Better Standard for Setting Standards

Better Standard for Setting Standards

This author makes a few suggestions for how the ASB can improve the way it defines and sets standards of practice.

The Actuarial Standards Board (ASB) and its predecessor1 have been involved in issuing Actuarial Standards of Practice (ASOPs) that seek to codify generally accepted actuarial practices since 1985.

How Standards are Set: Two versions of "Generally Accepted"
The Introduction to the Actuarial Standards of Practice2 (the "Introduction") states that, "in most instances, ASOPs are written to reflect generally accepted practice, i.e., practices that are broadly accepted by qualified actuaries as appropriate to the proper performance of a particular type of professional assignment or aspect of professional practice."3

After "reviewing the current range of practice," the ASB drafts a proposed standard and exposes it to the profession to be sure the draft has identified the range of generally accepted practices; rather than judging practices, the ASB is merely expected to codify them.

Actuaries like to use words in their proper sense, so when we have said a practice is generally accepted, we have simply meant it is generally accepted so long as you know what you're doing (and, of course, we used "qualified" to suggest you know what you're doing!).

I will have more to say about this; for the moment I'd like to characterize it as producing a "consensus standard" that merely requires the ASB's members to identify the relevant practices that a "meaningful number" of qualified actuaries is willing to use (or finds acceptable.) I note that, with its role limited to "codifying" these practices, the ASB is simply compiling a catalogue (i.e., "If enough qualified actuaries do it this way, it must be right.")

We've lived with this approach to standard setting for 21 years now. There's no practical problem if the results obtained by qualified actuaries using alternative practices don't differ significantly. And it is consistent with the view that the ASB lacks (or perhaps is reluctant to exercise) authority to impose a different view on practitioners until such time as it becomes widely practiced (or the requisite "meaningful number of qualified actuaries is willing to "accept" such a change). This standard–setting approach assumes that qualified actuaries will, over time, come to approve (or endorse) the practice in question. (You'll hear more about this before you finish this article!)

The alternative version of generally accepted goes beyond cataloguing and looks to the standard–setting Board to set standards! That is, it expects Board Members to use their skill, experience, intelligence and judgment to identify all practices that warrant consideration, evaluate them in light of the current realities and specify which practice(s) are to be designated "generally accepted."

This process, which has been used by the accounting profession since it's Financial Accounting Standards Board (FASB) was established in 1973,4 has been viewed by actuaries concerned with developing standards of practice as "standard–setting by fiat" rather than by consensus. They note that it involves extensive deliberation, expensive staff and public hearings in order to seek out best practices and bar the use of unacceptable ones.

An Actuarial History Lesson
Early Steps Taken to Ensure That Actuaries Perform Their Duties in a Professional MannerAs I see it, the Modern Actuarial Age5 in the United States began June 13, 1949, the date the Society of Actuaries was formed by the merger of what had been America's two largest actuarial bodies, the American Society of Actuaries6 and the American Institute of Actuaries.7

At the time of the merger, the Society comprised a modest 1,173 members. The great majority of its initial members were employed by life insurance companies on the East Coast. The growth of employee benefits, fueled by the unprecedented economic growth that followed World War II, lay ahead. And with it, a dynamic increase of actuaries in the pension and health insurance specialties. (Click here for chart showing 55–year SOA membership growth chart)

The merged entity's immediate post–merger efforts to strengthen professionalism focused on educating actuaries in all matters relevant to the practice of their profession. A strong Education Committee established an extensive curriculum with tough passing standards for every examination. This, plus ongoing reminders of the need for integrity in performing actuarial assignments, gave the leaders of the profession confidence that newly anointed actuaries would know what the "right thing" was, and would have the integrity to do it.

Indeed, all participants in that environment-the examiners who spent long hours to prepare (and grade) probing examinations, and the students who spent even longer hours to meet the challenge and pass those exams-were proud to be part of it. And this pride in one's own qualifications and integrity (and that of one's fellow actuaries) gave actuaries confidence that their experience, intelligence, fastidious work habits and good professional judgment would deal with the most challenging of assignments. In this context, the actuary's profile ensured the acceptability of "codifying" practices, i.e. the non–judgmental "cataloguing" approach discussed above.

