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Regulators Oppose Liabi lity D iscounting, Support Actuaries, Academy Survey Shows ass tort liabilities should not be discounted for the time-value of money, according to most state insurance regulators surveyed by the Academy for a report on reserving for asbestos and pollution liabilities . The Academy study, published in N1_ March, reports the views of twelve state regulators, twenty-two property/casualty insurance chief financial officers (CFOs), and nine consulting actuaries . Reserving for long-term liabilities has become increasingly imp tant to the property/casualty industry. "In the past 2 years,' says R Bhagavatula, chairperson of the Academy work group that conducted the study, "companies have responded to pressure from regulators and ratings agencies to take unprecedented reserving actions . The Academy undertook

this study to offer insight into the issues faced by actuaries, companies, and regulators in reserving for mass torts :' Although all participants remain anonymous, responses to the survey questions provide a glimpse of regulatory attitudes toward property/ casualty insurers and the actuarial profession. (For the complete set of regulators' answers, see Appendix B of the Academy report. ) On the issue of discounting asbestos and pollution reserves , the Academy found sharp disagreement between CFOs and consulting actuaries , who favor discounting, and regulators, who are generally opposed. Reasons cited for opposition include the belief that companies already understate their reserves, the uncertainty of the ultimate liability, and the margin of safety provided by

CFO and actuary estimates ranging from less than $30 billion to more tb* $100 billion. • The surveyed regulators believe that insurance companies should be more forthcoming in reporting their exposure to asbestos and pollution liabilities . One survey respondent said that without full company disclosure, "regulators are hamstrung . The actuarial work gets better . . . but actuaries have difficulty ing up with anything definitive ." This r, ;1110 for also commented that final action on Superfund reform "would help companies know what their liabilities will be :' • The regulators also call for clearer opinions from actuaries, and state that they no longer trust actuarial opinions that do not include estimates of asbestos and pollution exposure .

uncertainty is so great that if discounting were permitted, the regulators

Criticism of vague actuarial opinions was expressed . Said one regulator, "We can't have confidence if actuaries won't opine on A&E (asbestos and environmental) or have large caveats . The opinion always has a disclaimer . . . At least one state is now saying the actuary is not meeting its regulations if the opinion is not given for A&E exposures :' According to another : "We need an Actuarial Standard of Practice on estimating these types of liabilities. If there were a standard , the companies might be less likely to

would lose their margin of safety." However, some regulators expressed

duck their responsibilities ."

undiscounted reserves . One regulator said, "It seems an undue penalty on companies to have to recognize the full nominal value of liabilities, but the

qualified support for discounting . According to another regulator, "Actuaries have become sophisticated enough so that all reserves could be discounted, and it's only a matter of time before that will happen ."

Estimability is a key issue in reserving for mass torts . Most CFOs surveyed believe that their companies' asbestos liabilities are estimable, while approximately half of the CFOs believe that their pollution liabilities are not. Both CFOs and actuaries agree that asbestos liabilities are now reasonably estimable for most companies . The Academy survey also brought the following findings to light : • In general, regulators think that insurers domiciled in their states are handling their liabilities well and have reserves in the correct range . One regulator said, "Over the last 8 to 10 years, more and more companies have developed actuarial staffs, and this has allowed them to address loss reserves in a strategic manner.As a result, companies have a good handle on their reserves, and if they are wrong, it's not significant and would not threaten the company's solvency." However, half of the surveyed regulators expressed concern about insurers not domiciled in their states . • The insurance industry's asbestos losses are estimated to total between $30 billion and $50 billion, according to the majority of both CFOs and consulting actuaries .There is less consensus about ultimate pollution losses, with

• Regulators , consulting actuaries, and CFOs do not believe that mass torts other than asbestos and pollution will have significant effect on the US . insurance industry. However, ongoing monitoring was suggested for tobacco, breast implants , and lead paint. The disagreements between CFOs and regulators, particularly on discounting, reflect a difference of perspective that merits further discussion . What to make of such a diversity of opinion? Through its report, the Academy encourages regulators and insurers to engage in a dialogue aimed at a broad consensus on estimating liabilities and setting reserves . After its release, the Academy report was distributed widely among regulators, insurers, and other interested parties . Bhagavatula also met with reporters and regulators in a March 18 session at the National Association of Insurance Commissioners meeting in Orlando . Other members of the Academy work group are Ralph Blanchard III, Amy S . Bouska, Robert P. Irvan, Kenneth R . Kasner, Gustave A . Krause, Barry C. Lipton, and Lee Steeneck . For a copy of Reserving for Asbestos, Pollution, and Other Mass Tort Liabilities, fax a request to Doreen Evans at 202-872-1948 .

