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Gareth Morgan - The Big Game IV - Inside the Actuarial Snakepit |
The National Business Review – Part 4
November 3, 2006
Inside the Actuarial Snakepit
Gareth Morgan continues his investigation of investment rorts.
Lord Penrose in his 2003 report on the collapse of Equitable Life in the UK got it in a nutshell.
He commented that actuaries working for insurance companies were inappropriately working in areas beyond the reach of the auditor (auditors don’t check the propriety of actuarial estimates of long term liabilities, for instance) and were at times making calls well beyond the expertise of their discipline.
“One has the impression that actuaries have at times acted as if they were fully qualified in accountancy, law and other disciplines so as to need no outside support,” he said.
The more recent (March 2005) Morris Review of the Actuarial Profession (again a UK initiative) was called by the government specifically to respond to Lord Penrose’s concerns. But Sir Derek Morris reinforced Lord Penrose’s doubts and recommended the following:
- Regulation of the actuarial profession needs to be subject to independent (non-actuary) oversight by the body that sets accounting standards;
- This independent body should set the actuarial standards and actuaries must comply. The subcommittee it establishes must include non-actuaries, especially those who rely on the results of actuarial calibration (consumers and regulators); and
- The independent body needs to set the ethical standards for the actuarial profession, monitor compliance and administer disciplinary procedures. Importantly, the body should alter current ethical standards of the actuaries professional body where it sees them as inadequate.
So low was the level of actuarial ethics that the chancellor of the exchequer accepted the Morris recommendations immediately.
Now pan across to New Zealand. The New Zealand Actuarial Society works to only a short form of the UK’s Actuarial Standards and Guidance Notes.
The Kiwi connection
Here the profession is also self regulated, as is the life insurance industry itself.
From the customers’ perspective, this lack of independent scrutiny means the only recourse to reveal questionable reserving activity is litigation.
A policyholder is entitled to hold reasonable expectations as to what the outcome of entrusting their funds over long periods of time with a guardian should be. The onus is on that guardian and its advisers to meet those expectations.
On of the most severe criticisms from Lord Penrose was that the actuarial profession had failed to develop any comprehensive professional standard.
Examination of New Zealand life insurance company behaviour shows a similar trait of actuaries exploiting the discretions they have available to gain financial advantage for their employer and at direct cost to the reasonable expectation of the saver (see box).
The discretions are not even disclosed and they cannot be detected until several years after the insurance company has exploited them.
Actuarial principles, codes of ethics and rules, if not properly adhered to and ethically governed in consideration of the public interest, can abuse the sanctity of trust placed in the life insurance company and its actuaries.
But life insurance actuarial and accounting practices contain extensive undisclosed and opaque discretions, assumptions, variability and estimations based on professional decisions. When there are altered by overriding corporate management influences the customer is abused.
Examination of New Zealand life insurance company behaviour shows a similar trait of actuaries exploiting the discretions they have available to gain financial advantage for their employer and at direct cost to the reasonable expectations of the saver.
The code of conduct the Life Offices Association drew up in 1989 said life companies must comply with all other applicable rules of law, including the law relating to fiduciary duties. To the extent these companies abuse the saving public and can continue that abuse, then the actuarial profession is to blame.
Yet when one refers to the actuarial Professional Guidance Notes and Doctrines (that have rules delineating the boundaries for creation and application of reserves) as a template to benchmark behaviour, it doesn’t take long to uncover avoidance, denial of actuarial rules and application of discretions.
Rules don’t rule, OK
For example, some companies have stated they do not consider it necessary to comply with the GN8 actuarial rule (wherein they must pay due regard to the reasonable expectation of policyholders) because they are not required to do so under New Zealand law.
This declaration implies the companies don’t have to apply actuarial standards.
So the professionalism of actuary-employees is sacrificed at this altar of legality, making it “open season” against customers.
Spare a thought for the compromised company actuary. The boss comes in and asks, “Is there any reason you cannot adopt this particular discretion?” If the courts have declared the actuarial rules have no legal status, the actuary is vulnerable.
He agrees or the firm finds an actuary who will.
The statement by life insurance companies the GN8 isn’t binding has far reaching implications. It directly affirms the entitlement to create surplus reserves for the sole benefit of the company.
It is a good New Zealand example of what the Morris report touched on.
One skill that New Zealand life insurance companies have honed to perfection is drafting contracts for savings instruments that a re ambiguous and open to interpretation. The purpose is so that the actuarial rules can be applied widely to the advantage of the company.
You need only read a few savings and investment contracts to see the inbuilt discretions and silent terms. The actuarial contrivances and misbehaviours that then follow and are not in compliance with actuarial rules (because they have no legal standing) lead to reserves being created that would otherwise not exist.
The Actuary’s Litany
The Morris Review found that actuarial standards have:
- At times been weak and ambiguous;
- Failed to resolve contentious issues;
- Lacked consistency across practice areas;
- In some cases, been dominated by commercial interests; and
- Been insufficiently independent with no lay input into the standard-setting process.
Who then is answerable?
The view of actuarial profession is that it acts for the company as its client, not for the policyholder. That duty, the actuaries say, arises only for the directors. They in turn stated their obligations are to the company and shareholders.
If these companies had a fiduciary duty, then industry-wide, endemic abuse of the public would not occur. This is because under that obligation the company, when found wanting for even only suspected of misconduct, has no limited grounds or rights (in legal terms) to try to deny or explain way its misconduct.
On a fiduciary obligation the evidential process is reversed. It must product evidence to rebut the allegation of claim. No rebuttal evidence means the fiduciary is guilty by default.
The reason for this strong reversal of the normal legal process (guilty unless proven innocent) is that the courts see fiduciary status and duties as sacrosanct to society. This relies to the extreme on fiduciaries to act appropriately so that society can actually function.
Examples of this status-based fiduciary are the doctor-patient, lawyer-client, trustee-beneficiary and parent-child relationships. This fiduciary duty arises where there’s dominance over a vulnerable party. This is exactly the case with these superannuation and long term savings products.
The industry absolutely denies the status of fiduciary duty. This is the loophole it’s using to justify its expropriation of savers’ capital. The abuse extends to asserting that savers are no more than “unsecured creditors” and further to purport that discretion to create reserves must remain in order to “manage risk over the long term.”
So far life insurers have got away with this because regulators have allowed it to pool and unitise monies even though the real reason for those practices is to obfuscate and conceal what’s going on from customers. Incredulously, the industry has gone on to suggest no investor would understand the complex work of actuaries anyway so there is no need for disclosure.
The fact is that the investing public is in a special circumstance – one of vulnerability – when it entrusts its money for protection and administration. This automatically gives rise to a fiduciary obligation on the part of the company to ensure power isn’t abused and conflicts of interests aren’t resolved to the cost of the public.
The Actuarial Journal has acknowledged this; “saving though a life insurance company is based on trust. Savers rely on the office to treat them fairly and with integrity. They have little or no control over what happens after they have taken out a contract” (Needleman & Roff, British Actuarial Journal IV, 1995).
There it is – the snakepit uncovered.
NEXT WEEK: How the industry crushes complaining customers and has laws changed so you cannot get your money back.
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