CIA Annual Meeting LOOKING BACK…focused on the future

Presentation by W. Paul McCrossan St. John’s - June 29, 2005 Presentation by W. Paul McCrossan St. John’s - June 29, 2005 PD The Morris Review lessons for the CIA CIA Annual Meeting

LOOKING BACK…focused on the future The Run up to the Morris Review in the UK since 2000  Failure of the Independent (general insurer)  Curtailments and closures of UK DB pension schemes  Several insurance market conduct problems  Severe bonus cuts for many insurers  Capital problems for several large insurers  Failure of the Independent (general insurer)  Curtailments and closures of UK DB pension schemes  Several insurance market conduct problems  Severe bonus cuts for many insurers  Capital problems for several large insurers

LOOKING BACK…focused on the future The Run up to the Morris Review in the UK since 2000 (Cont’d)  Equitable closed to new business due to capital shortage  Lord Penrose’s report on the Equitable criticized actuaries  Lord Penrose calls for review of the actuarial profession  Severe press criticism of the “arrogant” or the “archaic” actuary  Equitable closed to new business due to capital shortage  Lord Penrose’s report on the Equitable criticized actuaries  Lord Penrose calls for review of the actuarial profession  Severe press criticism of the “arrogant” or the “archaic” actuary

LOOKING BACK…focused on the future The Key Conclusions Underlying the Recommendations  “Professional standards that have been weak, ambiguous or too limited in range and perceived as influenced by commercial interests”  “An absence of pro-active monitoring of members’ compliance with Professional Standards”  A profession that has been too introspective, not forward enough looking, and slow to modernize”  economic theory and  accounting theory  A profession that has trouble communicating  “Professional standards that have been weak, ambiguous or too limited in range and perceived as influenced by commercial interests”  “An absence of pro-active monitoring of members’ compliance with Professional Standards”  A profession that has been too introspective, not forward enough looking, and slow to modernize”  economic theory and  accounting theory  A profession that has trouble communicating

LOOKING BACK…focused on the future The Key Recommendation  “Continued self-regulation by the profession is unlikely to restore public confidence.”  Bluntly reflects loss of confidence in actuaries by their key constituencies  regulators  consumers  accountants and auditors  trustees and non-executive directors  CFOs  “Continued self-regulation by the profession is unlikely to restore public confidence.”  Bluntly reflects loss of confidence in actuaries by their key constituencies  regulators  consumers  accountants and auditors  trustees and non-executive directors  CFOs

LOOKING BACK…focused on the future The New Framework  Future Professional Oversight provided by Financial Reporting Council  Independent Actuarial Standards Board appointed by FRC (with majority of actuaries)  FRC oversight includes ethics, education, compliance, and discipline  Profession can continue to set ethical standards as long as FRC satisfied  Future Professional Oversight provided by Financial Reporting Council  Independent Actuarial Standards Board appointed by FRC (with majority of actuaries)  FRC oversight includes ethics, education, compliance, and discipline  Profession can continue to set ethical standards as long as FRC satisfied

LOOKING BACK…focused on the future A New Communications Standard of Practice  The new Actuarial Standards Board is to develop a generic communication standard for all actuarial reports to cover: Disclosure of assumptions used and a discussion of the extent to which professional judgment was exercised What methodologies were chosen and why Sensitivity analyses of outcomes to changes of assumptions and methodologies  The new Actuarial Standards Board is to develop a generic communication standard for all actuarial reports to cover: Disclosure of assumptions used and a discussion of the extent to which professional judgment was exercised What methodologies were chosen and why Sensitivity analyses of outcomes to changes of assumptions and methodologies

LOOKING BACK…focused on the future A New Communications Standard of Practice (Cont’d)  The new Actuarial Standards Board is to develop a generic communication standard for all actuarial reports to cover: Probabilistic analyses of key variables or indicators under particular scenarios Concerns the client should have bearing in mind the capacity of the client to cope with various types and levels of risk  The new Actuarial Standards Board is to develop a generic communication standard for all actuarial reports to cover: Probabilistic analyses of key variables or indicators under particular scenarios Concerns the client should have bearing in mind the capacity of the client to cope with various types and levels of risk

LOOKING BACK…focused on the future Total return from UK Equities over 1 year

LOOKING BACK…focused on the future Total return from UK Equities over 3 years

LOOKING BACK…focused on the future Total return from UK Equities over 5 years

LOOKING BACK…focused on the future What, if anything, should be recognized from fat- tailed equity returns in liability calculations? Duration Mean11.4% Median 9.8% Simulated CTE % 6.0% 6.8% Simulated CTE % 4.1% 5.2% Simulated 80% Confidence 4.8% 6.2% 6.8% Can the use of expected yields on equities be justified for use in liability calculations?