evolving actuarial qualification system . According to Hendricks, the Bulgarians appear to have "a good start" in forming their own association . Academy members

Social Security Solvency Is Pension Fellow Message

baby boomers pass the costs on to the next generation," Gebhardtsbauer asked, "or will we begin to

Action to restore Social Security to

make a few sacrifices today to spare our kids an expensive problem in the future?" Gebhardtsbauer also outlined proposals to shift Social Security trust fund assets to the pri-

long-range solvency should begin now, Academy Senior Pension Fellow Ron Gebhardtsbauer told a March 2 conference on Social Security's future in Tucson, Arizona .

vate sector or to move to individual accounts . Another option is to rely on a beefed-up private pension system to make up for reduced Social Security benefits . Whatever the so-

Gebhardtsbauer participated in the public education forum at the invitation of Rep.Jim Kolbe (R-Ariz.),

lution adopted, Gebhandtsbauer said, "To keep Social Security healthy, we will probably have to raise the retirement age to keep pace with the American people, who are living longer and staying healthy longer." Arizona public television featured Gebhardtsbauer in its report on the Social Security forum and Gebhardtsbauer's statistics were a

Rep. Jim Kolbe (canter) welcomes Academy btacafte Director Wilson Wyatt (left) and Senior Pension Follow Hon Gebbardtsbauer to his Capitol Hill office . Kolbe invited the Academy representatives to discuss actuarial participation an ipartrsan retirement work group .

source for a March 16 column by pundit George Will. On a related issue, leader of a bip 1W study group figures from a Gebhardtsbauer edon retirement issues in the U.S . itorial in the February Enrolled House of Representatives . Sen . Actuaries Report found their way Robert Kerrey (D-Neb.) also adinto a February 27 speech by Sen . dressed the meeting . Jim Jeffords (R--Vt.) . Speaking to In their re , Kolbe and the ERISA Industry Committee, Kerrey both e ed respect for Jeffords noted that ERISA's the actuarial profession's contribu$75,000 defined benefit pension tions to the Social Security debate . "We must intensify our efforts to educate the American people about the real issues ;" said Kolbe, "and actuaries have an important part to play. Hundreds of events like the Tucson forum, in all parts of the country, will be needed to inform the public ." Kerrey also

maximum would have increased to over $200,000 without restrictive congressional amendments . "Imposing heavy burdens on plans is not the way to help people save for their retirement days," Jeffords said. Gebahardtsbauer's editorial, "Tax Policy Versus Pensions : Cease Fire in Sight?" has received wide

praised the profession and invited the Academy to participate in a Nebraska forum later this year . Gebhardtsbauer told the conference that changing demographics are at the root of Social

distribution on Capitol Hill and among pension policy officials .

Security's financial problems. The retirement of the huge post-World War II baby boom generation will strain the system . Low birth rates

Bulgarians Learn U.S. ABCs (and MAAAs)

in the 1960s and '70s resulted in a much smaller work force to finance the program. Increased life expectancy means that Social Security must provide benefits longer and to more people than originally designed for. Although Social Security 's trust fund will not be exhausted until 2029, Gebhardtsbauer noted that "financing problems begin in 2012 when Social Security starts paying

The Academy office was the site of an actuarial cultural exchange in February, when seven actuaries of the Bulgarian state pension system visited Washington for a 2week seminar on the solvency of social insurance programs. During their February 6 stop

out more than it takes in:' An extra 2 .2 percent in taxes or benefit cuts of 15 percent would save the

at the Academy, the Bulgarians met with Senior Policy Adviser Gary Hendricks . He explained the role of the Academy in the U.S. public policy process and in

current system if implemented now, but more costly measures will

setting professional standards . The visitors, in turn, told

be necessary if action is deferred .

