THE CFO, THE CMO THE CFO, THE CMO ANDANDANDAND

THE APPOINTED ACTUARYTHE APPOINTED ACTUARYTHE APPOINTED ACTUARYTHE APPOINTED ACTUARY

S.C. JAINS.C. JAINCHAIR PROFESSOR (LIFE INSURANCE)CHAIR PROFESSOR (LIFE INSURANCE)

NATIONAL INSURANCE ACADEMYNATIONAL INSURANCE ACADEMY

AN ODD THREESOME

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A DYNAMIC TRIO

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Goals Roles Division ofGoals, Roles, Division of Labour and Accountabilityy

Roles• While there exists a goal congruence amongst all

three, there could be overlaps, even conflicts, in role specification and role performance that could lead tospecification and role performance that could lead to situations jeopardizing the smooth functioning and long term interests of the company.g p y

• The roles of CFO and CMO are conceived by the company and properly aligned with the organizational structure, but when it comes to the appointed actuary, part of his role is determined by the

l t i ti d i li tregulatory prescriptions rendering proper alignment a difficult process.

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Contd…

• The main role of an actuary is to monitor the fi i l i bilit f lif ffi ifinancial viability of a life office on an ongoing basis.

• He is a main-stream member of the senior management team, acting as advisor and consultant on all relevant aspects of management policies and performing duties and obligations as prescribed by the regulator.

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Contd…

• He has to simultaneously don many• He has to simultaneously don many hats.

• Mere goal congruence amongst the trio• Mere goal congruence amongst the trio does not necessarily ensure that there’ll b l l fli tbe no role overlaps or conflicts.

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• Unless the CEO establishes an effective mechanism for cross-functionalmechanism for cross functional interactions based on information sharing there could be disagreementssharing, there could be disagreements among the trio about their priorities and concerns.

• The CMO is generally concerned withThe CMO is generally concerned with the top line, the CFO with the bottom line and the appointed actuary with theline and the appointed actuary with the continued financial viability.

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Potential conflict areas• Short term losses as part of long term

strategystrategy• NB Strain versus Market penetration/Market

Share• Expenses on product launch, publicity,

incentives to sales force in excess of tiassumptions

• Competitors strategy – an important factor in overall business strategy but not factored inoverall business strategy, but not factored in technical / financial calculations.

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Contd…

• Incurring immediate expenses for long term customer value creation.

• Expected sales volumes not properlyExpected sales volumes not properly factored in arriving at incremental / marginal costs because of differingmarginal costs because of differing perceptions

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Potential areas of conflict withPotential areas of conflict with CFO

• Concern for the bottom line • Difference of opinion about statutory losses solvency• Difference of opinion about statutory losses, solvency

margins• Assurances to shareholders about break-even point p

and dividend based on financial plan• Difference of opinion on market and operational risks• Market opportunities for investment based on

expertise and analysis

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Contd…

• Appointed actuary’s tendency to take purely a technical and financial view in complete disregard of factors like quality p g q yof management, organizational capabilities cost reductioncapabilities, cost reduction programmes, support provided by and brand equity of the promoter groupbrand equity of the promoter group

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• Besides, the actual position of the appointed actuary in the hierarchical order of the company, particularly if he p y, p yhappens to be at a lower rung than the CFO and the CMO can create conflictsCFO and the CMO, can create conflicts

• When the former is perceived to be exercising veto powers to stall / thwart their suggestions and disregard their gg gopinions

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Who Has Last Word onWho Has Last Word on Reserves?Reserves?

• What happens if the Chief Actuary’s estimate of reserves is different than the CFO’s view?

• Who should be accountable for the reserves recorded in a company’sreserves recorded in a company s ledger?

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Controls versus Coordination

• Is it better to have the actuarial and financial functions reporting to one senior leader (CFO or Chief Actuary) or ( y)to report separately to the CEO?

• Should the actuarial function be further• Should the actuarial function be further separated between pricing and reserving to improve independence and credibility?

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y

Beyond Reserving

• How should the finance and actuarial teams work together on planning, strategy and product design issues? gy p g

• When plans vary from actual results, who should provide the explanations?who should provide the explanations?

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Coordination and AvoidingCoordination and Avoiding Surprisesp

External Constituencies

• How do the finance and actuarial teams work together to address concerns of rating agencies, regulators and g g , gstockholders?

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Communications

• How do you make sure that actuaries and financial staff at all levels are communicatingfinancial staff at all levels are communicating and that handoffs are smooth?

• How do you coordinate such that financial• How do you coordinate such that financial and actuarial assumptions are consistent across the organization in step with rapidlyacross the organization in step with rapidly changing market conditions?

• How do you cross-train actuaries andHow do you cross train actuaries and financial staff to speak each other’s language?

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g g

Reporting Frequency

• How does the different training for actuaries and accountants influence the way they view frequency and timeliness y y q yof reporting?

• How frequently do reserves need to be• How frequently do reserves need to be reviewed?

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Trends

• Are CFO’s and Chief Actuaries working together more closely than 5 years ago?

• If so give some examplesIf so, give some examples. • If not, why not?

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Forces for Change

Current Events

• How have the recent downgrades and insolvencies in the insurance industry changed the roles of Chief Actuaries gand CFO’s?

