UK: Future Role Of Actuaries In The Corporate Governance Of Life Insurers

Last Updated: 11 October 2002

Alongside its feedback statement on 28 May 2002 on the With-Profits Review the FSA also issued a feedback statement on the future role of actuaries in the governance of life companies. This statement was issued separately because, although it takes account of conclusions arising from the With-Profits Review, it is relevant to all life firms and not just those conducting with-profits business. The FSA intends to set out detailed proposals by the end of 2002 with changes to the appointed actuary regime coming into effect during 2003.

FSA motivation

The FSA is concerned that the appointed actuary regime has resulted in over-reliance on appointed actuaries by boards. It also considers that the regime is potentially inconsistent with the principle of directorial responsibility. The FSA’s position is that the appointed actuary’s function should be advisory rather than executive and that the ultimate responsibility of directors for all matters actuarial should be underlined. The FSA also has concerns regarding conflicts of interest affecting actuaries, the extent to which their work should be externally scrutinised and the efficacy of their existing financial condition reporting obligations. The feedback statement addresses all these issues.

Role of actuaries in with-profit and non-profit life business

The FSA proposes that in specified areas (those where discretion is applied in with-profits business) boards will be required to take advice from an appointed actuary. As regards non-profit business, existing responsibilities imposed on appointed actuaries will be removed.

Accordingly, as regards with-profits business, the responsibilities of the appointed actuary (as set out in Chapter 4 of the Supervision Manual (SUP4)) will be narrowed to focus on advising on matters impacting on the level of policyholder benefits.

In relation to other areas of with-profits life business, and in relation to non-profit life business, there will be created, as a required function, an "actuarial function" responsible for providing advice (presumably as and when a board wants it). In particular, the FSA envisages that this function would be responsible for giving advice on the calculation of policy liabilities.

The result is that the appointed actuary will remain in place as regards with-profits life business but will also carry out the actuarial function or will work alongside an actuary carrying out the actuarial function. For nonprofit life business appointed actuaries will no longer be required and may be replaced by an actuary carrying out the actuarial function or themselves be assigned to that function.

The FSA considers that the regime outlined above will fundamentally change the way in which decision-making based on actuarial advice is approached in many life firms and will help to bring about a strengthened system of governance for life insurers. It is difficult not to be sceptical. Certainly, it will be underlined that the buck stops with boards but directors are still likely to rely on the appointed actuary and/or actuaries carrying out the actuarial function. Further, as regards those areas of with-profits life business where advice from an appointed actuary is not to be prescribed, and as regards non-profit business (where there will no longer be an appointed actuary) the board will have to decide what actuarial advice it considers necessary.

Conflicts of interest

There are currently no specific regulatory constraints on an appointed actuary having other board or senior management responsibilities (this being essentially a matter covered by professional guidance). The FSA considers that there are potentially serious conflicts of interest, which cannot be dealt with by self-regulation, between the proposed new responsibilities of an appointed actuary, or the person who exercises the actuarial function, and the roles of chairman or chief executive. There is also, in the FSA’s view, potential for conflicts of interest with the roles of marketing and sales director and, in a proprietary firm writing with-profits business, finance director. Accordingly, the FSA proposes to consult on rules/guidance under which the appointed actuary, or the holder of the actuarial function, could not also be chairman or chief executive and could not hold other posts which could give rise to significant conflicts of interests (e.g. finance director in a proprietary company with a with-profits fund). However, appointed actuaries and holders of the actuarial function will not be required to be external to the firm and the FSA does not propose to prohibit profit-related pay for appointed actuaries or those carrying out the actuarial function.

Financial condition reporting

The actuarial profession’s guidance note GN1 currently includes a requirement for the appointed actuary to produce an annual financial condition report for the board (as set out in GN2). Alternatively, the appointed actuary has to take other steps to ensure that the board is sufficiently well informed of the foreseeable risks that could jeopardise the firm’s financial position. Because of the nature of the risks in long-term insurance business, the FSA proposes, as an "early warning" measure and an attempt to prevent problems being stored up, to require firms to produce a financial condition report, which would address all the risks to which the firm is exposed, and make it available to the FSA. In the light of commercial sensitivities, firms will not have to make such reports publicly available.

Independent review of actuarial work

The work of the appointed actuary has not, to date, been routinely and independently reviewed or certified. The FSA proposes, so as to give the "benefits of a second pair of eyes looking at key aspects affecting policyholder benefits", that the scope of the audit review should be widened to cover those matters that are currently the responsibility of the appointed actuary. The scope of this independent actuarial review may extend to some or all of valuation, regulatory returns, adequacy of premium rates and solvency, strategy, financial condition reporting and policyholder projections. However, its format and frequency are expressed by the FSA to be matters for further consultation.

Conclusions

The proposals in relation to independent review of actuarial work and risk reporting to the FSA seem sensible precautionary and prudential regulatory responses in the context of a risk-based regime. Advantages are likely to include potential problems being less likely to be obscured, although concerns are likely to be raised in relation to costs.

Likewise, the removal of the responsibilities of appointed actuaries as regards non-profit life business seems sensible given the limited role of discretion in that kind of business.

The FSA’s position in relation to conflicts of interest seems sensibly to focus on the ripest areas for conflict. The FSA does recognise, though, that an appointed actuary or actuary carrying out the actuarial function may have more influence with his firm’s board if he is also a director or if he has other senior management responsibilities and that, if actuaries are to be excluded from other senior executive responsibilities, it might become more difficult to attract actuaries of the right calibre.

However, the creation of a two-tier actuarial advisory system (appointed actuaries on the one hand and those occupying the actuarial function on the other) seems to be a potentially cumbersome structure. Boards are in practice likely to be no less reliant on actuarial advisers than currently. Indeed, the existing system runs the risk of being re-invented, but in a more piecemeal and confused way.

© Herbert Smith 2002

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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