Hendricks about the Bulgarian

Delay also raises a question of intergenerational fairness. " Will the

Society of Actuaries, which formed in 1994, and their still-

who served as volunteer instructors for the Bulgarian actuaries included Robert J . Myers, former chief actuary of the Social Security Administration, and Guy King, formerly of the Health Care Financing Administration,

Maryland Insurance Commissioner Dwight Bartlett, and former Social Security Administration Chief Deputy Actuary Bruce Schobel . The seminar was sponsored by the National Academy of Social Insurance.

Seminar inslnrctor Bruce Schobel explains a formidable list of U.S. actuarial designations to visiting Bulgarian actuaries .

Actuarial Existentialism ich came first, actuaries or the need for them? A brief look at the origins of our profession shows that actuaries exist because the public needs their skills . David Holland

In London in the 1530s, an early warning system for outbreaks of the plague was put in place ; it consisted of parish clerks submitting weekly numbers of plague deaths and other deaths . An increase in the number of deaths signaled the beginning of an outbreak, at which time those who could afford it moved from the crowded cities to the countryside . In 1662, John Graunt published Natural and Political Observations Made Upon the Bills of Mortality. Graunt's observations included" . . . some coveringTrade, and Government, others concerning the Air, Countries, Seasons, Fruitfulness, Health, Diseases, Longevity, and the proportions between the Sex, and Ages of Mankinde" He presented a forerunner of modem mortality tables based on 100 live births; he determined that thirty-six would die in the first 6 years, and assumed the number of deaths for each decade thereafter until there was only one life left at age 76 . In 1693, Edmund Halley of corn t fame published mortali ~ based on the more complete information from records of the city ofBresl me scholars date the be . g of actuarial science from this time . While statistics were being collected and analyzed in Great Britain, early work on probability theory was underway in continental Europe . In the 1600s, correspondence between Pascal and Fermat on gambling questions led to the foundation of probability theory. As Haberman and Sibbett note in their ten-volume History ofActuarial Science, "Some of the pioneers in the 1700s and 1800s were eminent scientists and mathematicians w are interested in actuarial problems . The practic d theoretical lines came together in England in 1762 with the founding offSociety for Equitable Assurances on Lives and Survivorship . Chief founder of the Equitable was James Dodson, an "accomptant and teacher of mathematics who was incensed at his rejection by the Old Amicable dividing society because of his advanced age of 46 . Dodson showed how premiums and reserves could be set up for permanent insurance, and the Equitable is said to be the first life insurance company founded on scientific principles. (Note, however, that Dodson died at 47 .) Edward Rowe Mores, who succeeded Dodson, chose the term "actuary" to refer to the Equitable's chief administrative offzcer.The term was then in use for clerks who recorded acts of the court, but actually dates back to the time ofJulius Caesar when the actuaries recorded the acts of the Senate. As Robert Mitchell wrote in From Actuarius to Actuary, published by the Society ofActuaries in 1974 : "Whatever qualifications Mores may have had in mind in choosing the designation, it is evident that mathematical ability was not one of them. In fact, none of the Equitable's first four actuaries had the technical ability to function as actuaries in today's understanding of the designation ; when the directors-who made all the major decisions-thought computations were needed, they had an outside mathematician make them" Dr : Richard Price was the Equitable's consultant, and his "Observations on Reversionary Payments" is considered by some the first major work on actuarial science in general . Price managed to get a job for his nephew, William Morgan, as assistant actuary at the Equitable . Morgan eventually became the chief administrative officer of the Equitable with the title of actuary. One ofMorgan's scientific contributions was the publication of The Doctrine ofAnnuities and Assurances on lives and Suwivorships in 1779. Morgan is said to have disliked the title of actuary, but nevertheless his skills and mathematical abilities led to the present-day meaning of word . Again quoting Mitchell : "Morgan was the first actuary who could be called a professional actuary in the sense that the term is understood today. . . . In creating the actuarial profession, he imbued it with two of his own characteristics : a scientific outlook that insisted on mathematical and statistical research as the basis for decision-making ; and an unmuzzled integrity that made him ready to risk his job rather than go along with potentially disastrous proposals from unwisely optimistic directors and policyholders ." A corollary question involves actuarial organizations . Without going into contentious history ; I've also concluded that the existence of actuaries predates the existence of organizations of actuaries . These organizations also meet a public need. In spite of the development of actuarial science, there were a number of failures of insurance companies in the first half of the 19th century. Again quoting Mitchell: "Since many of the failures were due more to ignorance than fraud, the knowledgeable insurance experts saw a need for a central organization that could encourage the spread of actuarial knowledge and promote sounder practices among life insurance companies ." Finally, the question often comes up, "Why are there so many actuarial organizations in North America?" My answer is that each organization exists because it meets the needs of its members . Any attempt at rationalization will be futile as long as individual members feel that the benefits of maintaining organizational sovereignty outweigh the advantages of merging into a greater union . For now, we have the Councils of Presidents and Presidents-Elect of the North American organizations and a spirit of cooperation for the greater good of the profession . Let's get on with our work . -HOnANn is ?RESIDENT OF THE SOCIETY OF ACTUARIES .

