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Bank Underwriting Brings Insurance Risks, Zimpleman Tells Congress


cademy President Larry Zimpleman testified before a congressional subcommittee on June 24 about the possible consequences of insurance underwriting by banks and offered Congress the Academy's help with the issue . Zimpleman told a receptive audience during a hearing before the House Commerce Committee's Subcommittee

on Finance and Hazardous Materials that insurance risk is often tremendously volatile . If banks do not maintain adequate reserves against that k, a large number of claims could drive them to,

insolvency, he said . "If Congas intends to protect the public from comparable solven- attached to the product or service b eing offered, and not to what that cy risks, it should establish reserving requirements and other solvency stan-- product or service is called," he said . "If a'debt cancellation contract' is condards for banks similar to those established for insurers on those products with tingent upon the death, disability, or loss of employment of the debtor, that a significant element ofinsurance risk,"he said . "Absent contract is essentially credit insurance and should b~ such reserves, the banks may be unable to pay policy- regulated as such ." holders' claims." NationalAssociation of Insurance Commissioners Zimpleman also told subcommittee members Vice President Glenn Pomeroy, who also testified at that the American Academy of Actuaries would be ," the hearing, told Congress that the NAIC's Special happy to assist Congress in its attempt to decide what` Committee on Banks and Insurance agrees with the regulation, if any, banks that underwrite insurance= # ' Academy on this issue, especially the Academy's dif should be subject to . "The actuarial profession is ferentiation between insurance risk and investment uniquely qualified to examine the various alternatives risk . to reform the financial services area, especially with Zimpleman suggested that Congress call on state regard to the tools used to manage insurance risk," he insurance departments to provide regulatory over said. sight to banks that underwrite insurance, or perhaps In addition, any regulation that is established establish a federal body to do so . Pomeroy agreed should require appropriate actuarial involvement in the with this suggestion as well, testifying that state deprojection and management of banks' insurance risk, part rrents have the experience and expertise necesZimpleman said, pointing out the importance ofactu- sary to do the job . "The state insurance depart-aries in the reserving process . Actuaries are "professionals experienced in the ments-not the office of the Comptroller of the Currency, not the Federal management ofinsurance risk," he said. Reserve, not the Federal Deposit Insurance Corporation, not the Office During his testimony, Zimpleman clarified to subcommittee members ofThrift Supervision, and not the Securities and Exchange Commissionthe difference between insurance risk and investment risk, which banks are are responsible for regulating the business of insurance," he said. more accustomed to dealing with . Very different skills are required to man- During the question-and-answer period that followed the testimony, age each of the two types of risks, and problems could arise if banks do Zimpleman had several more opportunities to offer lawmakers the Academy's not recognize those differences, he said . assistance, and reiterated the importance of actuaries to the process . The "Indeed, many property-casualty insurers that were more experi- House Banking Committee has approved a bill that would establish a counenced in projecting and managing insurance risk than banks failed or were cil offederal and state regulators to decide on regulatory jurisdiction for new pushed to the brink of failure as a consequence of the losses generated by products . In response to a question from Rep . Rick White (R Wash .), natural disasters like Hurricane Andrew," Zimpleman said Zimpleman urged actuarial representation on such a council . Another possibility is that banks will not adequately analyze or prop- Also testifying at the hearing were Arthur Wilkinson of the Illinois erly select the insured pool for a particular product, he said . "Banks are in- Bankers Association and Dino Gavanes of the Professional Independent experienced with the analysis and management of the risks involved with in- Insurance Agents of Illinois, who discussed a newly enacted Illinois law that surance . The insurer must project a range of loss factors in anticipation of represents a compromise approach to regulation of bank insuran ce sales . claims, and must be certain that adequate reserves are available to pay claims According to Wilkinson and Gavanes, the sharing of customer informaas they are made;' he .-Mesaid projection and management of insurance risk Lion was the chief stumbling block to achieving a bill acceptable to both is a complicated science ." bankers and insurers. Under the new law, large banks will be required to Zimpleman pointed out the problems that could arise if there are separate insurance marketing from their loan functions. different solvency or reserve standards for different entities that are engaging in the same business . Banks should be subject to the same standards as For a copy of Zimpleman's testimony, fax a request to Doreen Evans at 202insuran ce companies, he said . Different standards could create artificial 872-1948 . competitive advantages . "If the intent of Congress is to create a level playing field for all entities selling insurance, then functional regulation of banks' insurance activities should be based on the significance of the level of insurance risk

