December 1991 Actuarial Update by Lou Baccam

eAcuaf ial Upda e t

VOLUME 20 NUMBER 12

In this issue

AMERICAN ACADEMY OF ACTUARIES

DECEMBER 1991

The U .K . Government Actuary's Day in Washington by Jeanne Casey

Editor's Notebook

Standards Outlook

AICPA Seeks to Apply SFAS 106 to Multiemployer Plans

Changes on the Horizon at A.M . Best

Checklist of Statements

Annual Meeting Report : Practice Councils

ASB Clarifies Issues Regarding Statement on Cash Flow Testing

Enclosures Included in this month's issue of The Update are the following: • Government Relations Watch • In Search Of . . . • ASB Boxscore • Exposure Draft of Revised Version of ASOP No. 10 Exposure Draft of Actuarial Compliance Guideline for SFAS 106

In late October, Chris Daykin came to Washington, D .C . to talk to congressional staff about the appointed actuary system in the United Kingdomsomething he knows a lot about. He heads the Government Actuary Department, which in the U .K. is identified as part of the regulatory system . "We have a written agreement with the Department of Trade and Industry, the actual regulators, whereby we undertake to carry out the financial monitoring of companies. That's our job," said Daykin in an informal interview at the Sheraton Carlton Hotel in Washington . And a big part of that job is keeping in touch with appointed actuaries throughout the U .K. "We encourage an informal relationship," said Daykin . "They ring us up and we ring them up ." When there are financial problems within a company, the com-

House Energy and Commerce Subcommittee on Oversight and Investigations . Over the past year, this subcommittee, chaired by Representative John Dingell (D-MI), has held hearings on life insurer solvency . According to Academy Executive Vice President Jim Murphy, who had accompanied Daykin to the day's meetings on Capitol Hill, Chesson wants to learn more about the appointed actuary system In the U .K.in particular the clause that requires the appointed actuary to report to the regulator if company management is not heeding the actuary's warning or recommendations . Over the course of the day. Daykin also met with senior staff for the Congressional Research Service and Moses Boyd, counsel for the Senate Energyand Commerce Subcommittee on Consumer. In each of these informal meetings, Daykin Daykin, Hendricks, and Murphy relax after the talked about the day's "skirmish on the HILL " U .K.'s appointed

pany's actuary may be under pressure not to talk. DaykIn noted that actuaries in such straits "are really on their professional mettle-they have got to decide at what stage they're no longer able to do their job because of the way management is or isn't responding ." It is just this relationship between the appointed actuary and the regulator, or "supervisor" as the role is called in the U .K ., that congressional staffers in the United States are interested in learning about .

Earlier that afternoon, Daykin had met with Jack Chesson, counsel for the

actuary system, a system that has existed in its present form for the past eighteen years . For this interview, however, Academy Director of Government Information Gary Hendricks wanted to take a different tack: "I've heard now-for an evening and a day about the glories of the U .K .'s appointed actuary system . What's wrong with it? What doesn't work so well?"

Without much hesitation, Daykin mentioned four ways in which the U .K. system could be improved upon . (continued on page 4)

The Actuarial Update

of Actuarics President Harry D. Garber President-Elect John H. Harding Vice Presidents Robert H. Dobson R. Stephen Radcliffe Richard H . Snader Michael A . Walters Larry D . Zimpleman SecretaryPrreasurer Thomas D . Levy Executive Vice President James J . Murphy Executive Office 17201 Street, N .W. 7th Floor Washington, D .C . 20006 (202) 223-8196 FAX (202) 872-1948 Membership Administration Woodfield Corporate Center 475 N. Martingale Road Schaumburg, Illinois 60173-2226 (708) 706-3513

Chairperson Committee on Publications Roland E . King Editor E . Toni Mulder Executive Editor Erich Parker Associate Editors Gary D . Lake Stephen A. Meskin Charles Barry H . Watson Managing Editor Jeanne Casey Contributing Editor Ken Krehbiel Production Manager Renee Cox

American Academy of Actuaries 1720 I Street, N .W. 7th Floor Washington, D .C . 20006 Statements of fact and opinion in this publication, including editorials and letters to the editor, are made on the responsibility of the authors alone and do not necessarily imply or represent the position of the American Academy of Actuaries m the editors, or the members of the Academy.

by Charles Barry H . Watson

Notes from an Actuarial Tourist In caseyou had not noticed, the actuarial profession in the United States is taking on a decidedly international look .

By this is meant something much larger than the long-standing liaison with our Canadian actuarial colleagues . Look at what has happened over the past few years, almost without our knowing it . An organization has been set up . First, the Society of Actuaries established a Committee on International Relations . Not to be outdone, the Academy set up a Committee on International Issues . Raising the ante, the Society has just authorized the establishment of an International Section .