At the Eye of the Medicare Storm lick Foster of the Health Care Financing Administration IF ew actuaries have more impact on the American people's pocketbooks than the chief actuary of the Health Care Financing Administration (HCFA), which administers Medicare and Medicaid . During Rick Foster's 2 years in that job, both programs have come under careful scrutiny by Congress and the administration . Medicare's Hospital Insurance trust fund is due to go bankrupt in 2001, which gives extra urgency to reform . Foster's chief

function at HCFA is to evaluate the financial status of Medicare, but any proposal to change the program must also use his cost estimates . At the time of this interview in mid-March, Foster was analyzing competing proposals from the administration and Capitol Hill, as well as e xaminin g the policy implications of some outside studies on health spending . can you tell us what your office is working on right now? The Office of the Actuary performs a broad range of activities in addition to our "real work" of making

cost projections. Right now, we are analyzing a Duke University study on the health status of the elderly. The study shows a significant decline in disabilities among elderly

Risk Adjustment Change Could save Medicare Dollars Current Medicare reimbursement methodologies have serious limita Lions, Alice senblatt told the U.S. House Ways and Means Health Subcommon February 25 . She suggested that Congress consider modification of the Medicare risk adjustment mechanism . Rosenblatt, a member of the Academy Board of Directors and Health Practice Council, represented the Academy before the House panel, which requested . comments on proposed changes to Medicare's HMO payment method . At issue was a Clinton administration proposal to lower Medicare's per-enrollee payment to managed care plans from 95 perAlice Resanblatt answers the quegtrans ottbe ways and cent of fee-for-service costs to 90 percent . Means Health Subannrmitfae The 95 percent rate is generally thought too at tie Febmary2fi bearing high because enrollees in Medicare managed care tend to be younger, healthier, and less expensive than Medicare beneficiaries who opt for fee-for-service coverage. (See Academy Closeup of Rick Foster, above.) Rosenblatt cited a study by the Physician Payment Review Commission that showed managed-care enrollees spent only 63 percent as much as the average Medicare beneficiary The data indicate that current payments overcompensate managed care plans because of Medicare's prepayment risk adjustment mechanism, called the Average Adjusted Per Capita Cost (AAPCC) . The AAPCC methodology places beneficiaries into risk categories that account for age, sex, welfare status, institutional status, and basis for Medicare eligibility. The AAPCC is supplemented by an adjustment called the ACR (Adjusted Community Rate) that theoretically adjusts for the health plan's cost structure . This methodology, Rosenblatt said, discourages HMOs from offering coverage in areas where the ACR is low, increases adverse selection against fee-for-service plans, and may compromise quality of care. Rosenblatt also offered suggestions to correct problems in the current methodology. • Reduce the wide cost variations among geographic regions . • Base payment on a combination of prepayments and actual claims experience. • Carve out particular disease populations, such as diabetes, or procedures, such as coronary artery bypass graft surgery • Modify the ACR methodology. • Shift the AAPCC away from a fee-for-service basis, perhaps through competitive bidding . Said Rosenblatt, "It is important to address this issue, but a different approach is needed . The Academy is ready to work with Congress and the administration in developing a methodology that will work ." Since Rosenblatt's testimony, the Academy has been asked to testify at two additional congressional hearings on Medicare. See next month's Update for details.

people. That's good news , and seems to be supported by the data. However, people on Capitol Hill and elsewhere who should know better are concluding that this natural reduction in disability prevalence over time will take care of the financial Rick Faster problems of Medicare. That is just flat-out wrong. On very short notice, our ofi ng numbers to show the for the National Institutes of Health (NIH), which helped underwrite the study, and for policy makers interested in this question. How did your d& eceme involved? The Health and Human Services administrator called us and asked : Is this right? In cases like this, the Office of the Actuary steps in to provide accurate information about potentially misleading statistics . Clarifying this question is important because it could distract people from the real issue, which is the serious long--range financing problem of Medicare.