While Zimpleman was testifying before the Commerce subcommittee, Academy Senior Pension Fellow Ron Gebhardtsbauer spoke about Soda[ Security's future before a subcommittee of House Ways and Means . See page 4.

ACADE M Y FINANCIAL STATEMENTS New Investment Policy to Boost Academy Reserves

BALANCE SHEET DECEMBER 31. 1906 Assets: Current assets: Cash

5 411,354 1.286.500 1,627.444 91,524 24.552 127.151

Certificates of deposit Money market funds Accounts receivable Accrued interest receivable

Prepaid expenses Total current assets Certificates of depositLong term

Furniture . equipment, and leasehold improve.. net

53,568,525 1086.000 187.505 54,842,030

or the past two years, it has been my pleasure to serve the Academy as its secretary-treasurer. This role is a particularly IF gratifying one for me because it has re-

quired me to become knowledgeable about virtually every phase of the Academy's operations . This familiarity has impressed upon me the vital role that the Academy plays in our profession, as well as the dedication of the Academy staff and volunteers .

LIABILITIES AND FUND BALANCES Current liabilities: Accounts payable

S 198,998 1.646.117 79.930 X19.079 258,864

Deferred membership dues revenue Deferred revenue--other Accrued expertses

Deferred rent credit Total currant

I would like to apprise you, as members of the Academy, of the Academy's sound financial position . On this page, you will find financial statements and a functional allocation for the Academy's fiscal year ending


Fund balance (undesignated) Fund balance (AHED Litigation fund)

52.392 .979 52,364;100 84.951 54.842.130

SIAfEMENf OF REVENUE AND EXPENSES YEAR ENDED DECEMBER 31 .1996 Revenue. Membership dug Membership end ation fees Interest

Academy Alert subscriptions EA meeting distribution CLRS distribution Advertising income Service fees (ABCD 6 ASH) Magazine subscriptions 6 reprints Manual sales Other

53,803,655 27.675 223,527 102.090 1411,324 35.967 298,853 142.2111 1516 211,638 28,1137 54,836,483 4,470 .162

Expenses Excess (deficiency) of revenue over expenses

5 366.321

December 31, 1996 . Membership dues constitute the largest source of revenue for the Academy, representing over threefourths of revenue in fiscal 1996 . The functional allocation shows, on a per member basis, how much is spent in support of the Academy's Strategic Mission, "To ensure that the American public recognizes and benefits from (1) the independent expertise of the actuarial profession and (2) the adherence of actuaries to high professional standards in discharging their responsibilities ." In 1994, the Academy incurred significant costs in producing a range of cost estimates for the Clinton administration's proposed Health Security Act and a very successful series of health-care monographs that provided valuable information to federal and state policy makers . In response to this sizeable expenditure, the Academy's Board of Directors moved to bolster the Academy's reserves to be able to respond to similar needs in the future. As a result, the Academy's reserves have increased from $1,665,219 as of December 31, 1994 to $2,449,051 as of December 31, 1996 . This reserve amount represents 54% of 1996 expenses . Earlier this year, the Academy Board of Directors adopted an investment policy that segregates the *reserve fund into three categories: current operating funds, short-term investment finds, and Long-term reserve funds . The n adopted investment policy allows up to 80% of long-term reserve funds tnvested in corporate bong equity mutual funds . This change in investment policy should prove help the current reserve level and also mitigate any future dues increases . Finally, I would like to report that our auditor-(Thomas Havey, LLP) has rendered an unqualified opinion for the fiscal year ending December 31, 1996 .