Meetings have proliferated . Almost every program held by an actuarial body in the United States during the last five years has featured one or more sessions devoted to international (non-Canadian) issues, even the august and normally inward-focused Enrolled Actuaries Meeting. This flurry was capped off by the devotion of the 1990 Society of Actuaries Annual Meeting to an exploration of international opportunities (for life insurance companies and their actuaries, as might be expected) . The publication of material has followed apace-articles in TheActuarial Update and The Actuary, and a spasmodically regular "Foreign Correspondence" department in Contingencies. Even a collection of actuarial international experiences entitled "Letters from Abroad" appeared as part of the support mechanism for the 1990 Society Annual Meeting . Attention should also be given to educational activities . The Society of Actuaries has gradually assumed the burdens of actuarial empire from the Institute of Actuaries and the Faculty of Actuaries, particularly in the Pacific Rim countries, and has even granted "most favored nation" status to mainland China by sponsoring an actuarial training program in that country.

All this activity Is impressive and, viewed from this writer's perspective of over twenty years' involvement i International actuarial practice, Ion overdue . (Of course . I am an employee benefits consultant and so find the relatively single-minded. concentration on life-company issues somewhat annoying, but something is better than nothing.) However, what does it all add up to? What inspires it, and what does it portend for the future?

Why have the Academy, the Society of Actuaries, the Casualty Actuarial Society, and the other North American societies-none of them (with the possible exception of the Canadian Institute) previously noted for their internationalist fervor decided to dip their toes (no, entire legs) in foreign waters? There appear to be a number of reasons : some professional, some personal , and some profitable ; some reactive , and some (to use an unfortunate turn of phrase) proactive . Look first at the profit-related motives . (Actuaries are, after all. employees/consultants of business organizations .) ∎ Business opportunities abou abroad, for both insurance organizations and consulting firms . North American know-how is an advantage, but knowledge of the local scene is essential. Involvement by the professional societies can help . ∎ Competition from overseas business entities is growing (the reverse side of the coin), through increased product sales , purchases of domestic organizations, and mergers . In combating this challenge, you have to know the enemy to fight him . ∎ Competitive position vis-a-vis North American rivals for overseas business is strengthened by multinational alliances-insurance networks and consultancy chains . Turn next to professional issues. These are more up-front, but are actually more subtle in their implications.

∎ Our profession is small ; cooperation with foreign societies strengthens us, and them. ∎ We can learn from other societies (better to put our backs to the wl than to re-invent it.) The valua actuary concept was not "made in North America."

∎ As economic blocs develop (EC 1992, Pacific Rim, free-trade zones), we desire access on equal terms with our foreign

December 1991 counterparts (i.e ., another level playing field) . This requires cooperation . Certain matters of turf intrude . To blunt, we tend to view ourselves as e imperial successors to the Institute

and Faculty and wish to position ourselves to achieve this . (Oddly, this is not an uncontested notion .) ∎ Certain philosophical issues divide the actuarial societies. One line of demarcation is found in the control of education/accreditation : professional society or academia? Another lies in how the products of our professional work are controlled : government regulation or professional responsibility? The divisions are countryspecific and are in large measure linked: academia-based societies are usually government regulated . (The system in the United States, however, is a hybrid .) Theseareimportantissues, andweshould take a proactive (i) position on them . Finally, personalities do matter . Certain presidents and other influential actuaries, by inclination orwork habits, have advanced the cause of internationalism . Well, there we have it : a significant and growing international involvement by the North American bodies . This is positive development, and it should encouraged . There are, however, certain areas where caution needs to be exercised . ∎ Our experience and traditions should be presented for evaluation, not rammed down the throats ofothers . There should be no PaxAmericana, or new (American) global order, in the actuarial profession . ∎ We need to seek, and practice, reciprocity. The ability to carry on our craft freely in other countries, subject only to demonstrated knowledge of the local environment, is the goal that we, as a profession, should pursue .

