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The Role of the Actuary in Risk Oversight

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By Stuart Wason, FCIA

My work as an actuary for Canada’s federal regulator of financial institutions (OSFI) has recently been focused on a more formal assessment of the actuarial function (AF) of insurers. The lessons learned from this work may be of interest to boards, senior management, financial analysts, and others as they relate to the role of the actuary in providing risk oversight.

Reliance Versus Use

OSFI’s risk-based supervisory framework was amended in 2011 to add the AF to the list of insurer-independent oversight functions (i.e., internal audit, compliance, risk management) to recognize its important role in mitigating risk in financial institutions with insurance business. This change reflects a continuation of the shift from "reliance" to "use" of the work of the actuary by OSFI. This is in line with the importance placed on the work of the actuary by regulators and the attendant need for independent oversight.

Actuaries are employed in a variety of roles in insurers due to their education, skills, experience, and professionalism (e.g., pricing, product design, underwriting, claims management, investment, financial reporting, capital management, executive positions). The scope of an AF assessment may vary for each insurer, but clearly most actuarial roles are important for policyholders’ ultimate protection.

The assessment of the AF attempts to validate important aspects of the actuary’s work so that OSFI can have confidence in using that work. To be clear, under normal circumstances, this shift is not intended to replace the work of the company actuary (e.g., full modelling, data validation, recalculation, assumption setting).

Assessing the AF seeks to measure the most important qualitative and quantitative aspects of, and outputs from, the AF throughout the insurer/group (as appropriate) and between companies. While the regulator will not be resourced to verify all such qualitative and quantitative outputs, it will seek to determine the reasonableness, consistency, and comparability of material outputs, with emphasis on those related to key risks.

The complexity, size, and nature of the risks assumed by insurers have highlighted the need for insurers, and the actuaries who play key roles within them, to demonstrate sound practices in risk governance and management. Therefore, OSFI expects active involvement in risk management to be an essential component of the AF.

Independent Oversight

The need for independent oversight functions is well known. However, individual insurers will adopt different approaches taking into account the nature, scope, complexity, and risk profile of their operations. For larger, more complex financial institutions, fully independent oversight functions (i.e., risk management, internal audit, actuarial, and compliance) are expected. For smaller institutions, it would be useful to focus on the principles of independence, rather than the structure, to maximize functional independence. For example, do the control function personnel have clear performance objectives/incentives that link to the management of risk rather than targets related to profit, revenues, and volume? Is their incentive compensation calculated independently of the results of the business unit they oversee?

Boards and management should do more than rely on "gut and instinct" when assessing management. Gut and instinct are good things, reflective of the degree of experience and judgement of those performing such assessment. However, arranging for third-party reviews of the financial institution’s oversight functions from time to time will help boards and management (not to mention the regulator) to benchmark the institution’s risk management practices and processes and to address gaps.

Given the importance of the work of actuaries in insurers, it seems only fitting that the AF provide independent risk oversight within the insurer. However, in practice, the answer may vary substantially from insurer to insurer. In some insurers the scope of the AF itself may not be well defined and the connections between areas such as product pricing, asset liability management (ALM), financial reporting, and risk management may not be clear. In some insurers it may be difficult to define the head of the AF. Even if the head of the AF is well defined, to what extent does that person provide independent risk oversight? Is their role also combined somehow with an operational role? For example, it is difficult to provide independent risk oversight to a hedging program if the individual is also responsible for its design and operation.

The work of the external auditor and peer review processes help to provide independent reviews of parts of the AF and confirm its reliability, but they may not be comprehensive enough for the regulator. Some examples might include:
  • While the external auditor performs some re-computation of actuarial outputs, independent oversight of actuarial results is important given their complexity and significance to an insurer;
  • Increasing use of sophisticated internal models warrants independent oversight of their design, calibration, and use; and
  • The need to demonstrate effective linkage between activities such as pricing, ALM, valuation, capital models, etc.
The provision of independent risk oversight by the actuarial function is important to boards, senior management, and the regulator (among others) as it provides additional comfort in the insurer’s controls. This in turn can lead to an improved assessment of insurer net risk by the regulator and lessened supervisory work. On the other hand, if the AF of an insurer is not seen as providing sufficient independent risk oversight, the onus may fall on the other insurer oversight functions to assume those duties. This would also lead to increased supervisory attention and potentially a worsened assessment of insurer net risk.

Does your AF provide sufficient independent risk oversight?

Stuart Wason, FCIA, is a senior director at the Office of the Superintendent of Financial Institutions.

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