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Reserving Standards

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Be deliberately over-optimistic in setting reserves or over-conservative. ... Anything that cannot be described as unduly cautious or over-optimistic. ... – PowerPoint PPT presentation

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Title: 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
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