LOOKING BACK…focused on the future Key Accounting Concept Investment Recognition vs. Measurement  When money is transferred from gilts into corporate bonds or into equity is the financial position improved? “Yes”, if recognize expected gain from investing in a more volatile investment immediately “No”, if recognize gains only when realized “Somewhat”, if recognize that portion of expected gains that is “highly probable”  When money is transferred from gilts into corporate bonds or into equity is the financial position improved? “Yes”, if recognize expected gain from investing in a more volatile investment immediately “No”, if recognize gains only when realized “Somewhat”, if recognize that portion of expected gains that is “highly probable”

LOOKING BACK…focused on the future Key Actuarial Concept Investment Recognition vs. Measurement  “Traditional” actuarial practice of reflecting the “equity pick up” discredited as prematurely recognizing too much of expected gain too early  “Risk free rate” approach is market consistent but leads to liabilities felt by many to be too high  “Partial recognition” approach has not been well articulated  “Corporate bond approach” is in use but rationale is not well articulated  Without articulation of partial recognition approach rationale, risk free rates may be imposed  “Traditional” actuarial practice of reflecting the “equity pick up” discredited as prematurely recognizing too much of expected gain too early  “Risk free rate” approach is market consistent but leads to liabilities felt by many to be too high  “Partial recognition” approach has not been well articulated  “Corporate bond approach” is in use but rationale is not well articulated  Without articulation of partial recognition approach rationale, risk free rates may be imposed

LOOKING BACK…focused on the future Need for Incorporation of Probabilities in Conceptual Framework?  Expected based on “equity pickup” leads to liabilities that are too low?  Use of risk free leads to liabilities that are too high?  IAS 19 / FRS 17 look to high quality corporate yields (on what basis)?  Can CTE (TailVar) concept be used?  Is there a case for different liabilities for funding and accounting?  If so, what about plan member security?  Expected based on “equity pickup” leads to liabilities that are too low?  Use of risk free leads to liabilities that are too high?  IAS 19 / FRS 17 look to high quality corporate yields (on what basis)?  Can CTE (TailVar) concept be used?  Is there a case for different liabilities for funding and accounting?  If so, what about plan member security?

LOOKING BACK…focused on the future Pension Conflict of Interest Regime  Written agreement on how to handle conflict of interests before shared engagement  Material conflict of interest may be declared by any of three parties  First right of refusal reserved for plan trustees  Written agreement on how to handle conflict of interests before shared engagement  Material conflict of interest may be declared by any of three parties  First right of refusal reserved for plan trustees

LOOKING BACK…focused on the future Pension Scheme Controls on Plan Actuary  Professional reviews (annually informal, triennially formal)  Trustees expertise (upgrade by education and experts)  Separation of Services (fund actuary, manager selection, strategic asset)  Re-tendering (every 5 – 7 years becomes best practice)  Independent Review (scrutinize scheme actuary by independent expert)  Professional reviews (annually informal, triennially formal)  Trustees expertise (upgrade by education and experts)  Separation of Services (fund actuary, manager selection, strategic asset)  Re-tendering (every 5 – 7 years becomes best practice)  Independent Review (scrutinize scheme actuary by independent expert)

LOOKING BACK…focused on the future Lessons from the UK  Consensus standards may be at the lowest common denominator  Loss of intellectual vigour may allow obsolete standards to continue  Resistance to independent scrutiny is poison if problems emerge  Client interest over public interest is poison if problems emerge for reserved (statutory) roles  Honest Broker role is suspect when favoring one side seems apparent  Consensus standards may be at the lowest common denominator  Loss of intellectual vigour may allow obsolete standards to continue  Resistance to independent scrutiny is poison if problems emerge  Client interest over public interest is poison if problems emerge for reserved (statutory) roles  Honest Broker role is suspect when favoring one side seems apparent