1906 General Fund

Staff salaries

Employee insurance Payroll taxes Pension plan Temporary help 6 personal fees hot Telephone Postage and freight Committee meetings President 6 President-elect travel

General office supplies 6 equip . rental Printing Service agreement

Audit and accounting Insurance Depreciation and amortization Subscriptions and periodicals

Communications Affiliation fees Academy Alert Cnnfingencies magazine

Manuals Health Practice Council Pension Practice Council

Life Practice Council Casualty Practice Council Council an Professionalism [nterurganizatianal unison 3% Proftissianalism 3% Change in Reserves Communications 3% 23%

Actuarial Board far Counseling and 111scillilkw

Total General hold

$1.374,389 74,447 95,484 110.379 23,3911 269740 34,755 01,73 149,014 77,610 19.249 103,712 141.706 82.304 16,845 21.063 52A34 36.34'3 85.725 43.262 25.931 335.739 88.715 86.851 174.501 29.750 24,472 22,846 27.903 5.807 31.524 12.318

5139,649 7.563 9.7011 11713

$79.0 4,325 5,548 2,413

27,493 3,531 29.520 52,351 27.740

15.672 2,1119 4,454 54.539 12,824

16.536 98.826

6.025 I5.42D

1.711 2.140 5.327 3744

979 1.224 3.046 2.111


51.593.875 86,335 119,732 128.1105 23.390 312,815 40,305 145,687 255,904 113,174 19 .249 1211,273 255.952 B2.304 19.535 24,427 1111.807 42.204 85.725 43,262 25.931 335.739 88,715 86.851 174.5111 26,750 24.472 22.846 27.9[13 5.807 31 .524 12,318 9,771






$432.722 ,




Travel 6 related expenses


Actuarial Standards Board

Professional services

Standards notebooks Income taxes Loss an disposal of furniture/equip . litigation fund expense Other Total expenses


Medicare Solvency Minimum Age Federal solvency standards for Medicare provider service organizations (PSOs) currently under consideration by Congress might create undue risk to the public, Academy Health Vice President

Bill Bluhm told a House-Senate conference committee in a July 10 letter. The conferees met to craft a compromise between House and Senate versions of the Balanced Budget Act of 1997, both ofwhich would ease state licensure requirements for PSOs that serve Medicare beneficiaries. Under the

Senate Medicare proposal, PSOs would be allowed to participate in Medicare under minimum federal standards, with states allowed to impose more stringent standards after three years . In the House proposal, state regulations may be waived under certain circumstances for a three-year period . Traditional Medicare indemnity plans and HMOs would continue to meet state standards . Such a difference in regulatory requirements could endanger health plan solvency, according to Bluhm . "Different solvency standards give competitive advantages to organizations that provide the lowest degree of solvency protection," he wrote. "If Congress is

concerned about a level playing field for those participating in the Medicare program, it will be necessary to ensure that PSOs are subject to similar regulatory and solvency requirements as HMOs and traditional insurers:' Bluhm's letter also addressed other health-care provisions of the balanced budget legislation . Delaying Medicare eligibility to age 67, as proposed by the Senate passed version of the bill, would eliminate a small amount of the Medicare deficit but could boost employers' retirement health-care costs and lead to scaled-back coverage for early retirees, Bluhm wrote . A proposal in the House bill to expand small-employer health in-

surance coverage by promoting association health plans (AHPs, formerly known as MEWAs) could improve access only for the healthiest employees with favorable risk characteristics, according to Bluhm. In addition, features of the House bill that exempt AHPs from state regulation and impose solvency standards less stringent than those met by other insurers might encourage adverse selection and increase chances of health-plan bankruptcy. These bill provisions might "actually lead to higher insurance costs, through insolvencies and through pricing based on risk characteristics rather than the efficient delivery of quality medical care at truly lower costs;" Bluhm wrote .