∎ As a corollary, we belong to a growing free trade bloc, in which services will inevitably be affected . Extension of actuarial free trade to Canada has presented no problems . However, extension to Mexico will require careful, considerate statesmanship on ourpart . ∎ Finally, we must shoulder our responsibility as world citizens . The actuarial profession has much of value to offer to developing countries, and we should be willing to offer educational and training facilities, as well as the e_nefits ofour experience in these areas . But gently, and in all humility. Watson is associate editor of The Actuarial Update. He is a consulting actuary with The Wyatt Company in Washington, D.C,

∎

C "M

Standards Outlook by Christine Nickerson

The Actuarial Standards Board (ASB) reviewed a lengthy list of projects at Its final 1991 quarterly meeting . Meeting on October 8-9 in Dallas, the ASB considered several proposed standards and various administrative Items. New Board and Committee Members As a first item of business, the board approved members of the operating committees for 1992 . Operating committee chairpersons for 1992 are : Michael J . Miller, Casualty Committee ; Robert W. Haver, Retiree Health Care Committee ; Paul F . Kolkman, Life Committee ; Stephen G . Kellison, Specialty Committee ; Mary Hardiman Adams, Pension Committee ; Jerome A . Scheibl, Editorial Advisory Committee ; Ted A . Lyle . Health Committee ; and Bartley L. Munson, Long-term CareTask Force .

The ASB also welcomed Richard Robertson to the board . Robertson was appointed to replace Walter N . Miller, whose second term on the board expires in December 1991 . Willard Hartman and P . Adger Williams. whose first terms expire at the end of 1991 . were both appointed to a second three-year term on the board . JackTumquist will replace Walter Miller as ASB chairperson ; vice chairpersons for 1992 are James Hickman and P. Adger Williams .

Life Insurance Harold Ingraham, outgoing chairperson of the Life Committee, presented a revised version of Actuarial Standard of Practice (ASOP) No. 10, Methods and Assumptions for Use in Stock Life Insurance Company Financial Statements Prepared in Accordance with GAAP. The revised version of ASOP No . 10 incorporates material previously contained in Financial Reporting Recommendations 1, 5, and 6 and their accompanying Interpretations and would fully replace these documents . Because the material taken from the financial reporting recommendations was condensed and paraphrased when it was added to ASOP No . 10 . the Life Committee recommended the revised version of the standard be exposed . The board agreed with this recommendation and approved release of the document as an exposure draft .

Ingraham also updated the ASB on revisions to Financial Reporting Recommendation 7 . Statement of Actuarial Opinion for Life Insurance Company Statutory Annual Statements . This document is being revised to provide guidance for meeting the requirements of the new Standard Valuation Law-particularly with respect to asset -adequacy analysis. A special task force within the Life Committee has been formed to undertake this revision . The task force hopes to complete its work early in 1992 and to have an exposure draft ready for the ASB to review at its April meeting .

Actuarial Appraisals The ASB voted to adopt the proposed standard of practice for actuarial appraisals . It was presented to the board by the chair of the Actuarial Appraisal Task Force, Robert Shapiro. The purpose of the standard is to describe the considerations that bear on the actuary's professional work when performing actuarial appraisals . It prescribes appropriate procedures for performing actuarial appraisals and for documenting assumptions and methodologies in an actuarial report. The board suggested various changes to the document, including clarifying the definition of the term "actuarial appraisal" in order that it not be limited only to statutory appraisals . The standard is scheduled to be distributed with the January 1992 Actuarial Update. . (continued on page 8 )

The Actuarial Update

4 DAY IN WASHINGTON (continued from page 1) First of all, there is no process whereby the profession can screen for actuaries who are best suited to be appointed actuaries . The present law allows any fellow of the Institute of Actuaries (in England) or the Faculty of Actuaries (in Scotland) to become an appointed actuary . But, as Daykin points out, "the primary quality one would want in an appointed actuary isn't technical skill , but the ability to stand up to aggressive management and to be a presence in the board room . "Not every actuary has that," he acknowledged, and "there is no process whereby the profession can decide which actuaries are best suited or not . It's almost a process of trial and error ."

But according to Daykin, there is now an agreement between the Department of Trade and Industry and

the professional bodies to introduce an appointed actuary practicing certificate . Daykin noted that the profession would then be able to remove an appointed actuary from the position, simply by removing the practice certificate, leaving the actuary free to practice in other areas. A second drawback being addressed is the fact that "the law really doesn't say anything about what the appointed actuary has to do, other than to produce an annualvaluation ." Daykin explained that the agreement reached in 1973 called on the profession to fill in the gaps with professional guidance .

To date, professional guidance has included such things as, "The actuary has responsibility to ensure that the board receives the report." "What's now to he done," said Daykin, "is that the actuary is going to have to certify . . . to the supervisor [regulator]

AICPA Seeks to Apply SFAS 106 to Multiemployer Plans by Stephen Meskin On September 5, the American Institute of Certified Public Accountants (AICPA) issued an exposure draft of a proposed statement of position (SOP) that could have a significant impact on multiemployer health and welfare funds . The SOP, "Accounting and Reporting by Health and Welfare Benefit Plans," would require plans to measure their accumulated postretirement benefit obligation (APBO) in accordance with Statement of Financial Accounting Standards (SFAS) 106 .

