whether the fund is growing or contracting,) FSA indicated in its May 2002 feedback statement that it would make proposals to address references to the Appointed Actuary in policy conditions. Legal advice may nevertheless be required given section 340 of the Financial Services and Markets Act 2000. 11 Responsibilities Arising from Corporate restructuring Customer Protection determination of discretionary charges on policies (e.g. increasing management charges in line with inflation, resetting mortality and morbidity charges in line with emerging experience) It is reasonably common for policy conditions to require the appointed actuary to determine various amounts. Responsibilities have specifically been given to the Appointed Actuary under many Schemes of Transfer (on demutualisation or other transfers of business). These can be very substantial, and represent the primary source of protection for transferred policyholders. The FSA normally require the appointed actuary to report on proposed transfers under Part VII of the Financial Services and Markets Act 2000 (as well as an Independent Expert report). In insurance company start-ups the Appointed Actuary is typically required as a minimum to certify business plan and financial projections assessing capital requirements and adequacy. (Alternatively the role of the actuary appointed to advise on the exercise of discretion - and potentially the scope of the statement of Principles and Practice of Financial Management - could extend beyond with-profits business) Assumed to be Appointed Actuary (particularly in the case of with-profits business). May be covered by FSA proposals for references to the Appointed Actuary in policy conditions. Legal advice may be required as to who has responsibilities given to an appointed actuary under a court-approved Scheme if both the Actuarial Function and the Appointed Actuary are actuaries appointed under section 340 of the Financial Services and Markets Act 2000. October 2002 Page 5 24/10/02