LOOKING BACK…focused on the future Public Interest Obligations for Actuaries with Reserved Roles  Clarify (for pension scheme, insurer reporting actuary, insurer reviewing actuary)  Scrutiny (by independent experts)  Legal Protection (embed in law)  Confidentiality Waiver (consider embedding in law for reserved role actuaries and regulators)  Clarify (for pension scheme, insurer reporting actuary, insurer reviewing actuary)  Scrutiny (by independent experts)  Legal Protection (embed in law)  Confidentiality Waiver (consider embedding in law for reserved role actuaries and regulators)

LOOKING BACK…focused on the future Lessons from the UK (Cont’d)  Mutual Support from regulators, accountants, legislators needs to be cultivated and earned  Intellectual Capital must be continuously improved and, if members can’t / won’t do it, academia must  Business interest focus can be deadly if profession is to retain support  Mutual Support from regulators, accountants, legislators needs to be cultivated and earned  Intellectual Capital must be continuously improved and, if members can’t / won’t do it, academia must  Business interest focus can be deadly if profession is to retain support

LOOKING BACK…focused on the future Key Issues for All Actuarial Associations  Conflict of interest: sponsor vs. members or insurers vs. policyholders  Liability measurement: different values of liabilities insurer vs. pension  Recognition vs. Measurement: insurer (release from risk) vs. pension  Financial condition: measures risk bearing capacity  Conflict of interest: sponsor vs. members or insurers vs. policyholders  Liability measurement: different values of liabilities insurer vs. pension  Recognition vs. Measurement: insurer (release from risk) vs. pension  Financial condition: measures risk bearing capacity

LOOKING BACK…focused on the future Key Issues for All Actuarial Associations  Economic theory: fat-tailed risk ruin theory (stochastic analysis) missing  Adverse development reports: clarify need and protections  Scrutiny: regular independent peer review insurer?  Outside oversight by other professions, users, public is essential  Economic theory: fat-tailed risk ruin theory (stochastic analysis) missing  Adverse development reports: clarify need and protections  Scrutiny: regular independent peer review insurer?  Outside oversight by other professions, users, public is essential

LOOKING BACK…focused on the future Morris Fiduciary Duty and Conflicts  Fiduciary duty Traditional thinking is that the pension actuary who works for both the plan sponsor and the pension scheme must balance competing interests Morris requires the actuary in such a situation to give primacy to the interests of the plan members in a dual engagement situation  Conflict of Interest Traditional thinking is that a potential conflict of interest can be resolved when the engagement is made Morris requires that the scheme trustees (on behalf of the plan members) have first right of refusal to the actuary’s services  Fiduciary duty Traditional thinking is that the pension actuary who works for both the plan sponsor and the pension scheme must balance competing interests Morris requires the actuary in such a situation to give primacy to the interests of the plan members in a dual engagement situation  Conflict of Interest Traditional thinking is that a potential conflict of interest can be resolved when the engagement is made Morris requires that the scheme trustees (on behalf of the plan members) have first right of refusal to the actuary’s services

LOOKING BACK…focused on the future The Dangerous Event May Be Close (one scenario)  Commodity inflation leads to …  Severe recession which leads to …  Profit squeeze and unemployment which leads to …  Falls in interest rates back to historic long term levels (2 ½% to 4%)  What makes you think you will be allowed to fix your standards if problems arise?  Commodity inflation leads to …  Severe recession which leads to …  Profit squeeze and unemployment which leads to …  Falls in interest rates back to historic long term levels (2 ½% to 4%)  What makes you think you will be allowed to fix your standards if problems arise?

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future Canadian Yield Curves

LOOKING BACK…focused on the future What are the Core Competencies of the Actuary?  Mortality  Interest  Effect of Guarantees If these led to Morris in the UK, are we ready in Canada?  Mortality  Interest  Effect of Guarantees If these led to Morris in the UK, are we ready in Canada?

LOOKING BACK…focused on the future Thank you very much... If you wish a copy of this presentation, please send an e:mail to If you wish a copy of this presentation, please send an e:mail to