Currently, SFAS 106 applies to employers rather than to plans ; plans do not have to accrue an annual expense forpostretirement benefits, and no portion of the APBO appears on the plan's balance sheet as a liability. Plans merely have to disclose the APBO in a note accompanying the financial statements .

"Clarification " or Significant Change? In a separate but related matter, the SOP also clarifies that all benefit obligations, including claims due and payable, premiums due, claims incurred but not reported, and accumulated eligibility credits are not plan liabilities . Even so, these obligations must all be measured and disclosed in the same note as the APBO . Some would say that this "clarification" of SFAS 106 constitutes a significant change in plan accounting .

If a plan does not follow the SOP, then the financial statement does not satisfy generally accepted accounting principles (GAAP), and the accountant has to say so in a qualification to his or her opinion . The proposed effective date of the SOP is for plan years beginning after December 15, 1992, with a two-year extension for small plans . The time table is the same for complying with SFAS 106 . However, "financial statements of prior plan years are required to be restated . . . if presented together with financial statements for plan years beginning after December 15, 1992 ." (See SOP, page 20 .) Thus, for a calendar-year plan that presents the immediate prioryear in Its financial statements, a measurement of the APBO will be required for December 31 . 1992 . The Academy's Committee on Health and Welfare Plans submitted comments to the AICPA, which will be reviewed, along with other comments, by the AICPA's Employee Benefits Committee, November 15 . Meskin is associate editorfor The Actuarial Update . He is v cepresident and actuary with Martin E. Segal Company in Washington . D.C .

that the guidance notes have been compiled with by the company ." Thirdly, although the appointed actuary system is well established, "n-0 all boards of directors, not all nonactuarial management , are fully aware of the appointed actuary's role." Daykin noted that the Institute of Actuaries has created a small booklet outlining the role of the appointed actuary for distribution to CEOs as well as every appointed actuary in the U .K. The fourth and final Improvement to the present system involves the Government Actuary Department itself, said Daykin . "We decided to adopt a much more proactive supervisory role . . . not just looking at [financial] statements, which Inevitably give a rather out-of-date picture, but visiting the company and talking with the CEO and senior management staff, and with the appointed actuary and actuarial staff, about the strategic direction of the company . . . where the company is going, what its strengths and weaknesses are . . . and how the actuary ensures that the necessary checks and balances are in place ." Daykin is optimistic, although tentatively so, as to how much currency the U .K.'s appointed actuary syste will gain with the advent of the Europeai Community. '

"It is probably foolish of us to anticipate that everyone else will adopt our system, but we do believe that we have developed a very good system . It works in the competitive market which most of the other countries haven't had . They've had much more closed, very . protected markets . If we can build something similar on the property/ casualty side, I would feel very comfortable with our regulation being applied throughout Europe," said Daykin . In closing, Hendricks asked Daykin if he had any particular impressions about the U .S. system from "today's small skirmish on the Hill ." Daykin responded, "I have been coming to grips with an understanding of the American system for a number of years now . I feel that I am beginning to understand certain elements of it . It inevitably remains something of a mystery to an outsider . "I was appreciative of the interest of some of the people we met today, and Imk think most challenged by Jac. Chesson's throwing down the gauntlet a challenge to the profession to help them come upwith aworking solution." Casey is Update managing editor.

December 1991

Changes on the 41orizon at A X Best by Jeanne Casey "A.M . Best Is going to be tightening its belt a notch or so," said Larry Mayewski, vice president of the company's lifehealth division . Although the rating company has always looked at insurers' assets and liabilities under normal maturation and even stress cycles, never has Best evaluated companies' ability to withstand "nuts on the bank ."

Recent developments In the life insurance Industry, specifically the regulatory takeovers of Executive Life, First Capital Life, Fidelity Bankers Life, and Mutual Benefit, have spurred A .M . Best to alter its approach to rating analysis . Best's ratings for these companies were A, A-, [A+c, and A+ respectively one year before regulators took them into conservatorship to forestall large numbers ofpolicyholders cashing out their policies . Some analysts fau]tA.M . Bestfornot having given policyholders adequate warning of these company failures . There are really two issues involved in

is charge . What were the underlying risks associated with each company's assets, which precipitated the decline in confidence in the company? and, Should A.M . Best have been able to signal that a company was in trouble before public confidence declined? A statistical analysis of Best's ratings, "Life Insurance Company Ratings ; How Reliable Is A.M . Best?" by Lee Slavutin (Financial & Estate Planning, August 1991) . is critical of the predictive value of Best's ratings as compared with Moody's and Standard & Poor's (S&P) bond ratings . Slavutin observes that of the 269 companies rated A+ in 1981, 7 companies failed within 10 years . Bonds with Moody's and S&P's highest ratings for that period never approached that failure rate of 2 .6% . "A.M . Best has not discriminated among A+ companies in very different financial conditions and gives out its A+ rating to the larger carriers more easily than Moody's, S&P. and Duff and Phelps give out their top ratings," Slavutin concludes . (He acknowledges that this comparison is based on the premise that insurance

npany and bond ratings are equivalent.) In fairness to A .M . Best, the data Slavutin compiles also show that only 5% of the 98 rated companies that failed between 1975-1991 had had a