Most current proposals offer a 1(1-year fix. Is that a good approach? Prompt short-term legislation could postpone the depletion of the Medicare Hospital Insurance trust fund, which is estimated to run out of money in 4 years . Thus is an urgent problem and can be fixed for the time being through traditional legislative measures . Such an approach will buy us time to agree on a solution for the much more serious long-term problem that involves the retirement of the baby boomers . However, we can't afford to postpone action for very long. Delaying action will mean fewer feasible options in the fixture and more abrupt, disruptive impacts .

Is demographics the problem? Yes, in large part. The number of beneficiaries will increase much more rapidly than the number of workers who pay for the system . Another phenomenon, which applies to health care in general as well as to Medicare, is the increasing utilization, cost, and complexity of


health care services . We've seen an improvement in these trends in recent years, but utilization and costs are still growing faster than the payroll that supports the program.

i lixatinn problem?

Is managed core the solution for the uti-

Managed care seems to do a better job than fee-for-service in reducing unnecessary utilization and promoting cost-effective treatment . Medicare's problem is that under current law we are paying too much for managed care . For each enrollee in a managed-care organization, Medicare pays 95 percent of the cost of a fee-for-service enrollee, even though most studies show that managed care enrollees are somewhat healthier on average . Moreover, savings due to the management of care do not affect the Medicare payment rate. Because of the reimbursement formula and the effects of favorable selection, the typical enrollee in a managed program would cost Medicare less in fee-for-service . The cost savings of managed care are not being passed on to Medicare .

Would the administrations proposed reduction to 911 percent be effective? The administration's proposal is a somewhat crude step in the right direction. It would offset the average effect of favorable selection among plans . A better fix in the long-term would be to improve our risk-adjustment methods to include diagnosis-based judgments . Of course, such a system would require a large amount of data from managed-care providers, including information that currently is not being recorded. Providers would be very reluctant to take on this additional burden . Besides the reduction to 90 percent, the administration plan would reduce the wide variation of payment rates across the country : This variation has the effect of concentrating managed-care plans in highcost areas. The impact of reducing

the variation has been the subject of considerable debate among actuaries . Are uniform health records that follow individuals throughout their lives feasible? Speaking as a good actuary, it would be nice to have that information. However, the public's concerns about privacy would be hard to answer. Who would have access to such files and how would the data be used? Collecting and maintaining those records also would be very expensive. What solutions nu looking at? HCFA is currently sponsoring some health studies that should help provide answers to these financing questions . For example, we are conducting act on competitive bidding i rover . Many people think that competitive bidding is the best way to reduce costs to a minim um . Other demonstration projects look at improved methods of risk adjustment to better determine the difficulty of acquiring data and to test their effectiveness at matching payment amounts to beneficiary characteristics .

You have one of the most sensitive jobs of any actuary. no you feel the political heat? Nobody tells us what kinds of estimates to make or how those estimates should turn out . They know better than to try With occasional exceptions, most politicians recognize the need for independent and unbiased information. Questions of future cost of social programs have become more crucial, and most Washington decision makers realize that they need good information to make sound decisions . My theory has always been that all parties in the debate should have access to the same information . That is not always a popular philosophy, but we try to adhere to it as close as we possibly can in our work at HCFA. Through the efforts of Bob Myers, Gordon Trapnell, Haeworth Robertson, Guy King, and others, our office has earned a reputation for steadfast integrity and professionalism. My highest priority is to uphold this proud tradition.


Pension Views Sought on Cost Methods and Liability Measurement


Wilson W.Wyattjr, PRESIDENT

Larry Zimpleman. PRESIDENT ELECT

T he Pension Committee of the Actuarial Standards Board is seeking comments from pension practitioners. The committee is developing a new actuarial standard of practice on actuarial cost methods and measurement of actuarial liabil. Responses to the following questions , as well other related comities ments, would be greatly appreciated .

