This article provides an overview of the Emerging Issues Advisory Committee (EIAC) Annual Reports for 2005.
By Larry N. Stern
In October 2002 the Board of the Society of Actuaries (SOA) addressed a concern about defining emerging issues and produced the following result (as taken from minutes of a Board orientation session 10/26/03):
- A significant environmental/industry/demographic change or trend impacting the Society or the profession as a whole.
- An issue that if not addressed will potentially damage the Society or the profession (direct damage, lost opportunity, loss of competitive edge).
- Not all emerging issues are strategic.
- Not all emerging issues are appropriate for Board dialogue and deliberation.
Note this definition applies to emerging issues that impact the profession as a whole. The Life Practice Area Committee (LPAC), in the fall of 2003, wanted to broaden the definition to include various technical issues of interest to life practicing actuaries that could affect their professional lives. Specific ways the LPAC could precede with "emerging issues" was by:
- Establishing a framework for identifying emerging issues.
- Setting up a process to determine what to do with each issue.
- Implementing a course of action for issues identified.
This could be best handled by establishing a small group consisting of seasoned, experienced and knowledgeable life practicing actuaries covering a broad range of specialties to feed LPAC intelligence on emerging issues. Thus, in late 2003 the Emerging Issues Advisory Group (EIAG) was created with four initial members and the SOA staff life actuary whose purpose was to provide guidance and perspective based on their respective backgrounds into issues being considered by the LPAC. The EIAG essentially became a "think tank" to make recommendations to the oversight subgroups of the LPAC.
Since 2003, the practice areas of the SOA have been transformed into strategic action teams (SATs). The EIAG was re–titled as the EIAC. The committee has adopted a formal mission statement and goals, and drafted a document to define its structure, logistics for procedures of its meetings and conference calls and work product—the annual reports to be communicated to the Board and the membership of the SOA.
Although the EIAC has also grown in size to 19 members, its function and purpose have not changed. And neither has the concern of the Board wavered with regard to identifying emerging issues for the profession. Bob Beuerlein's Present Value—Issue 6 was devoted to the topic of issue identification and strategic management system. Responding to 2005 SOA strategic plan initiatives, the SOA membership identified this topic of high importance (7.5 out of a scale of 10). Performance by the SOA was identified as moderate (5.8) leaving a gap of 1.7. Beuerlein states, "The ability to adapt rapidly to the changing external environment is recognized as critical to success by many of our employers. The same is true of our profession. Identifying economic, social and political issues impacting our profession is the cornerstone of the SOA's strategic plan. Defining and monitoring these current and emerging issues is the goal of the strategic management system and the responsibility of the SOA Board of Governors, through the Issues Advisory Council (IAC)."
The EIAC's purpose is to support life–practicing actuaries by identifying and communicating in a timely manner emerging and "emerged" issues relevant to them. Emerging issues are issues not yet widely recognized as an issue, but expected to be in the future. "Emerged" issues that fall within the scope of the EIAC's interest are those issues that are receiving attention from some segments of the SOA membership, but have a wider impact than is currently realized. By recognizing the potential impact of both types of issues now, actions can be taken to influence their impact, leading to better outcomes. Identifying emerging issues often calls for spotting the significance of events and trends that may not be obvious on the surface. (Click here for sidebar)
Issues can span a very broad range. To provide some specificity and set some boundaries that will focus the committee's efforts, the EIAC seeks to identify the following types of issues:
- Technical issues.
- Societal issues.
- Professional opportunities and threats.
Although not yet formalized, the EIAC expects to be tied in some fashion to the Issues Advisory Council (IAC) of the SOA.
Areas of Environmental ScanningCurrently the EIAC has identified the following areas of interest to life–practicing actuaries as worthy of efforts to perform environmental scanning activity:
- Global business environment—free trade, globalization, comparative advantages among countries in resources and factors of production, geo–politics.
- Domestic regulatory environment (state and federal)–including FASB, rating agencies, etc. This includes consumer protection as well as financial soundness regulation, i.e., economic/riskbasedcapital,STAT/GAAP/ IAS accounting etc.
- Taxation (USA).
- Risk management structures for the life insurance industry—emerging risks, attitudes toward risk, risk assessment techniques, structures for life insurance and reinsurance companies, broader financial services organizations—banks, mutual funds, etc.
- Asset markets and macroeconomics––risk management environment (market and credit risks): emerging risks, attitudes toward risk, risk assessment techniques, etc.
- Demographic and secular trends—including lifestyle and labor force trends.
- Product trends—life insurance, savings products, other.
- Insurance distribution system.