5 rating above B- one year before they failed. (Half of all failed companies were not rated .) The question remains whether a downgrade one year or less before a company fails is adequate warning . Perhaps to debunk the notion that Best's ratings are Inflated when compared to S&P's and Moody's . A.M . Best Vice PresidentJackSnyder pointed out that Mutual Benefit had investment-grade ratings (BBB or better) from all three rating agencies at the time it went into receivership. "We're not rating on a bell-shaped curve ." said Mayewski . "Why do we have so many A and A+ ratings? We set standards that companies have worked hard to achieve ." He suggests that rating downgrades reflect the tougher economic environment in which these companies are operating and investing. In the current environment , It seems that a company's long-term viability depends, at least in part, upon its quick liquidity-its ability to satisfy cashvalue surrenders . Liquidity has always been considered for purposes of rating a company, according to Mayewskt . Now, A .M . Best plans to add a new factor to its qualitative rating analysis to better measure a company's quick liquidity, its ability to respond to quick calls on its assets .

Policyholder Confidence Factor An August 2 press release reported that A.M. Best's "policyholder confidence factor will be used to closely evaluate the potential Impact ofdemand-deposit type products, such as annuities and guaranteed investment contracts (GICs), on an insurer's financial stability." To determine this factor for each company, A .M . Best will be soliciting additional information for the company's qualitative review . For one thing, "companies will have to provide more specific data about the process they go through in coming up with market-value adjustments," noted Mayewski . This information now comes up In Best's interviews with company management. Additional information on the level of business in surrenderable liabilities is gathered from financial statements and interrogatories : What are the sizes of the annuities and contracts? How are the contracts distributed-through brokers? What are the risk features of the products? How many ways are there to cash them out? What are the penalties?

F-----------November 1991 I Checklist of Academy Statements a PS-91C-11 Summary of Meeting of Academy, AICPA, and NAIC on P/C Blank Instruction 12 U PS-91L-4 Life Financial Reporting Committee Comments on Present Value- based Measurements In Accounting U PS-91P-3 Comments to DOL on Fiduciary Standards for Selecting Pension Annuity Providers

U PS-91H-7 Comments on AICPA Statement of Position on Accounting/Reporting for Health I and Welfare Plans I

L- ------------ 1 When asked what effect this new confidence factor would have on company ratings, Mayewski commented, "Right now, we do not expect many or dramatic rating downgrades due to this qualitative factor ." He emphasized that A.M . Best had no intention to divide the industry into two types of companies : "those that can withstand a run and those that can't." Insurance companies are "in business to handle long-term obligations," observed Mayewski . To assume that an insurer is sound only if It can satisfy an immediate, significant call on its assets runs contrary to the role of the industry, he said . The new factor wouldn't be applied "in a fashion that creates an image that this company can't withstand a run," he emphasized . When asked how Best would ensure that downgrading a company's rating didn't become a "self-fulflllingprophecy" by prompting a drop in policyholder confidence, Mayewski said that there "has to be public acceptance that [for Best] to downgrade a company from A+ to A doesn't mean it's not a strong company." He said that A . M . Best would try to articulate reasons for the downgrade so as not to incite undo concern . The potential for media attention triggering a decline in policyholder confidence will also be weighed In the new ratings, according to Snyder and Mayewski. Best's rationale for including this as part of the new policyholder confidence factor is that if a company (continued on page 71

The Actuarial Update

1991 Annual Meeting Report: Practice Councils either in written form, or as oral testimony , as appropriate . Current issues of concern to the committee include: Two committees report to the Life Practice Council : the Committee on Life Insurance, which is chaired by Phil Polkinghorn, and the Committee on Life Insurance Financial Reporting, now chaired by Arnold Dicke. The Joint Committee on the Valuation Actuary will be terminated this fall. Issues regarding the valuation actuary will be transferred to the Committee on Life Insurance Financial Reporting .

