Actuaries may always have been associated with insurance, but, argues Catherine Baldwin, their skills are in demand elsewhere as the regulation revolution continues.
It is commonly observed that “what gets measured gets managed”. But historically many organisations assessed risk on a subjective or qualitative basis rather than by using quantitative disciplines.
Today, risk management has become core to good corporate governance. The understanding and management of risk using both quantitative and qualitative measures is increasingly recognised as a means of achieving strong performance against financial, social and environmental business objectives.
The actuarial profession has its origins in risk quantification. The traditional role of actuaries involves quantifying risk to set adequate insurance premiums. This role has developed over the years into providing high quality analysis for management and boards of varying financial services organisations – and also for regulators.
More recently, actuaries have become involved in other activities where the demand for better financial risk management has been increasing, including banking, funds management, project finance and in the utilities and the resources industries. Actuaries are relied upon through their professional education and affiliation to ensure their advice is unbiased and candid.
The insurance business is the business of absorbing risk, both short and long term. That risk would otherwise be borne by individual people or businesses, and is often accompanied by considerable volatility. It is, therefore, not surprising to find some of the most sophisticated risk frameworks and methodologies in place within insurance companies. Many of the major insurers have more recently developed internal risk frameworks using an enterprise risk management approach of integrated assessment, control and management of risk across the corporate structure.
Following the collapse of HIH, the prudential regulator (APRA) moved to introduce a more stringent reporting regime in general insurance, including the expanded role of actuaries in preparing financial condition reports (FCR). An FCR draws together, for the board of an insurer, all the important factors and issues that affect its present financial condition and its outlook, and issues that need noting or attention.
The concept of the FCR began in life insurance, where it has proved to be invaluable for boards and top management. In recent years the FCR has also been applied to the prudential management of private health insurance and medical indemnity insurance –and now general insurance.
Regulatory standards in life, health and now general insurance place the responsibility for preparation and sign-off of the FCR on actuaries because of their training and experience in the principles and practice of conducting insurance on a sound and fair basis, and the insights gained in doing this. Moreover, the APRA initiative in general insurance signals an expanded role for actuaries beyond the current requirement for the approved actuary to provide advice on the valuation of outstanding claims liability. In particular, actuaries will need to extend their scope to be able to report on reinsurance arrangements, asset & liability management, operational risk management and premium pricing.
There will necessarily be a high dependency on other professionals within the general insurer in the preparation of the FCR. Actuaries will need to access relevant data and information across the entire business to ensure they can provide this more holistic view of its risk management. Where there are limitations on the availability of or access to data and information, actuaries will be required to provide a suitably qualified report.
APRA acknowledges that the introduction of such a comprehensive approach in general insurance as soon as January 2006 represents the start of a journey that will improve reporting now and lead to improved quality and scope in FCRs over the next few years.
The FCR is a central and valuable tool in establishing an integrated risk management framework and provides a prospective health check for the organisation. However, FCRs are of most benefit when used by boards and management to inform business strategy and corporate sustainability, rather than being seen as a compliance document required to satisfy regulatory demands.
From 2007, banks will be required to determine capital requirements to meet operational risk exposure under Basel II. Under the advanced measurement approach (AMA), banks will be able to determine their own approach to the assessment of exposure to operational risk subject to the approval of the regulator. The method taken must be comprehensive and systematic and have demonstrable integrity.
Actuaries are working with other professionals to develop methodologies for the measurement of risk in banking, which is especially important in an environment where there are data limitations and the need to find solutions that balance statistical rigour with a thorough understanding of operational conditions.
The new Basel II framework is intended to reward stronger and more accurate risk management and to align the capital requirements of a bank to its risk appetite. The AMA will mean that capital better reflects the organisation’s own risk profile with the benefit of reinforcing the inter-connectedness of risk, capital and management behaviour.
Heightened demand for risk management signals a significant step up for the actuarial profession, as it requires actuaries to be knowledgeable across the whole business, covering all risk management functions, reinsurance arrangements, asset and liability management and product pricing. Involvement in Basel II provisions open up areas of credit risk, market risk and operational risk, and new opportunities to develop strategies and quantitative techniques for risk measurement and modeling.
Moving from its original base in insurance and superannuation, and more recently into banking, the actuarial profession is continuing to apply its training and expertise across areas such as economic capital, project finance, real options analysis, environmental finance and energy markets trading.
In support of these initiatives the Institute of Actuaries of Australia has established a Risk Management Group to co-ordinate activities and promote the valuable contribution the profession is making to risk management. Papers addressing a range of practice and professional issues to do with risk management were recently presented to the institute’s biennial convention.
The quantification and measurement of risk, and an assessment of its impact across business lines, is a crucial tool within the enterprise risk management framework that allows an organisation to balance the necessary tension between risk and reward that underlies all strategic business planning and management.
The actuarial profession is increasingly recognised as a guardian of the organisation’s risk appetite by balancing growth with the capacity to finance it and to cope with its attendant risks. This role makes the actuary the CEO’s valued ally in achieving sustainable growth and the superior shareholder value it generates.
Catherine Baldwin is chief executive officer at the Institute of Actuaries Australia