The various U.S.–based actuarial bodies, recognizing that our credibility as a profession required suitable Codes of Conduct, turned their attention to this area during the 1950s and 1960s. It was not, however, until the Academy was established as an umbrella organization that progress was made in achieving reasonable uniformity throughout the profession and an entity-the Actuarial Board for Counseling and Discipline (ABCD)-was established to investigate alleged violations, hold hearings, and (if necessary) recommend sanctions to the actuarial organization involved.8

The Need to Provide Guidance When Faced with Rules Set by Others
Twenty years after the Society was formed, no formal effort had been made to meet the need for developing actuarial standards of practice. But starting in 1966, actuaries found themselves in a world that increasingly required them to produce actuarial values conforming with rules set by others.9 A recognition of this potential intrusion was surely one of the reasons the Academy was established in 1965. The Academy met this need by assembling a task force of qualified actuaries in each of the relevant specialties and putting them to work producing compliance guidelines. It soon became clear to the dedicated individuals involved in this process that there should be a more organized way to deal with standard–setting and so a Committee to Study the Requirements of Professionalism was set up in 1982.

The Art of Compromise: Half a Loaf Is Better than None!
The "imposed rules" that committee members had dealt with made them wary of "extreme prescriptive guidance." Many felt that imposing any stronger standards would be anathema to actuaries and their confident "I know what I'm doing" profile. As deliberations proceeded, the feeling grew that the project was DOA unless it limited standard–setting to cataloguing. And this approach was endorsed.10

The committee's work led to the formal creation of an Interim Actuarial Standards Board in 1985 and the Actuarial Standards Board three years later.

What is the Real Issue?
The issue is not whether the ASB must choose between prescriptive rules and actuarial freedom; the choice is between traditional principles and new ideas that challenge today's practice. The ASB's real job must be to chose between practices that are "right" (i.e., acceptable) and those that are "wrong" and unacceptable. This is not a matter of majority rule, nor necessarily a function of prevailing practice.

The ASB was, in part, created to make our self–regulation more credible. The public may question the profession's historic reliance on self–regulation if it feels the ASB is reluctant to grapple with modern challenges to historic principles. Although we value broad principles highly and find detailed rules imposed on us by others irksome, the profession's case for self–regulation will be enhanced by an ASB that makes judgments, sorting out good actuarial principles from bad-regardless of popular practice.

The strong standards of practice that our profession needs today must be the product of informed judgment and forward–looking leadership.

The Need for Leadership by the ASB
We, as a profession, must call actuaries to strict standards, thereby protecting those who diligently and knowledgeably comply with them-or face the danger of being discredited en masse, as the experience of actuaries in the United Kingdom in recent years forewarns.

Some actuaries are concerned that strengthened standards may be cited in litigation challenging earlier practice. Every profession faces this issue and must treat it with care. The ASB will want to emphasize that such changes reflect all actuarial advances that are known at the time the ASOP is approved and that the new ASOP will become effective only on and after a specified date.

It has been stated that the ASB has the authority to recognize and adopt new principles that flow from advances in actuarial science. I am not, however, aware of many instances in which the ASB has chosen between popular existing practice and more rigorous innovations in the underlying science.

Even though there are various sources for innovation in actuarial science, the ASB needs to study, judge and choose among alternative claims for actuarial acceptability. The profession needs a focal point where innovation meets learned judgment. We cannot be assured that innovations will filter upward. Like it or not, judgment must be exercised by our leaders who must rise to the occasion with knowledge, commitment, and attentiveness.

Let me put it this way: let's make believe that a breakthrough in actuarial science-perhaps a soundly–designed statistical analysis of historic interest rates correlated with appropriate economic variables, or an innovative theoretical technique, or even a well–documented approach in another discipline such as economics or financial engineering-has demonstrated that the most acceptable rate for discounting future payments is 10 percent.

Since that would dramatically reduce the present value of pension (or life insurance) liabilities, it represents a classic win–win situation. Actuaries who fail to use the 10 percent discount rate as soon as possible would be remiss in their duty to their clients or employers. Adoption by "a meaningful number of qualified actuaries" would occur quickly.

Now, let's assume the same "solid science" has demonstrated that the most acceptable rate is three percent. Professional integrity warrants quick adoption as well. But I suspect bad, though accurate, news doesn't get there as quickly-if ever.

What do Due Process do?
In their recent article "In the Eye of the Beholder,"11 Michael LaMonica and Lauren Bloom discuss the "due process" laws that govern the ASB's role in standard setting. Let me summarize the substance of these issues as follows:

• "Due process" requires the ASB to give notice of proposed ASOPs i.e., a meaningful opportunity for actuaries subject to the ASOP to comment and then to consider all comments with an open mind-i.e., fully and fairly.
• A standard that (a) unreasonably restricts actuaries' right to practice, (b) sets such minimal requirements that it gives actuaries insufficient guidance, or (c) fails to discuss an element of practice that may be pertinent in a critical situation could be viewed as having been promulgated negligently.

LaMonica and Bloom conclude that this, together with the constraints of the Introduction,12 effectively limits the ASB to cataloguing practices in current use.

