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How an Actuary on the Board Contributes to Risk Management

How An Actuary On The Board Contributes To Risk Management

Do you have the skills necessary to be a perfect candidate for a Board of Governors?

I am an actuary by training, but spent most of my career in general management with a large international life company. In addition, I spent my final year with that company implementing an Enterprise Risk Management system. I am now on the Board of a small- to mid-size Canadian mutual life insurer. In this article, I will give my perspective on how an actuarial background can enhance the contributions of a director, with particular emphasis on risk management.

The Role of the Board

In the light of scandals and governance breakdowns, much has been written recently about the role of a Board of Governors. Numerous and varied lists of Board responsibilities have been published and almost all of them contain the following:

  • The Board assesses and approves company strategy.
  • The Board monitors compliance and company performance.
  • The Board appoints the CEO and monitors his or her performance.
  • Particularly in a financial institution, the Board must ensure that company risks are properly understood and managed.
  • The Board does NOT manage the operations of the company.

These articles have also emphasized the need for independence from management and the skills and accountabilities of the Board.

Generally, much of the work of the Board is done through committees-a typical insurance company will have Audit, Governance and Nominating, Human Resources and Conduct Review Committees and might also have a Risk Management or Investment Policy Committee.

Board Member Skills

A strong Board will be made up of members with different backgrounds and skills and the members of each committee will have the skills needed to fulfil the mandate of their committee. For example, members of the Audit Committee should understand the financial operations and statements of the company and recent regulation has required that the Committee include a financial expert under Sarbanes-Oxley or that members be financially literate in Canada. As well, members of the Audit Committee must be independent directors under a prescribed definition of independence.

In addition to any general skills, Board members should also be able to understand the business of the company and the risks the company faces. For an insurance company, all members of the Board should have a general understanding of insurance company accounting and financial statements and some members should have a strong understanding in these areas and also understand the risks that are specific to the insurance business. Since an effective Board functions as a team, each member must be adept at communicating his or her opinions and concerns so that the Board can make sound and informed decisions.

Risk Management in a Life Company

Insurance companies in North America are heavily regulated and are required to have robust risk management processes. In Canada, a Board member quickly becomes aware of Risk Based Supervision, Minimum Continuing Capital and Surplus Require-ments, the Standards of Sound Business and Financial Practices and Dynamic Capital Adequacy Testing. In the United States, similar requirements would include such things as Risk Based Capital. Various reports on risk management and controls come to the Board on a regular basis and, to a greater or lesser extent, any individual director will have an understanding of these reports and the company's risk management processes. However, the Board must ultimately rely on management to report on compliance with regulatory requirements and so must gain confidence in the company's reporting systems.

Some of the obvious risks that a life company faces arise from the company's insurance businesses, e.g. underwriting, mortality and morbidity or product design. Many others relate to the company's assets and liabilities and the relation between them. These include risks such as liquidity, foreign exchange, credit and asset/liability matching. These risks can often be quantified and the company's actuaries and investment professionals are usually involved heavily in measuring and managing these risks. Although the Board will not, and probably should not, get into the technical details, directors must receive reports from management that satisfy them that proper procedures are in place to understand and manage these risks within acceptable limits.

A company is also faced with many other risks that are generally difficult to measure, but can have a major impact. These could include such things as risks from sales practices, outsourcing, reinsurance, acquisitions, terrorism or risks to a company's reputation. Again the Board must rely on management to confirm that the various risks are understood and appropriately managed and that a good internal control system is in place. At the same time, the Board should have sufficient understanding of the different risks to be comfortable with the management assurances they receive. Importantly, the Board must understand that "risk-free" is not an option and that the company must take on certain risks to survive and grow. This requires the Board to understand the risks and rewards associated with the decisions they make. As well, a good Board will be able to call on their varied experiences to ensure that risk management is not too narrowly focused on how the business has always been in the past and that any scenario testing looks very broadly at the risks the company might face in the future.

In performing their risk management functions, a Board is assisted by a number of independent oversight functions such as the internal and external auditors, the appointed actuary, the chief risk officer and the compliance officer. As well, from time to time, outside expertise might be enlisted either by management, the Board or a Board Committee to review specific risk factors. For example, a report from a third party on Asset/Liability Matching or the peer review of the appointed actuary can be very useful to the Board.

The Application of Actuarial Skills

Clearly all actuaries do not have detailed experience in all areas of a company's operations, but there are some skills common to most actuaries that can help a Board fulfil its responsibilities. These include a general understanding of the insurance business and the financial operations of a life company as well as the ability to analyze and solve complex problems. The actuary is also trained to identify and assess risk and can help to synthesize data from many different areas to get a full picture of the company's risk profile.

It is also likely that the actuary has developed some specialized skills in one or more of the following areas:

  • Valuation and Capital Requirements
  • Asset/Liability Management
  • Pensions
  • Risk Management
  • Product Design and Pricing
  • Mergers and Acquisitions
  • General Management

Any of these backgrounds can be very valuable and an actuary with any of these skills can make a significant contribution to Board discussions and decisions.

Perhaps the best way to look at the contribution an actuary might make is to look at some specific matters that might come to the Board:

  • The Board and the Audit Committee review the financial results and the report of the company actuary or appointed actuary. Given the challenge for some non-technical Board members to understand the intricacies of these statements, it will often fall to the actuary on the Board to ask the right questions about the results and the underlying reserving. The actuary should in some cases challenge the opinions of actuaries in management and, in others, should provide support to help the Board rely on the reports they receive.
  • The actuary is well equipped to understand the asset/liability matching process and the reports provided to the Board. The actuary should also be able to understand the risk measurement that is taking place and the potential consequence to the company.
  • When the company is introducing a major new product or entering a new line of business, questions should be asked about the potential impact on the company's future results. In particular, the actuary should be able to understand whether there are any inherent major risks such as overly aggressive pricing or embedded guarantees and ask how these risks will be managed.
  • When a potential acquisition is presented to the Board, a number of potential risks need to be considered in addition to the financial analysis. Are there any special valuation or capital questions, are there asset/liability matching issues or are there any special product features that could have long-term impacts on the business case? Again, the actuary is well equipped to understand these issues and to ensure that the Board asks the right questions.
  • The actuary can help the Board understand the company pension plans and how these plans impact financial results and compensation questions.
  • The Board must be aware of relations with the company's regulators and from time-to-time this includes understanding the reports and assessments of actuaries working for these regulators.
  • To be satisfied that a strong risk management process is in place, the Board must have a general understanding of how risks are being identified and managed. Again the Board must rely on management reporting systems, but also know enough about the process to have confidence in the reports they receive.
  • The Board usually must approve the company's investment policy. Both capital requirements and the relationship between assets and liabilities can have a significant impact on policy decisions. Knowledge of these considerations can contribute significantly to a good decision process.

Conclusions

An actuary can make a major contribution to the Board of a life insurance company through his or her knowledge of the business and its financial drivers and through an understanding of risk and risk management. An effective Board works together as a team and an actuary must be able to communicate with the rest of the Board and must be able to help them understand the technical complexities of the business and of risk. At the same time, the actuary must avoid the temptation to get too far into the details and not cross that line between the responsibilities of Board and management.

Lee Watchorn, FSA, FCIA is president of the Watchorn Advisory Group and a director of Equitable Life of Canada.