Committee on Life Insurance The Committee on Life Insurance monitors legislative and regulatory activities in the life insurance area . The committee may prepare statements on life insurance issues for dissemination to the membership or for submission to appropriate organizations, both governmental and private . Issues on certain specialty subjects, such as financial reporting and risk classification, are generally referred to those committees for action . Issues to be discussed at upcoming meetings include : ∎ Monitoring regulatory activity : Items discussed in the past have included Guideline XXX on deficiency reserves and special state requirements that have arisen . ∎ Examining sales illustration practices : There will be continued examination of the smoothness test contained in the Standard Nonforfeiture Law. ∎ Miscellaneous Commissioners' Annuity Reserve Valuation Method (CARVM) issues : This includes looking into cliff surrender charges, variable annuities, index annuities, change-infund methodology, and interest rate classification .

Committee on Life Insurance Financial Reporting The Committee on Life Insurance Financial Reporting monitors financial reporting activities related to life and health insurance. It reviews proposals made by various governmental and nongovernmental organizations that could affect accounting practices vis-avis life and health insurance companies . The committee prepares analysis and recommendations that are presented

∎ Development of risk - based capital formulas and asset valuation reserve . Any new model Standard Valuation Law needs to be coordinated with the risk-based capital approach . (Look for more on the risk-based capital concept in The Update in the months ahead .) ∎ The F inancialAccounting Standards Board's efforts to mark asset values to market values will be monitored . It will be important to tie assets to liabilities in this process .

∎ The Actuarial Standards Board may develop additional standards for the valuation actuary. A new version of Financial Reporting Recommendation No . 7 : Statement of Actuarial Opinion for Life Insurance Company Statutory

The Casualty Practice Council, which met during the Annual Meeting, reviewed Its present qualifications process and discussed how to fine-tune the application form . As assessed by Academy Vice President Michael Walters, the key problem is that many applicants do not fill out the form properly . In order to approve an actuary as qualified to sign loss reserve opinions, the council must determine whether the applicant has learned what he or she needs to know to assess loss reserves properly. In particular, can applicants show that they have understudied for three years with a qualified actuary? In reviewing the form and process, the council also took a global perspective . For example, if a European actuary applies to the Academy for membership and seeks qualification from the Casualty Practice Council . should the same requirements apply? And if the Academy denies a foreign actuary qualification, how might that bode for U .S . actuaries applying to work in the new European community? Although an extremely tough issue, council members were cognizant of its ramifications, since European countries have a different set of environmental problems than the United States, -which means

Annual Statements will include the concept of asset adequacy. ∎ The committee will provide mor specific information on solvency an liquidity Issues to the Forecast 2040 program in 1992 . ∎ The Pension Benefit Guaranty Corporation's brightlining for pension plans is another issue . One question is whether the valuation actuary should offer an opinion to pension-plan sponsors . ∎ Regarding FASB's thoughts on interest methods for discounting, there needs to be consistency between casualty and life insurance practices. In the past, the Committee on Life Insurance Financial Reporting has primarily addressed generally accepted accounting principles (GAAP) issues and therefore has been oriented toward stock companies . With the current concern about solvency and liquidity In the industry, the committee will be concerned with issues that are important to both stock and mutual companies . Q

different loss reserve considerations (i .e ., Britain does not have a serious asbestos problem, and France's manufacturin regulations and requirements are mucfe less stringent) . One council member noted that the International Relations Committee of the Casualty Actuarial Society is looking into these kinds of questions as well .

Investigate insolvencies In a report from David Hartman. chair of the Committee on Property and Liability Financial Reporting, the council learned ofa pending update to the 1990 study of effectiveness of casualty loss reserve opinions. Hartman was pleased to advise the council that, unlike the first survey in which not all state insurance departments responded, all states responded to the committee's requests for information this time . He also said that this survey appears to support the initial one's findings that actuaries are Involved in less that onethird of all insurance company Insolvencies . The discussion of the survey led the council to Informally approve a recommendation that the new Actuarial Board for Counseling and Discipli investigate all Insurance company insolvencies, effective with 1991 insolvencies . Council members said the Academy and the profession have an obligation to follow up on Insolvencies .

December 1991 Other Business In other business, the council scussed the need to develop and 4egularly update a database of state laws and regulations that affect insurance in general and loss reserves in particular . The council also discussed developing standard wording for nonstandard opinions, which could be promulgated through the same process that theActuarial Standards Board uses for its materials. Walters also noted that council members need to be aware of the fact that . the National Association of Insurance Commissioners' profit liability formula for 1989 is not calculated properly, but he added that the miscalculation is more of a ratemaking issue .

Academy Vice President Larry Zimpleman was ringleader for a freewheeling discussion of the myriad issues facing actuaries involved in ension practice and social insurance . e dozen actuaries in attendance eluded Rowland Cross from the Internal Revenue Service (IRS) and the newvisiting actuary at IRS, Joan Weiss ; JoeApplebaum from the Department of Labor ; and representatives from the various pension committees : Mary Riebold (Conference of Consulting Actuaries) and Bob Guarnera (American Society of Pension Actuaries) . Jim Turpin represented the Academy's Pension Committee .