I suggest that this conclusion fails to recognize the essential purpose of due process: to protect actuaries (and their firms) from being tyrannized if ASB members' standard–setting should fall short of the "due process" requirements. It is, after all, inherent that due process considerations may create a tension between the ASB on the one hand and the actuaries who must meet the ASOPs it issues on the other; it "comes with the territory."13

Conclusions
The Introduction codifies the ASB's traditional flexibility–preserving approach that relies on the informed judgment of practicing actuaries. Standards are generally promulgated only after practice has evolved. There are exceptions for new areas, for rare pruning of unacceptable practices and for individual actuaries to defend practices that deviate from the "accepted" ones.

I believe this "hands–off" philosophy must be reconsidered in light of the challenges actuaries face today and will continue to face in the years to come. ASOPs should be promulgated by the ASB only after a thorough, deliberative process that meets "due process" requirements and goes beyond codifying existing practices.

Better new approaches-even unpopular ones-must REPLACE inferior older ones. Sometimes older practices remain acceptable and may be retained. Otherwise, they should be replaced.

Speed is not the main issue: getting the good practice(s) in and the bad practice(s) out is!

Standards are not set in an instant and are not the arbitrary answer of one person or one small committee: standards work their way through an intellectually rigorous process over several years and at the end of that process may be judged on their merits rather than on their popularity or "acceptance" level.

Section 3.1 of the Introduction articulates a "hands off" philosophy that must be reconsidered in light of the challenges actuaries face today and will face in years to come. The core of our profession is actuarial science. It is subject to analysis, argument, innovation, and evolution; although there is room for the practice to inform the science, judgments must be made by learned leaders embracing the best principles of actuarial science lest inferior principles lead to a "race to the bottom."

The ASB and its practice committees are certainly the proper venue for the exercise of professional analysis and judgment.

Even if our profession lacks the resources to fund a full–time leadership institution á la the FASB, our volunteers must be committed to independent decision–making informed by in–depth study of the actuarial science issues at hand. They must advance our tried and tested science in front of our practice. Following, rather than leading, the practice is a prescription for stagnation and an invitation for outsiders to impose their rules upon us. We must lead or we will be led.

I encourage all responsible actuaries to join this ongoing debate on the role of the ASB and the ASOPs and move us all toward leading rather than being led. In light of significant challenges to our profession around the world, it is imperative that we establish a more rigorous and vigorous approach to rule–making by actuaries.

I would like to acknowledge the time Doug Borton, Ed Burrows, John H. Harding, Harper Garrett and Steve Kellison made available to me to discuss the circumstances that led to the establishment of the Actuarial Standards Board. They were there when it took place.

* The views expressed in this article are those of Mr. Kass and not the ASB.

David R. Kass, FSA,MAAA, is president of David R. Kass & Company as well as a newly elected member of the ASB as of January 2007. He can be contacted at drkfsa@sbcglobal.net

A counterpoint article to this one will appear in the April/May issue.

Footnotes:

1. The Interim Actuarial Standards Board, [IASB]
2. Adopted by the ASB in December 2004.
3. Section 3.1.2.
4. And its predecessor Accounting Principles Board established in 1959.
5. Younger actuaries may understandably consider this to have been the Dark Ages or even Medieval Times. I'm sure they're wrong, but ...
6. Established in 1889, the 56–year old Society effectively dominated the major life insurance companies and burgeoning actuarial consulting firms in the east. It brought 1,069 members into the mix.
7. Members of the younger Institute (established in 1909), plied their trade in America's southern and western states, reflecting the spread of financial companies over the first half of the 20th century.
8. Building a structure to deal with actuarial conduct is an important element of assuring others of the credibility of our work. I will restrain myself from commenting on this further in light of the already overly ambitious scope of this article.
9. The accounting profession did so in the pension field, starting with APB 8 in 1966 and in 1987 with its successor (SFAS No. 87). It also issued audit guides in 1972 for meeting GAAP standards for stock life insurance companies affecting the calculation of life insurance reserves and related actuarial values; Federal pension legislation (ERISA) in 1974 imposed complex requirements administered by three federal agencies, the IRS, the DOL and the PBGC. The NAIC set Standards on Life Insurance Dividends in 1980, and later required "qualified" actuaries to sign a Statement of Opinion.
10. The 'catalog' approach was not a written rule until the Introduction was adopted two years ago. Before that, the ASB's independence allowed it to catalog or prescribe as it saw fit.
11. This article appears in the March/April issue of Contingencies Magazine. It contains an extensive discussion of "due process."
12. Especially Section 3.1.2.
13. And, if actuaries decide that the constraints of the recently adopted Introduction are not warranted, they should be removed.