Actuary Law

New ASOP on Enterprise Risk Management

The Actuarial Standards Board has adopted its newest actuarial standard, ASOP 46, Risk Evaluation in Enterprise Risk Management.   As defined in ASOP 46, “enterprise risk management” is 

The discipline by which an organization in any industry assesses, controls, exploits, finances and monitors risks from all sources for the purpose of increasing the organization’s short- and long-term value to its stakeholders.

The scope then of the new standard is defined as:

This standard applies to actuaries when performing risk evaluation professional services for the purposes of enterprise risk management (ERM).  

Risk evaluation is often performed as one part of an ERM control cycle. Within a typical ERM control cycle, risks are identified, risks are evaluated, risk appetites are chosen, risk limits are set, risks are accepted or avoided, risk mitigation activities are performed, and actions are taken when risk limits are breached. Risks are monitored and reported as they are taken and as long as they remain an exposure to the organization. 

This standard focuses on five aspects of  risk evaluation: risk evaluation models, economic capital, stress testing, emerging risks, and other risk evaluations.  Guidance for activities related to risk treatment is addressed in proposed ASOP,  Risk Treatment in Enterprise Risk Management.  

This standard does not apply to actuaries when performing risk evaluation professional services that are not for the purposes of ERM. Examples of risk evaluation services that may be performed for purposes other than ERM include pricing of insurance products, and the evaluation of liabilities of insurers and pension plans.  

The effective date of the new standard is May 1, 2013.

Lawyers writing about actuarial topics — badly

In my last post I pointed to ASOP 41 and the importance of clear communication by actuaries.   Judge Richard Posner of the US Seventh Circuit Court of Appeals recently bemoaned the problems created by some appellate lawyers who could not communicate pension and actuarial concepts clearly to lay judges.  In Chicago Truck Drivers, Helpers & Warehouse Workers Union (Independent) Pension Fund v. CPC Logistics, Inc., No. 11-3034, 2012 WL 3554446 (7th Cir. Aug. 20, 2012), he discussed the challenges the panel of judges faced in a withdrawal liability case under ERISA:

Hideous complexities lurk in the briefs in this appeal.  Many appellate lawyers write briefs and make oral arguments that assume that judges are knowledgeable about  every field  of law, however specialized. The assumption  is  incorrect. Federal judges are generalists. Individual judges often have specialized knowledge of a few fields  of law, most  commonly criminal law and sentencing, civil and criminal procedure, and federal jurisdiction, because  these fields generate  issues that frequently recur, but sometimes of other fields as well depending on the  judge’s career before he  became a judge or  on special interests developed by  him since.  But the appellate advocate must not count on appellate judges’ being intimate with his particular legal nook—with its special jargon, its analytical intricacies, its commercial  setting, its mysteries. It’s difficult for specialists to write other than in jargon, and when they don’t realize the difficulty  this poses  for generalist  judges neither do they realize the need to write differently.

Federal pension law is a highly specialized field that judges encounter only intermittently.  Yet the lawyers in this case made no allowance for our lacking their specialized knowledge.

After quoting from both parties’ briefs to provide an example of what he was talking about, Judge Posner wrote:

All this was terribly opaque to us because the parties failed to provide context—failed to explain what exactly the  pools  are, why  interest rates are  important to withdrawal liability, what the “funding interest assumption” is, and why what they confusingly call a “cap”  on the Segal Blended Rate (confusingly because in most years the “cap” required as we’ll see the substitution of a higher rate than the Blended Rate) caused a loss to CPC when the “cap” was removed.

And so at the oral argument one of the judges felt compelled to ask one of the lawyers, pleadingly, whether she  could explain in words  of one syllable what the case was about. She was a good lawyer and tried, but, perhaps surprised by the question, failed.

There’s an important lesson here for those of us who work at the intersection of legal and actuarial work.   We need to step back from all the jargon.   Knowing all the jargon of actuarial techniques and provisions of the Internal Revenue Code may make us valued advisors to our clients, but carries with it the risk that we forget that the rest of the world, even smart appellate judges, don’t live and breathe actuarial equivalencies and discount rates.   Sometimes being a good lawyer means being a good translator.