• Should the actuary be required to demonstrate the impact of various plausible events on plan funding and the plan's funded status? Examples of such events include plant closings, expected future benefit increases, and indexation of Internal Revenue Code limits . Should such demonstration be made periodically or merely under certain circumstances?

• The committee has tentatively concluded that the standard should set forth principles that apply to selection of actuarial cost methods, but not define or list the specific methods that are acceptable . Do you agree with this approach? If so, do you still feel that any specific methods should be banned entirely (e .g ., pay-as-you-go)? • Which underlying principles should apply in selecting an actuarial cost method? • Should the standard set forth a step-by-step process in selecting or val-

Send responses and comments by e-mail to 75703, or to

idating a cost method? • Have you observed practices that you believe should not be acceptable under the standard? • Do you favor a requirement to disclose expected contribution or cost patterns under certain circumstances? Possible events that could trigger the disclosure requirement include introduction or change of a method, reasonable belief that significant future increases will be revealed, or pattern sensitivity to actuarial experience . • Do you favor a requirement to disclose funding progress relative to a standard liability measure such as plan termination liability? If yes, what should be the liability measure, how often or under what circumstances should disclosure be required, and how specific should be

Allan M. Kaufman VICE PRESIDENTS Vince Amoroso William 1:13luhm Arnold A. Dicke Ken W Hartwell Barbara L. Snyder Michael L.Toothman SEcRETAw(-TR'EAsURER Stephen R . Kern


Pension Funding Methods and Liability Measures Actuarial Standards Board Pension Committee 1100 Seventeenth Street, NW, 7th Floor Washington, DC 20036

The American Academy ofActuaries 1100 Seventeenth Street NW


AERAF Award Would you like recognition for your research? The Actin Education and Research Fund is seeking submissions for its annual Practitioners Award from actuaries who do not work for academic institutions . Submissions need not be formal papers and will be judged partially on the basis of practical application . Submit your entry before June 2 to AERF Executive Director Curtis Huntington at 475 N . Martingale Road, Suite 800, Schaumburg, IL 60173-2226 .

Wash in tu~on, DC 20036 202 2i-8f966Fax 202 872-194.8



Woodfield Corporate Center 475 N. Martiugale Road - .,.: Schaumburg.IL 60173 2226

David Holland Explains Actuarial Existentialism

(847) 706-3513

HCFA's Rick Foster en fixing Medicare T .CA IONS

the standard of liability determination?

Academy. Testifies an. Risk Adjustment

See You 7n S cotts dale The 1997 Academy Annual Meeting will be October 6 at The Phoenician in Scottsdale, Arizona, in conjunction with the Conference of Consulting Actuaries . At the meeting, Allan Kaufman will take over as Academy president, new life and pension vice presidents will be announced, and new regular board members elected . The Academy Health, Life, and Pension Practice Councils winl present sessions on their 1997 projects and work in progress on key issues, and the Council on Professionalism will hold a mock disciplinary hearing . A prominent Washington political figure, to be announced, joins us for the Academy Luncheon address . Academy members who are not Conference members are encouraged to participate . All Academy members will receive registration material later this spring . For more information, contact Keith Stewart of the Conference at 847-419-9090 .

AssociATE EDrroRs William Carroll

Ronald Gebhardtsbauer Patrick J. Grannan MANAGING EDITOR

Je&ey Spe cher 74764,2620@compuserve.coni CONTRIBUTING EDITOR . Ken Krehbiel PRODUCTION


Renee Saunders

Statements of fact and opinion in this publica-

Disciplinary Notice The Academy's Discipline Committee , acting in accordance with the Academy's bylaws and under recommendation of the Actuarial Board for Counseling and Discipline, has expelled Larry D . Coate from membership in the Academy. The 45-day period for Mr. Coate to appeal the decision of the Discipline Committee to the Academy's Board of Directors has expired without any communication from Mr. Coate.

tuludlng geditorials letterstotheeditr' a made on the responsibility of the au thors alone and clo not necessarily imply or represent the position of the American Academy , ofActuaries, the editors, or the members of the Academy. 61997 The American Academy of Actuaries, All Rights Reserved

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April 1997 Actuarial Update