- Emerging research—theory, tools, techniques and data that are relevant to the actuarial profession. Academic as well as practical. Include actuarial as well as related disciplines such as statistics, finance, risk management, etc.
- Developments in competing/related professions—accounting, underwriting, risk management, investment management, financial engineering, MBAs, etc. Scanning will include trends in these professions (size, scope), value proposition, educational standards, professional organizations, etc.
Scanning Activity Results
During each of the committee's conference calls and at the annual face–to–face meeting conducted in conjunction with the annual SOA meeting, committee members directed a discussion in their area of interest. Throughout 2005, almost all of the areas of interest just mentioned were covered. The work product of the EIAC consists of this overview report of the EIAC's activity as well as the attached reports from the members' own environmental scanning activity. Following is a brief summary of the scanning activity. Extensive details are presented in the individual reports.
Economics—The global economy has changed considerably in recent years. The opening of previously closed economies and the transfer of technological know–how to under–developed countries, combined with the latent human resource skills and the innate entrepreneurial spirit in those countries have produced a tremendous expansion in economic activity and an astonishing growth in productivity in several parts of the world. Migration of industrial production and certain service functions from advanced countries to developing countries is occurring at a fast pace, taking advantage of a labor arbitrage opportunity made possible by advances in communication technology, information processing, cheap and fast transportation and the unprecedented mobility of capital funds. Currently, these effects are working their way through the U.S. economy, a major by–product of which is a burgeoning U.S. trade deficit.
Some of the effects of the trade deficit are exacerbated by U.S. fiscal policy, i.e., the growing federal deficit and debt. The future impact of these factors on interest rates, exchange rates, economic growth and stock market returns can be considerable and need to be studied by life actuaries, on account of the importance of these parameters in the life insurance industry. Other prominent risks at this time include oil shocks, a health pandemic and geo–political instability.
Regulation—Regulatory focus is currently on two issues: reserve standards and capital relief. Traditional formulaic reserving methods do not work satisfactorily for complex new products, so regulators are examining a principles–based valuation/RBC regime as an alternative to requiring excessive reserves to assure solvency. In addition, a preferred mortality experience study has been launched as another means to provide capital relief by reducing redundant reserves for life products.
Principles–based valuation and risk–based capital will cause an increase in the actuary's responsibilities and bring considerable attention to the actuary's work at insurance companies, since a company's capital requirement can potentially depend on the actuary's analysis and professional judgment. Companies with good risk management programs will get the benefit of lower capital requirements. Potentially, the valuation and risk management processes will become integrated, with the actuary becoming the focal point of an analytical process involving investment policy, risk management discipline and economic capital deployment facilitated by a common modeling platform.
Taxation—The trend is to lower taxes, higher deficits, and a potential fiscal crisis related to Medicare and Social Security. Of particular interest to the life insurance industry is the lowering of taxes on stock dividends. New proposals floating in Congress at year–end further threaten life insurance business due to favorable treatment of equity earnings and possible unfavorable impact on the inside interest build–up of insurance account values. Whether or not principles–based valuationmethodologies will be adopted will also impact life insurance company taxation.
Risk Management—trends include more sophisticated instruments, greater ability to deploy them due to computing power and improving market liquidity, securitization and commoditization of risk. Some of these solutions are available only to the largest companies because of economies of scale for the cost to employ such solutions. Traditional reinsurance solutions are being developed for small– to medium–sized companies.
Asset Markets and Macroeconomics—Due to technological innovation, expansion of free markets and government policy promoting individual savings accounts, the world has become one large marketplace for the trading of bonds and stocks, with a growing number of people of modest means participating in the market. This trend will continue, as populations in China and India become more affluent and accumulate savings. However, the U.S. life insurance industry currently provides savings products primarily for the affluent, and has only modestly penetrated the middle market with protection–oriented products. This is an untapped opportunity, which must be addressed if the insurance industry is to become a viable player in the broader market for savings and investment management, on par with mutual funds and banks.
Long–term guarantees is the one factor always singling out the insurance industry over all other financial industries. We know now that long–term guarantees are valued by customers with respect to protection and savings products. The need for long–term guarantees will always play a role in the future of individual financial planning. The industry needs to build on it.
As the population ages there will be a shift in the motivation for insurance purchasing decisions. As the ethnic structure of the population changes (immigrants contribute the largest share of the growth in the U.S. population), it presents an opportunity for insurance companies, since immigrants are more family–oriented and tend to be conservative investors, depending on hard work rather than investment savvy to accumulate savings.
