by Phil Bieluch
Remember the old song by Dr. Hook & the Medicine Show, "Cover of the Rolling Stone? These days it seems more likely that financial professionals will get their picture on the cover of the New York Times. Add this to your enterprise risk list.
As the song starts out, "Ha, ha, ha, I don' t believe it," it appears that some common financial practices are now undergoing closer regulatory scrutiny. While Elliott Spitzer, the attorney general of New York, is leading the charge, other regulators such as the SEC and the NAIC are getting involved. Many of you are probably more keenly aware of what is being investigated than I am, but let me highlight some of the areas I have gleaned from reading the press.
Variable Annuities: The concern here is that the prospectus given to policyholders and prospects does not discuss (or even worse came out and stated), that the underlying mutual funds do not allow rapid trading. Yet some companies allowed it for their larger, financial clients.
12(b)1 Fees: These fees allowed under the Securities Act are designed to be used for marketing, yet it is felt that some companies use these fees as another source of revenue and profit.
Payments to Brokers: Another area under investigation is what when I was studying for the exams was referred to as payments to brokers for quality business. Investigations are in progress and a complaint has been filed by the New York Attorney General against a broker containing an allegation of impropriety related to payment of commissions contingent upon, among other items, renewal rates. The day after the complaint was filed, the broker named suspended acceptance of these payments. I have now seen two conflicting defenses articulated in the press, the first is that everyone knew these practices were going on so they did not have to be disclosed to clients and the other defense is senior management did not know these practices were going on.
Consultant Payments: Payments to consulting firms from medical insurers are being scrutinized to see if there are any conflicts with the advice these same firms are providing companies.
We have also seen individual actuaries being the target of publicized investigations into who they told what and when. Discussions with individual board members are being parsed to determine if the overall board had knowledge.
All of these investigations involve disclosure. The regulators appear to focus on what the buyer of a product or services knew about these practices at the time of purchase. How, if at all, was information disclosed and was this information broadly disseminated outside of the industry insiders? What insiders may have taken for granted seems to be called into question when it is put on the cover of the New York Times. We have a Code of Professional Conduct that requires an actuary to make appropriate disclosure of all material compensation that the actuary or the actuary's firm receives. Hopefully this has been done and the definition of material is broad so as not to limit disclosures in the above examples.
"We sing about beauty and we sing about truth, for ten–thousand dollars a show (right)." Isn't this what we want as professionals in whatever we do–beauty and truth? The price might be low for an actuarial report, but the goals are aligned–or are they?
Are there pertinent secrets we keep? Let's examine a few areas:
In the past few years, there have been settlements with insurance carriers over race–based pricing. We all knew that companies stopped using race as an underwriting class, but were we all aware that in–force contracts were still being charged a rating? State insurance department investigations over the last 30 years produced only denials that there were any such policies in–force. I am sure actuaries will come down on both sides of the legality of the issue, but perhaps we should defer to our legal brethren on this one. Social goals embodied in law override actuarial classifications.
Another area where we may not be forthcoming is in cash balance plans. Would you as an actuary feel comfortable defending your report on converting to a cash balance plan if it was on the cover of the New York Times? Do you make statements in there that you do not believe the masses should hear? Certainly some of these lawsuits currently in court will try to ascertain motives. Actuarial reports will certainly be a key part of the discovery.
When we discuss long–term care pricing, do we mention that if everyone who purchases the policy intends on keeping it in–force, the rates must increase? The Illustration Actuary requirements reduced the opportunity for lapse support in life insurance pricing, but there is no similar requirement for long–term care. Do you think the public would be surprised if they understood lapse support?
Are we comfortable with the assumptions underlying our calculation of pension liabilities on employers? balance sheets? Even if this isn't our responsibility, would the public view it differently?
If a long–term policyholder is better off exercising a settlement option than purchasing a new immediate annuity, will we still allow the immediate annuity to be sold? Do we feel an obligation to disclose the payments available under the settlement option?
Are we comfortable with the number of lost policyholders we have, especially companies in the debit business? Do we actively seek ways to pay claims on multiple policies when one of the beneficiaries notifies us of a death? Do we seek to pay any possible death claims when we are notified that a pensioner on our annuity roles has died?
Another area of concern is with variable annuity guaranteed living benefits. Does your pricing support anywhere near 100 percent utilization? Should it? What would the buying public expect?
Non–disclosure or obfuscation has been around for a long time in the insurance industry. The NAIC has focused some effort in this area with requirements for minimum point types and readability standards. Yet we still call a substandard class a "special" class.
Would greater disclosure as part of the sales process stop the sale? Would we as actuaries have to increase the price of coverage if we had to disclose? If so, is this a reason not to disclose?
Past concerns with disclosure and practices have proven to be unfounded once implemented. The concerns about unsupportable illustrations were only served by the implementation of the illustration standards. There is still a market for health insurance despite mandatory coverage of certain expenses and guaranteed issue requirements. Pension and other health and welfare plans survived despite the passage of ERISA.
In this era of enterprise risk management, we should all reassess what we tell the public about what we provide. We should allow buyers to make informed choices based upon all the facts. We should recognize that regulatory and judicial forces will be focused on the products we produce for a very long time.
While Dr. Hook sings, "We got a genuine Indian Guru, who's teaching us a better way," as professionals we should be looking for our own better way. Better disclosure will reduce risks to our employers and clients, not to mention ourselves. Being on the cover of the Rolling Stone is fine, being on the cover of the New York Times may not be.