ASOP 41 and clear communication

There is an article in the September/October issue of Contingenicies regarding Actuarial Standard of Practice 41 on Actuarial Communications which became effective on May 1, 2011.   This standard applies to all actuarial disciplines and concerns how actuaries express the results of their work to the users of that work.  The article, titled Let’s be Perfectly Clear, was written by James Gutterman, FSA, who is currently a member of the ABCD.  Gutterman offers some thoughts about how to handle disclosing materials which were relied upon in developing actuarial estimates, and how to handle the situation of a principal who directs the actuary to use an unreasonable assumption.  

For the latter situation, Gutterman states:

Once again, it comes down to the clarity of an actuary’s communication and appropriate disclosure of his or her views concerning the assumptions used. One possible approach here—in addition to stating prominently (not burying it in a footnote to a supporting exhibit in the report) that use of this mortality table is unreasonable—would be to assert in writing that the report should be provided to others only in its entirety. In this manner, when journalists from the local XYZ Tribune look at the actuarial report, they will be able to recognize why liabilities suddenly have decreased by 50 percent, why the plan actuary used a particular table, and why that actuary considers its use to be inappropriate.

It’s good advice.   No one ever got in trouble for being too complete, or too descriptive in explaining all the assumptions, data sources, and techniques used in developing a set of actuarial estimates.   Always err on the side of saying more.  

Limiting Distribution of Work Product — Avoiding Actuarial Malpractice

This is part of an ongoing series of tips for managing the risk of exposure to professional liability lawsuits.

As a general proposition, actuaries should only be liable to their clients, that is, the persons who are paying for the actuarial work product.  If an actuary does not limit the client’s ability to distribute her work to third parties, the actuary may in some circumstances find herself exposed to professional negligence claims by third parties who received and relied on the work.  The basic risk management step to avoid this kind of a liability to third parties is to prohibit the client from distributing your work without your prior written consent.  The condition for giving your consent will be an agreement by the third party that the third party will not bring any sort of claim against the actuary arising out of the work.  After all, if the third party is getting this work for free, why should they get the right to bring a suit for thousands or millions of dollars?  In situations where obtaining such consent is impossible or impractical, a risk management approach is to obtain the client’s agreement to indemnify the actuary for any liability or expense related to a claim by third parties.  

Sometimes actuarial work product is prepared for filing with a government entity such as a Statement of Actuarial Opinion or pension plan’s Form 5500.  In these settings, the actuary should make clear that his work is intended solely for the internal use of company management and for the purpose of the filing, but for no other purpose. 

Limitation of Liability Clauses — Avoiding Actuarial Malpractice

This is part of an ongoing series of articles on tips for avoiding being a defendant in an actuarial malpractice case.

It is a basic fact that actuarial estimates often involve projected liabilities in the millions or even billions of dollars.  A claimed mistake by the actuary can result in an equally large exposure.  See, e.g., the claim by the State of Alaska against an actuarial consulting firm for $2.8 billion.  It is reasonable for an actuary to negotiate over the allocation of that risk among the actuary and the client.

In many circumstances, it will be appropriate for there to be a monetary cap on the maximum potential liability of the actuary for malpractice claims.  Such clauses will not be enforceable in a situation of intentional wrong doing by the actuary or, in some jurisdictions, where there has been gross negligence, but in the majority of jurisdictions a limitation of liability clause can be used to limit the exposure of a professional to negligence claims by his or her client.   Limitation of liability clauses can also exclude liability for lost profits or other types of “consequential” damages.

Proper drafting of a limitation of liability clause requires legal expertise.   Most lawyers practicing commercial law should be able to draft one for an actuarial firm’s contracts.

The Management Representation Letter — Avoiding Actuarial Malpractice

This is the second in a series of posts on practical tips to avoid becoming a defendant in an actuarial malpractice lawsuit.

A useful risk management technique is the management representation letter.  A management representation letter requires that an appropriate representative of management acknowledge in writing the accuracy and completeness of data and other information being provided to the actuary.  Actuaries are not auditors and are not responsible for the accuracy or completeness of the information on which they base their reports beyond a duty to review such data for reasonableness and consistency.  (ASOP 23 - Data Quality).  Instead, the actuary is entitled to rely on information presented to him or her by company management.  It is useful to show that management has acknowledgment its responsibility for this information in a management representation letter.  

A management representation letter might take the format of a written acknowledgment that  ”the data and information contained in data files x, y and z are accurate and complete to the best knowledge of corporate officer Smith.”  The representation letter might also contain management’s written responses to a series of inquiries made by the actuary about items relevant to the actuarial analysis being performed.