Crafting Newt Century's Valuation Law .A Conversation with Rob ert Wilcox ast December, after four years of service as Utah insurance commissioner, Robert Wilcox returned to private consulting. However, he hasn't left regulatory questions behind . When the National Association of Insurance Commissioners Life and Health Actuarial Task Force (NAIC LHATF) requested that the Academy undertake a study of valuation for life and health insurers, Wilcox agreed to lead the Academy effort . Wilcox's task force is now midway through first phase consisting of a year long study of th ant valuation em and a blue-sky inquiry into an ideal s yste or today's insurance marke tplace. After a July task force meeting in Arlington,Virginia, the Update's managing editor spoke with Wilcox about the status of the project . How did the Academy come hi he involved in t e davalup f a now vafuefmn law? Over the few years, the Academy has proposed increasing assistance to the NAIC, most recently in developing a new nonfor feiture law. The LHATF decided that to fully implement the nonforfeiture law, it would be necessary to examine the valuation law as well. So the NAIC turned to the Academy once again . Our charge is to start from a blank sheet of paper. In other words, we are looking at the kind of system we ought to have without being constrained by how the valuation process has been carried out for the past 150 years.

The maw io nfarhâ‚Źhtm'e law was designed to accommodate nontraditional insurance products. Is this also the nmtivai behind the valuation project? Yes, to a great extent . The standard valuation law was developed around a generation ofproducts that are much simpler than those available today. Many insuranc e products now being sold, especially on the life insurance side, cannot be valued appropriately under the current valuation law For many products, such as universal life, regulators must interpret what they think the law really means . There are just no dear definitions in the law. The adjustments to the law that have been made over the years were merely patchwork attempts to solve each particular problem.

What has your task force achieved so far? In June, we presented a preliminary

report to the NAIC in which we identified three objectives that a valuation law should meet. First, a valuation should analyze a company's ability to continue in business under a range of conditions . Second, the adequacy of resources relative to obligations must be analyzed. And third, the valuation process should measure the asset level needed to give policyholders confidence that benefits will be paid . At our subsequent meetings, we have been working to refine the language in our final statement of objectives, which we are fairly close to achieving. Several subgroups are making progress on specific issues. The subgroup on taxation is developing methodology for measuring the impact on federal taxes of possible changes to the valuation law. Another subgroup is examining specific tools that will be available for a new valuation system when we get to the implementation stage. We also have an ongoing group looking at valuation in other countries, so that the task force can work on the ham of the best information available in the rest of the world .

Your June report outlines on approach that emphasizes verall company solvency rather than merely measuring reserves. Is this a shift from current practice? Yes . It represents quite a substantial difference. The current system virtually ignores assets and measures only liabilities. In recent years, cash flow testing also has been incorporated into the process . Now, we will be looking at virtually all the

How dues your task force treat the special circumstances of property/casualty and health insurers?

opinion--sometimes several times-

When we first received the request from the NAIC to undertake the study, it originated with their Life


and Health Actuarial Task Force, and we were asked to cover all aspects of life and health valuations . This certainly presented concerns about the special circumstances and particular products of each of these

resources that a company has available to meet its obligations . This is a much broader approach. We are also taking a new look at the audiences that rely on valuation information .Their needs ate simply not being met under the traditional reserves-only approach. We have a chance to be truly innovative in providing regulators, management, and policyholders with necessary information. The management of an insurance company needs to know not only its current financial situation but also if it can remain viable in the marketplace given the market strategy that it is pursuing. To a large extent, that is a new objective. The current valuation system is built around supporting the statutory regulation system .

What does the task force mean in its Joan report when It calls for a holistic approach to valuatam? A holistic approach looks at the viability of the entire entity, instead of at provisions for specific blocks of business .


lines of insurance, but since the work is proceeding from basic principles those concerns are being resolved as we move forward by having strong participation from each area. In June, the NAIC suggested that we increase involvement from the P/C professionals so that any recommendations that would have applicability to those lines would have been considered from that perspective. We had already included some participation from P/C actuaries because we thought they had approaches that could prove useful in our analysis . We are now seeking broader involvement of P/C actuaries in response to the expanded NAIC request . We encourage P/C actuaries, as well as members of the Academy and those of other disciplines who are interested in the project, to actively participate.