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Corporate Governance

• In light of Sarbanes-Oxley, Enron and other corporate governance issues, how are CFO’s and Chief Actuaries communicating differently with the Board Audit Committee and CEO – andBoard, Audit Committee and CEO and each other?

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Credibility

• What are the most important skills actuaries d CFO’ t h t b f l?and CFO’s must have to be successful?

• Do credentials currently carry as much importance in job performance and credibility for the actuarial and financial functions as they did in the past?

• Is experience limited to the P&C industry p ybeneficial or a hindrance?

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The Actuarial Profession• Types of actuaries

P t / lt– Property/casualty– Life

P i– Pension• Primary functions involve the financial

i li ti f ti t timplications of contingent events– Price insurance policies (“ratemaking”)

S t (li biliti ) f th f t t– Set reserves (liabilities) for the future costs of current obligations (“loss reserving”)Determine appropriate classification– Determine appropriate classification structures for insurance policyholders

– Asset-liability management7/14/2011 26

Asset liability management– Financial analyses

Recent Developments inActuarial Practice

• Risk and return– Pricing insurance policies to formally reflect risk

• Insurance securitization– Transfer of insurance risks to the capital markets by

transforming insurance cash flows into tradable ffinancial securities

• Dynamic financial analysis– Holistic approach to modeling the interaction

between insurance and financial operations

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Duties and obligations of Appointed Actuary Includes:

R d i t i l d i t th t• Rendering actuarial advice to the management particularly in the areas of product design and pricing, insurance contract wording, investments and p g, g,reinsurance;

• Ensuring the solvency of the insurer at all times;• Complying with the provisions of the Section 64V of

the Act in regard to certification of the assets and liabilities that have been valued in the mannerliabilities that have been valued in the manner required under the said section;

• Complying with the provisions of the Section 64V of y gthe Act in regard to maintenance of required solvency margin in the manner required under the said section;

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• Drawing the attention of management of the• Drawing the attention of management of the insurer, to any matter wherein his opinion action is required to be taken by the insurer toaction is required to be taken by the insurer to avoid – Any contravention of the Act; ory– Prejudice to the interests of policyholders;

• Complying with the Authority’s directions from p y g ytime to time– To certify the actuarial report and abstract and

other returns as required under Section 13 of the Act;To comply with the provisions of Section 21 of the– To comply with the provisions of Section 21 of the Act in regard to further information required by the Authority

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• To comply with the provisions of Section 40-B of the Act in regard to the bases of premium;

• To comply with the provisions of the Section 112 of the Act in regard to recommendation of interim bonus or bonuses payable by life insurer to policyholders whose policies mature for payment by reason of death or otherwise during the inter-valuation period;

• To ensure that all the requisite records have o e su e a a e equ s e eco ds a ebeen made available to him or her for the purpose of conducting actuarial valuation of p p gliabilities and assets of the insurer;

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• To ensure that the premium rates of the insurance products are fair;T tif th t th th ti l h b• To certify that the mathematical reserves have been determined taking into account the guidance notes issued by the Actuarial Society of India and anyissued by the Actuarial Society of India and any directions given by the Authority.

• To ensure that the policyholder’s reasonableTo ensure that the policyholder s reasonable expectations have been considered in the matter of valuation of liabilities and distribution of surplus to the participating policyholders who are entitled for a share of surplus;T b it th t i l d i i th i t t f th• To submit the actuarial advice in the interests of the insurance industry and the policyholders.

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• Informing the Authority in writing of his or her• Informing the Authority in writing of his or her opinion, within a reasonable time, whether –– The insurer has contravened the Act or any otherThe insurer has contravened the Act or any other

Acts;– The contravention is of such a nature that it may

affect significantly the interests of the owners or beneficiaries of the policies issued by the insurerThe directors of the insurer have failed to take– The directors of the insurer have failed to take such action as is reasonably necessary to enable him to exercise his or her duties and obligations under this regulations; or

– An officer or employee of the insurer has engaged in conduct calculated to prevent him or herin conduct calculated to prevent him or her exercising his or her duties and obligations under this regulation.

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Financial Statements

• Financial statements analysis is an information system designed to provide data for decision makingg

• Evaluation of pastC t fi i l iti• Current financial position

• Forecasting the planning futureForecasting the planning future

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New Business Strain

• The higher the first year reserve, the hi h ill b th b i t ihigher will be the new business strain

• New business strain is funded by yshareholders and should be returned to them in subsequent yearsq y

• For new companies, this strain will put limits on growth depending onlimits on growth, depending on availability of capital

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New Business Strain

• For a mature company, NB strain can be f d d th hfunded through– Retained profits– Return of NB strain in respect of old business– Shareholders

• For a mature company with a slow growth rate, the return of NB strain in respect of old business may be more than adequate to finance current new business strain

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New Business Strain

• Unduly high level of NB strain– Distorts the profits of a life insurer

P t lif i i f bl– Puts life insurers in an unfavourable light when compared to other financial institutions

– Particularly important for new insurersParticularly important for new insurers

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Reserving Methods andReserving Methods and Valuation BasesValuation Bases

• Reserving method and valuation bases t bli h th fi t destablish the first year reserve and reserve

increases in subsequent years• Strong valuation method / bases increase the

level of NB strain• Strong valuation methods / bases are driven

by solvency considerations that serve the y yBalance Sheet, but distort the P&L Account

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