Actuarial Standards of Practice often include a statement that the actuary should “inquire” about particular items or facts that could have impact on the actuarial subject being examined.  See, e.g., Actuarial Standard of Practice No. 43, section 3.5 (dealing with inquiries concerning the company’s claims handling practice).  While such a duty of inquiry can be met simply by an oral conversation with an individual within company management, you may get management to take its obligations more seriously if they are asked to respond to such questions in a signed document.  For the sake of convenience to the client, you could walk through the inquiries orally, prepare a document which contains the answers received orally from management, and then have management review and sign the representation letter.  At the end of this process, you will have a clear record of having made the inquiries required by the Actuarial Standards of Practice and showing the specifics of the information on which you relied in preparing the actuarial analysis.  

Know Thy Client — Avoiding Actuarial Malpractice

This is the first in a series of tips about practical steps to reduce the risk of being a defendant in an actuarial malpractice lawsuit.   

One of the basic steps in avoiding malpractice claims if you are a consulting actuary involves client screening and selection.  Clients vary with respect to the likelihood that they will be the source of a malpractice claim against you.  For example, a client who has sued its professionals in the past is more likely to be a client who may bring claims against professionals, including you, in the future.  A client who has been “fired” by its prior professionals, who resigned from their engagement, may be a client who is uncooperative in working with its professionals or who refuses to follow the professional advice which it has received.

A client’s financial status can also be an indicator of a riskier client.  Very frequently, when an insurer or other entity goes into receivership or bankruptcy, the receiver or trustee is likely to bring claims against outside professionals asserting that those outside professionals took some action which contributed to the insolvency.  Such claims are becoming almost the standard of practice for insurance receivers.  Therefore, it is important that you be aware of the client’s financial status and recognize that a client who might be in a zone of insolvency is a client for whom you should be particularly careful.  

Another client characteristic to screen for is the client who has had prior legal or regulatory trouble.  A client who has previously been convicted of crimes or subject to regulatory action, particularly action which involves areas where you will be involved as the actuary, is a client you may want to consider hard before agreeing to provide actuarial services.  

There are a number of resources available to assist you in performing such client screens.  Searches on Google on the internet can provide a wealth of information.  Review prior regulatory filings by the prospective client.  Learn the identity of prior professionals and have a discussion with those professionals if possible before you are engaged.  Obtain a Dunn & Bradstreet report on that client.  

In summary, do your due diligence before agreeing to be the actuary.

Even flawed actuarial work can be a defense to a securities fraud claim

Flawed actuarial work provided a defense for the individual officers and directors who relied on it in a recent decision by the federal district court for the Southern District of New York.    In re CRM Holdings, Ltd. Securities Litig. (S.D.N.Y., May 10, 2012).  This decision on a motion to dismiss a securities class action by the public shareholders of CRM Holdings, Ltd. (CRM) offers some useful language for defense of misrepresentation claims against actuaries and insurance company management.

CRM provided administration services to run various group workers compensation self insurance trusts in New York and California.   After an initial public offering in December 2005,  at least one large trust in New York administer by CRMH, the Health Insurance Trust of New York (HITNY), came under scrutiny for apparent under-reserving.   The court decision describes various criticisms raised the following year of the reserves set by the independent actuaries hired by HITNY.  Although CRM’s financials were not directly impacted by those reserves, the ability of CRM to continue to generate fees from HITNY and other trusts depended on the continued viability of those trusts.

In early 2008, the majority of the trusts which made up the business of CRM in New York had terminated, and the company’s stock price had dropped dramatically, leading to this securities fraud class action lawsuit against individual officers and directors.   This decision ruled on the defendants’ motion to dismiss the complaint on the basis that it had not alleged the requisite “scienter” — a knowing intent to deceive the investing public.   

Despite the fact that there were numerous alleged criticisms being heaped on the original independent actuary of HITNY for under-estimating reserves during the class period, the Court found that just alleging that an actuarial reserve estimate is wrong is not sufficient to show an intent to deceive:

Plaintiffs allege that “[t]he magnitude of the reserve  insufficiencies  here  supports  a  strong inference  of  scienter.”  (Id. at  39.)  However,  as discussed  supra, while  CRM  established  initial loss  reserve  amounts  for  the  trusts,  it  was  the responsibility  of  an  independent  actuary  and accountant     to     ensure     that     the     claims liability/expense   amounts   reported   by   CRM were  accurate.  See,  supra  p.  9-10.  Insurance reserves   “are,    by   their    nature,    ’extremely conjectural,  and  may  need  adjustment  as  time passes  and  their  accuracy  can  be  tested  in retrospect.’”  Zirkin  v.  Quanta  Capital  Holdings Ltd., No. 07 Civ. 851 (RPP), 2009 WL 185940, at   *11   (S.D.N.Y.   Jan.   23,   2009)   (quoting Stephens  v.  National  Distillers  &  Chem.  Corp., 6  F.3d  63,  65  (2d  Cir.  1993)).  Reserves  are opinions,  and  the  Complaint  must  allege  facts showing  ”that  defendants  did  not  truly  hold those  opinions  [either  knowingly  or  recklessly] at  the  time  they  were  made  public.”  Fait  v. Regions Fin. Corp., 712 F. Supp. 2d 117, 124-25 (S.D.N.Y.  2010).  Plaintiffs  have  not  made  any such  allegations  in  the  [Consolidated Amended Complaint]. 

This discussion of reserves now goes into my folder of cases to cite when someone argues that an actuarial estimate which misses the mark by a wide range must have meant that the actuary was guilty of fraud. As the decision says, loss reserve estimates are opinions, and while an erroneous opinion might vary widely from what actually develops, it creates no inference of fraudulent intent. In this case, the existence of an independent actuary issuing a reserve opinion, even an opinion that was alleged to be flawed and wide of the mark, was sufficient to provide protection to individual officers of CRM from being forced to defend themselves in a securities fraud case.

When actuarial errors cause overpayments

One type of actuarial malpractice claim involves mistakes which lead a pension plan to make payments which exceed amounts actually payable under terms of the Plan.   An example of this type of claim was highlighted in a May 30 article  about the Virginia Retirement System in the Richmond Times Dispatch.  According to this report, the actuaries for the system miscalculated a cost of living adjustment in 2009, resulting in overpayments to 120,000 retirees over the past 3 years.   The total amount overpaid was $28.7 million.

An important factor in a case like this is the ability of the Plan to recover the overpayments.   When a Plan overpays by mistake, the Plan is justified in the position that the recipients should not be entitled to keep the over-payments.   If the overpayments are repaid, the Plan has not suffered any damages.   Very often, a Plan which is making ongoing payments to retirees can recoup overpayments simply by offsetting it against some future payment to the recipient.   

This appears to be what the Virginia Retirement System has decided to do.   There are group life insurance policies on these retirees, and the VRS is attaching the claims for return of the overpayment (80% of which are under $500) to those policies.   For retirees who have already died and life insurance benefits have already been paid, the actuarial firm is going to reimburse the system.

Even if there is not a future source of payments, the actuary facing a claim like this can argue that the Plan should pursue recovery of the overpayment, even including filing suit to recover the overpayment, in order to mitigate the Plan’s damages.  

As a risk management step, an actuary can add to a contract with its pension plan client an affirmative obligation for the Plan to attempt to recover overpayments before asserting any claim against the actuary.  

Public plan sponsor sues its Plan

There is a very public dispute between the City of Houston and the public pension plan for its firefighters, the Houston Firefighters’ Relief and Retirement Fund.  In the latest round, the City announced on May 17 that it had filed suit against the Fund for release of certain census information about the participants in the Fund:

The City of Houston today filed a lawsuit to obtain access to information the Houston Fire Fighters Relief and Retirement Fund (HFFRRF) refuses to provide. The lawsuit seeks data to allow the city to calculate the pension benefits that taxpayers will have to pay fire fighters covered by the HFFRRF over the next 30 years. The data being requested is available to the city under state law and needed to adequately budget for the future. 

The firefighters have a different view:

Every year, the city of Houston receives reports that describe in detail how much money the pension fund receives from all sources. These reports provide all of the information related to the firefighters’ pensions that the city needs to include in its budget development process. The other information the mayor is requesting is of no use for budget planning and claiming otherwise is nothing but pretext. This request for the members’ private information is like asking the members of the public to disclose what they have in their own private savings and checking accounts. When someone has your private information, that person gains power over you.  [Mayor] Parker is up to another old fashioned power grab at the expense of Houston firefighters.

I think a pension actuary would agree that detailed census and enrollment data is needed in order to perform a replication audit of a plan, if that is what the City has in mind.   Whether the City is entitled to perform such an audit would be a matter for Texas law.   This is one public plan sponsor who believes it cannot and should not just rely on the actuarial reports of the plan’s actuary.