Your task force is pledged to operate through cam. Has this been difficult to achieve so far? It takes patience, but it is working relatively well. You have to go slow, let the task force members express their

and eventually nsensus emerges.


49 project is

attractin g anor-

mans interest among insurers and interest groups. Who is represented an the task force? Because we are charged to start from square one, it's important to have task force members who are capable of thinking outside the box, rather than representing specific interests. People who think creatively can help the process, and the question oftheir employers' interests is not an issue . Individuals with special expertise in investments as well as the perspective of the rating agencies have been participating . In addition, we ate working with individuals who can act as liaisons to outside special interests. Groups such as the American Council of Life I nsuran ce, Health Insurance Association ofAmerica, and National Association of Life Companies are participating through individuals who can provide special expertise . What is the timetable far your task farce? We expect to deliver an interim report in December that will outline our proposed concept. We then expect the LHATF to do some additional interpretation and offer guidance. This or a similar task force will then reconvene in 1998 to work on the implementation phase, which should prove to be the hard part.

Do you have a gual far final completion? It is probably ambitious to think that we can finish in 1998, but I'm certainly going to give it a try

14 1 VI 1 Ilt A A II IC70i

Actuarial Chickens Come Home to Roost


T he actuarial profession can be proud of those few in our ranks who have devoted their careers to the analysis of our country's social insurance programs . Several actuaries have decided to say nay when necessary, even at great cost to themselves. This select group includes two former chief actuaries of the Social Security Administration, Bob Myers and Haeworth Robertson. These distinguished actuaries often differ, sometimes vociferously However, they agree that in the aggregate the scheduled taxes and benefits of US . social insurance programs are currently out of actuarial balance, and that maintenance of the status quo is not a valid option for the baby boomers and subsequent generations . In his latest book, The Big Lie: What Every Baby Boomer Should Know About Soda Smsrity and Medicare, Robertson offers a comprehensive account ofthe looming failure of our most important social insurance programs. The Big lie is a small book, only 137 pages long, that can easily be read and even understood by the literate fiaction ouits intended audience, the baby boomer generation. Its ten chapters tell the story-the deceiving of the public, the six myths that make up Social Security's big lie, a call to action, the author's proposed solution to the problem, and finally a plan to make provision for one's own retirement years . Ten other sections provide supporting details and other pertinent information. While the public generally appreciates the benefits of the social insurance programs, how they operate is not well understood . For example, the very name of the withholding tax, the Federal Insurance Contribution Act, for decades has fostered the belief that accounts are maintained for each contributor . More recently, consider the Medicare demagoguery of the past election, and that Arizona and Florida gave their electoral votes to the demagogue Zwhose latest "solution" to the Medicare financing problem appears to be price controls) . Although Robertson correctly identifies politicians as the primary source of public misunderstanding about Social Security and Medicare, I believe he too often lets them off easy by accusing them of bad judgment rather than deception . The book's title is not, after all, The Big Misunderstanding . Furthermore, he almost completely lets off the hook a secondary but important group, namely, the media . The big lie would have been exposed long before the actuarial chickens started coming home to roost if there had been more insightful and enlightened reporting on the subject a generation or two ago . In the meantime, of course, the chicanery goes on . Recently. I attended a social insurance meeting where an official proposed to "balance" the Social. Security equation by reducing the long-term analysis period from 75 to 50 years. Presumably,I was supposed to then go home to tell my fiveyear-old daughter that the system had been saved and was in actuarial balance-but only for her taxes, not for her benefits . And this concerned only her pension-she'd better plan not to fall ill in her old age! The politicians have bequeathed an actuarial problem that has replaced the erstwhile USSR as the greatest threat to the survival of the United States as we know it. Their willingness to buy votes with the fruits of the labor of future generations will come back to haunt us all . Robertson knows this and knows how to explain why. The Big Lie is

that rarity, an essential book . With luck, perhaps it may serve as a paddle to help us to shore before we are swept into the social insurance cataract that is now within earshot.