Steve Kellison, chairperson of the Academy's Social Insurance Committee, was first up. He outlined his committee's activities briefly, acknowledging that attendees were probably more interested in pension topics . The committee's projects over the past year included work on proposals for Medicare (Part B) cost projections, review of the three Social Security Advisory Reports, and the drafting of a proposed standard of practice on social insurance for the Actuarial Standards Board (ASB) . Several in attendance were eager to discuss the fact that the chief actuary AL r the Health Care Financing iniitratinn, Guy King, had qualified s opinion and that the public trustees for Social Security had taken issuewith his doing so. Kellison noted that it was

unprecedented for the public trustees to come out against the chief actuary in this way . Weiss commented that it may be important to clarify what' s at issue in this matter for the public . Turpin pointed to the value of having standards .of practice that could alleviate pressure on actuaries to use dictated assumptions . Riebold reported that the pension committee for the Conference of Consulting Actuaries had decided to divide in two-with half its members "infiltrating" the Academy's public interface committees, and the other half planning the Conference' s annual meeting . She referred to the Council of Presidents' Working Agreement, which limits the scope of the Conference and Society of Actuaries in dealing with issues external to the profession-a role delegated to the Academy in the United States . The Conference's committee will continue to focus on education and research . Guarnera, president-elect of ASPA, reported thatASPAhad given testimony on pension simplification . The testimony argued for eliminating Internal Revenue Code Section 415(e) on the grounds that the Section 404 and Section 415 limits make 415(e) duplicative . In addition, ASPA is developing criteria for certification of defined-contribution plan practitioners, akin to the enrolled actuary certification . This work is deemed important because of the explosion of 401(k) plans and age-based profit-sharing plans . Reporting on the Academy's Pension Committee, Turpin outlined the committee's activities: work on pension simplification, joint testimony with ASPA (by Ed Burrows) on proposed separate-line-of-business regulations, a survey on plan terminations, testimony before the IRS and Treasury on the 401(a)(4) proposed regulations, and testimony at the ASB hearing on shutdown benefits . The committee has also been monitoring the small-plan audit program . Turpin said that the reason the Pension Committee has not issued a statement on the small-plan audit is because its members have not reached consensus concerning Schedule B assumptions . Zimpleman identified a new issue for the Pension Practice Council to follow up on in the coming year : the issue of guidance for pension plans investing in insurance company annuities, given recent Insurer insolvencies .

Reports on the Health Practice Council and the Council on Professionalism will appear in the next Update .

CHANGES ON THE HORIZON ATA.M . BEST (continued from page 5) has a high media profile and is experiencing difficulty, that in itself can expedite a run . Asked whether making the actual rating media-sensitive might not make the rating more reactive than predictive, Mayewski answered that Best's analysis would consider that questionapparently on a case by case basis . In such cases, the rating agency would ask "Has media exposure gone to the point where no matter what happens to a rating, the company is still in a downward spiral?" in other words, Best would hesitate to downgrade a company precipitously on the basis of its media profile alone .

Risk-Based Capital Model Risk-based capital models are designed to evaluate the relative risks associated with a company's investments and products . .A M. Best Is developing a risk-based capital model, which, along with the policyholder confidence factor, will be incorporated into Best's yearend ratings . Among other things, A .M . Best's risk-based capital model looks at the size of a company's individual Investments . their diversification, and characteristics of Its loans and mortgages (e .g ., the geographical spread of loans, whether or not mortgages are FHAsecured) . The National Association of Insurance Commissioners (NAIL) and its industry advisory groups are developing a risk-based formula also . Although aware of the NAIC's and other organizations' efforts to develop riskbased measures for evaluating an insurance company 's asset mix (Moody's has already developed such a formula), Mayewski believes analysts at A.M . Best "can bring more to the playing field from our experience ."