Technology—IT for business processing has run its course. Few productivity gains remain in this area. Potential for further productivity gains exists in customer service and back office services through off–shoring and a strategic opportunity exists in the full–enabling of risk management, in which actuaries will play a key role. The impact of IT on distribution will continue to be an area of key potential.
Service–Oriented Architecture is a new IT concept driving system design. This has significant potential to change the way business applications are designed, to make them platform–independent and robust, improving maintainability, extending system life, promoting integration across systems, enabling enterprise–wide standardization of data, centralization of IT functions and controls, and reducing cost. With access to standardized business processes through ACORD (the leading insurance industry standards body), a standard service–oriented architecture for the insurance industry is likely to be developed.
Demographic and Secular Trends—Issues of interest to insurance companies include the uncertainty about future mortality improvements at older ages, the limited potential for further improvements at younger ages, and the value of new underwriting techniques as selection and classification criteria. As the population ages, focus will be directed to payout annuities and long–term care. The Committee's environmental scanning with respect to death rates revealed that in addition to overall trends, actuaries should pay attention to the impact of medical advances and specific health conditions on insurance pricing and underwriting. The Committee discussed the "obesity epidemic" in detail and noted a number of subtleties and potential implications for the life insurance business. Another topic analyzed in detail was the older age population—its structure and composition, income and wealth level, lifestyle and living arrangements, health status and evolving needs, with a view to understand the insurance needs of this growing segment. A well–defined population segment with substantial wealth and predictable needs, one that will play a major role in the future economy as it grows in size and influence, it should be analyzed carefully in order to understand and serve its needs.
Product Trends—Keeping pace with the aging of "baby boomers," there has been a shift in the past few years from life insurance sales to annuities—most notably variable annuities with investment guarantees. In the life insurance product arena, premium guarantees play an important role in the marketing of term and universal life insurance coverage. Finding adequate reinsurance and/or capital market solutions for XXX and AXXX reserve strain causes major concerns for capital being available to support marketing efforts. In keeping with the aging population, products for the senior market and innovative payout options on immediate annuities are drawing attention. Last but not least, new reserving and nonforfeiture methodologies will have increasing implications for product development.
Distribution—Trends noted include the aging of the agency force, increasing importance of financial services channels (as annuity sales have become prominent) and the change in the relative significance of affiliated versus third party channels, due to shrinking of the affiliated agency force and the concurrent growth of independent agents. Other prominent issues include the slow adoption of mass distribution, the underserved middle market and flat sales of life insurance. Items to watch in 2006 include regulations pertaining to commission disclosures, the growing life settlement market and the significant advances in technology occurring in the distribution area.
Emerging Research—Markets for life insurance and annuity products continue to evolve creating the need for better models, techniques and data. Research is needed into the direct transfer of mortality risk with derivatives such as swaps or mortality bonds, since there are a number of subtleties that need to be understood. A challenge for the research actuary is the relatively small amount of data available to researchers. From the perspective of competing technologically with other countries in the future, the poor state of mathematics education in the United States is a concern, which extends to innovation and leadership in the actuarial arena as well. Another focus of the academic actuary currently is to effect a shift to university based actuarial education, which will strengthen the profession for the long term.
Developments in Competing/Related Professions—The EIAC did not have the opportunity to discuss this topic in 2005. However, Narayan Shankar previously prepared a report on the future of the life insurance company actuary which has been widely distributed among SOA volunteers and has been included in the EIAC's 2005 report available through the SOA Web site.
Communication to Membership
An important aspect of the EIAC mission is to maintain a holistic view of the life practice, pooling together the specialized knowledge of the various SOA sections that serve life–practicing actuaries. The EIAC supports the environmental scanning, issues identification and thought leadership efforts of the life–related sections by reporting to them on its findings as well as by reporting to the IAC, SOA committees and other entities as appropriate. The EIAC will also communicate its findings directly to the SOA membership by ensuring reports are publicly available via the EIAC Web site as well as by publishing timely reports in The Actuary, section newsletters and other media. While no process can guarantee that all relevant issues will be identified, the EIAC's efforts significantly enhance current SOA capabilities.
Much progress was achieved by the EIAC in 2005. We formalized our mission, goals and structure. We are making our work product—the results of our scanning activity—public to the Board and SOA membership. As we move forward into 2006, many of the areas of interest will continue to be on the cusp of emerging and emerged issues to warrant additional scanning activity. Those having been transformed more into the public domain will be dropped. New issues will evolve and will be picked for further investigation. To the extent we miss something, we welcome the contribution of the SOA membership to our cause. We exist to keep you informed.
Larry Stern is president of Canterbury Consulting LLC and chairperson of the Emerging Issues Advisory Committee. He can be contacted at firstname.lastname@example.org.