Larry Zimpleman PRESIDENT--ELECT Allan M. Kaufman

The Big Lie is arar7ablefrom Rethement Policy Institute, BOX 53446,Was)th ton, DC 20009. --KILBOURNE IS A CONSULTING ACTUARY IN SAN DIEGO AND A MAN OP STRONG OPINIONS. Periodically, the Update publishes commentary on issues ofpublc concern.

Academy members may send their comments by e-mail to Jeffrey Spelcher at speirhwr@aauary. org or at theAcademy s Washington address.

Social Security Could Derail Balanced Budget Congress should not count on a Social Security surplus to help achieve long-term budget balance, Academy Senior Pension Fellow Ran Gebhardtsbauertold the House Ways and Means Subcommittee on Social Security at a June 24 hearing . "At pr at Social Se urityls tax income exceeds its outgo by $30 billion, which helps the federal deficit look lowerthan it actually is; said Gabhardtsbbauec " This $30 billion annual surplus starts to decrease around the year 2008, which is avztly when the baby boom generation starts to retire . By 2012, Social Security's tax income will than it pays out" he added . At the subcommittee's request Gabhardtsbauer also commented on the recent Social Security Advisory Council recommendations "All three options solve the fa nancial problems of Social Security for the upcoming 75-year period and maintain a stable trust fund at tine and of that period," said Gebhardtsbaue , "but it is not sufficient just to put Social Security back in actuarial balance over the next 75-year period. If that is the only action Congress takes, than in 20 years there could be another crisis . This is because , as future deficit years get included in the 75-year period, the system gets out of balance a little each year," he said. In Gebherdtsbauer's two-hour appearance before the penal, he was questioned by committee members interested in the actuarial point of view. In response to a question from Rep . Jon Christiansen (R-Neb,) on possible equity investment of Social Se unity fu s, Gebhardtsr auer noted that successful examples of federal involvement in the equity markets can be found at the Pension Benefit Guaranty Corporation, which employs an independent investment manager, and the Federal Employees Thrift Plan , which invests in funds indexed to overall market performance. However, the immense scale of Social Security's investments--trillions of dollars--could lead te market distortions or government interference in corporate decision making . Rep. Sam Johnson (R-Tea) asked whether the Consumer Price Index should be the measure for Social Security cost-of-living increases . Gabhardtsbauer replied that the Academy takes no positions on policy questions but would be happy to assist in developing another inflation yardstick if asked by Congress . Gebhardtsbauer also emphasized that Social Security reform could have unintended consequences for employer-sponsored pension plans. He suggested fisting employer-based plans could be protected by waivers from added Social S contributions . Gebhardtsbaue r's comments draw praise from Rep. Rob Portman (R Ohio), who agreed that the effects on private pensions should be considered in the debate on Social Security individual accounts.

VICE PRESIDENTS Vince Amoroso William C Bluhm Arnold A . Dicke Ken W Hartwell Barbara L . Snyder_ Michael L .Toothman SECRETARY- TREASURER Kerb -

EXECUTIVE OFFICE The American Academy of Actuaries 1100 Seventeenth Street NW 7th Floor

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Bob Mrax an Rewriting the Valuation' Low Social Security and the 'Balanced Budget

Enrrox Adam Reese AssocxATE EDITORS William Carroll Ronald Gebhardtsbauer Patrick J .. Grannan MANAGING EDrr0R Jeffrey Speicher speicher alactuaryorg_. CONTRIBUTING EDITOR Ken Krehbiel PRODUCTION MANAGER Renee .SaundersStatements of fact and opinion in this publics ty ding editorials and-letters to the-editamade on the responsibility of the authors alone and do not necessarily imply or represent the position of the American Academy ofActuaries, the editors, or the members embers of the Academy. Š1997The American Academy of Actuaries . All Ri is Reserved

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August 1997 Actuarial Update