At this time, A .M . Best has no plan to go public with its model . Mayewski commented, "We're hesitant to just slap a formula out there . We haven't crossed the bridge as to whether we'll make [it] public . But we will discuss It with company management during a company's qualitative review ." The real question for actuaries and policyholders is whether these changes will enhance A.M . Best's ratings as predictive measures of a company's long-term financial strength in the current economic environment . In truth, only time will tell . 6

The Actuarial Update

ASB Clarifies Issues Regarding Statement on Cash Flow Testing in Actuarial Opinion by Walter N . Miller and Jack M. Turnquist Two important questions have arisen on interpretation of Actuarial Standard of Practice No . 14, When to Do Cash Flow Testing for Life and Health Insurance Companies. Should Disclosure Regarding Cash Flow Testing Appear in the Actuarial Opinion? The Actuarial Standards Board (ASB) was asked whether Section 6 .1 of the standard requires the actuarial opinion accompanying the statutory annual statement to include disclosure as to whether cash flow testing was performed, and if not, the reason for not doing so. The requirement for such disclosure for reserve testing is obvious and is not at issue . The question is whether the disclosure is to be made a part of the actuarial opinion itself or is required only to be included in the actuarial report or memorandum that supports the actuarial opinion . While a strict and narrow reading of Section 6 .1 of the standard might support the latter approach, it was the intent of the ASB to require such disclosure in the actuarial opinion itself, as well as in any actuarial report documenting the work done in support of the opinion . In December 1990, the National Association of Insurance Commissioners (NAIC) modified the instructions for the annual statement to require the actuary to state compliance with the applicable standards of practice promulgated by the ASB. This change was made to bridge the gap until the more extensive responsibilities of the appointed actuary, defined by the 1990 amendments to the Standard Valuation Law, become effective in the various states . The insurance regulators assumed that the revisions to the instructions would require the opining actuary to disclose what cash flow testing had been done in support of actuarial opinions prepared in accordance with the current provisions of the Standard Valuation Law . Two drafts ofa reformatted version of existing Financial Reporting Recommendation 7 dealing with the actuarial opinion for the statutory life and health annual statement have

previously been submitted to the ASB . However, the amendments to the Standard Valuation Law and modifications to the instructions have demonstrated the need for a more comprehensive and encompassing standard . Accordingly . a special task force has been created by the Life Committee of the ASB to develop a new and expanded standard that will address the actuary's responsibilities under both the current and pending versions of the Standard Valuation Law . This standard-will. address more specifically the wording and disclosures for the various versions of the actuarial opinion to be required . It is anticipated that the first draft of this new standard will be presented to the ASB at its January meeting . Until then, it is the recommendation of the ASB that the actuarial opinion for the 1991 statutory statement make full disclosure as to whether cash flow testing was used, and If not, state the reason why not . What Are the Consequences of Not Performing Cash Flow Testing Because of a Lack of Time or Resources?

As previously mentioned, ASOP No . 14 requires disclosure of why cash flow testing was not performed, if that is the case . Consequently, when cash flow testing has not been performed because of lack of time or resources, a qualified opinion must be rendered, perhaps using language such as the following : Scope paragraph addition : "En addition, my examination considered the need for cash flow testing, but none was performed because of time and resource limitations associated with the issuance of this opinion ." Inserted paragraph : "The following opinion is based on the assumption that the reserves of the company are supported by valid assets which have suitable scheduled maturities ormarket value and sufficient liquidity to meet the company's cash flow requirements . However, because cash flow testingwas not performed, this assumption may not be valid . Opinion Paragraph insert: "In my opinion, except for the matter referred to In the preceding paragraph, the amounts carried in the balance sheet

on account of the actuarial items identified above . . ." The ASB believes that a qualified opinion relating only to time or resour limitations could be insufficient . F example, it would not excuse the valuation actuary from the requirement to perform cash flow testing if he or she reasonably should have known that a significant portion of the company's assets were impaired or that a material disintermediation of assets and liabilities existed .

The valuation actuary should also be aware that an opinion qualified as to time or resource limitations may be unacceptable to insurance regulators . Miller is the outgoing chairperson of the ASB, and TLmquist is the incoming chairperson.

STANDARDS OUTLOOK (continued from page 3) Pension Assumptions The ASB reviewed the proposed exposure draft ofa standard on selecting economic assumptions for measuring pension obligations . The board decided that the standard needed further w to improve consistency and clarity . revised version of the proposal will be reviewed at the January 1992 ASB meeting.

Retiree Health Care Robert Haver, chairperson of the Retiree Health Care Committee, presented a proposed exposure draft ofan actuarial compliance guideline for Statement of FinancialAccounting Standards (SFAS) 106, Employers' Accounting for Postretirement Benefits Other Tan Pensions . This proposed compliance guideline would provide guidance to actuaries with respect to actuarial calculations required under SFAS 106 . As stated in the proposal, the "guideline is believed to accurately represent current understanding of SFAS 106 as it pertains to actuarial calculations ; the guideline is not an actuarial standard of practice .' The primary emphasis in the guideline is on health care benefits . The board reviewed the proposal and approved its release as an exposure draft .

The next meeting of the Actua Standards Board is scheduled* January 8-9, 1992, in Washington, D .C. ASB meetings are open to the public . Ntckerson is director of the standards program.