10 Questions to Ask Your Actuary [Risk Management]

Many companies retain their risks and there are many ways to do this logistically; insurance programs with large deductibles and self-insurance programs are popular choices. Regardless of method, there is always one critical step: conducting an actuarial analysis of the retained liabilities remaining on the corporate balance sheet.

Company risk managers, controllers, chief financial officers and others who work directly with an actuary generally obtain a reasonable level of value from the actuarial analysis. However, these company managers often miss opportunities to get more value from it.

Thus, employing the actuarial services of an outside partner can help. For those that go this route, here are 10 questions that a risk manager should discuss with their actuary.

1. Is the actuary aware of all intended uses of the report?

The obvious purposes of an actuarial report include a reserve estimate to support the company's financial statements and an estimate of retained losses for the upcoming year to support the company's budgeting process. But the risk manager may find additional uses. And absent an understanding of these extra uses, the actuary may not devote sufficient attention to the aspects of the report that will support them.

As an example, say XYZ Company has retained $500,000 for each workers compensation claim since 1985. The most recent actuarial report estimates the following workers compensation reserves as of 12/31/11:

The XYZ risk manager plans to begin negotiations to closeout the 1985-1995 policy years using the $20 million estimate in the actuarial report.

Unfortunately, the risk manager did not discuss this intended use of the $20 million estimate-which may not be appropriate for that purpose-with the actuary. With knowledge of the upcoming closeout negotiation, the actuary may have discounted the $20 million reserve estimate to encourage consideration of the time value of money. The actuary may have developed a more refined estimate for the 1985-1995 policy years given its potential significance in the context of the closeout negotiation. The actuary could also have provided insight into the upside/downside risk to help with the company's decision making process on the closeout.

2. Has the actuary helped create a customized report?

A risk manager should not be expending a significant amount of time pulling together information scattered throughout an actuarial report. This time and effort decreases efficiency and increases the risk of errors in transferring information from the report to the company's financial statements. An actuary can customize the report by building charts and an executive summary that make everything simple.

Demand certain documents, including an executive summary, a summary of overall reserve estimates at fiscal year-end, and a summary of ultimate loss projections for coming year. Also, request summary charts that show key performance metrics (e.g., loss rates, claim frequency, average claim size), charts that compare estimates from the current and prior report, and charts that reconcile the raw data with the data displayed.

3. How good is the exposure data the actuary receives?

The quality of the data affects any analysis. The two main types of data an actuary receives are claims data (e.g., paid losses, case reserves and claim counts) and exposure data (e.g., annual payroll, sales and vehicle counts).

A self-insured company typically pays close attention to the completeness and accuracy of the claims data its actuary receives. The data generally comes from a well-controlled claims reporting system. The exposure data, on the other hand, is often much dirtier. This lack of quality can lead to exposure data that is inconsistent from year to year, and is missing significant components or includes other errors.

4. How does the actuary stay informed about company changes?

The actuary should be aware of any changes. One may include a new approach to establishing case reserves on open claims-something that often follows changes in the company's insurer, TPA or internal staffing. The actuary should also know about any new employee safety initiatives. This can corroborate early signs of improvement in claims data, allowing actuarial estimates to respond faster to the improvement. Lastly, expansions or contractions of company operations and locations can affect how the actuary uses historical data to project future losses.

5. How does the actuary reflect external information?

Even for fairly large companies, consideration of external information can often improve the quality of an actuarial estimate. Comparison of relevant external information to a self-insured company's own claims experience may also be useful, even if it is not used directly in the actuarial analysis. Benchmarking can be an important consideration. Examples of external information that actuaries often consider are loss development factors and trends in claim frequency, severity and loss rates.

6. Is the actuary's quality control process sufficient?

How does your actuary check that the report's calculations are free of errors? How does he confirm that the selection of methods and assumptions and overall results in the report are reasonable? The absence of a quality-control process increases the chance of material errors. Such mistakes can adversely impact the accuracy of a company's financial statements and its ability to monitor the cost drivers of the company's self-insurance program.

The quality-control process typically involves two separate quality checks performed by actuarial staff not centrally involved in preparing the report. The first quality review checks for basic technical accuracy; the second, a peer review performed by another credentialed actuary, assesses the reasonability of methods, assumptions and overall results.

7. How does the actuary translate the report to the financial statement?

During the course of an external audit, the audit firm's actuary may review the report on the company's self-insurance liabilities. This review sometimes finds that the estimates in the actuarial report are reasonable, but the company's financial statements are inconsistent with the actuarial report's estimates. This inconsistency often results from the company's difficulties in correctly translating the actuarial report to the company's financial statement accruals. Direct assistance in this translation process from the actuary can reduce the risk of errors and material financial statement mistakes.

8. Is there a better time of year to conduct the actuarial report?

For year-end financial statements, some companies obtain the supporting actuarial report after year-end, but before issuance of the financial statement. Other companies provide claims data to the actuary months earlier so she can complete the actuarial report well in advance of year end.

This approach has several advantages. It minimizes the potential for conflict with the year-end closing process. It allows more time for year-end planning. It also allows time for a more extensive actuarial analysis that identifies cost drivers. And it better supports the timing of other management objectives (such as insurance program renewal, budgeting and collateral negotiations).

However, an early completion of the actuarial report has one potential disadvantage: the report will not reflect claims information from the date of the daims data to the date of your company's financial statement. Conducting a more abbreviated analysis of the incremental claims activity between the actuarial report and a company's year-end can generally mitigate this disadvantage.

9. What is the succession plan for an external actuary?

Most self-insured companies eventually need to replace the person serving as its external actuary. The need for a replacement may arise due to the actuary retiring, changing employers or the decision of the self-insured company's management. The need for a change may arise suddenly and leave little time for an orderly transition to a new actuary.

A company can take several actions today to smooth such a transition. First, it should retain prior years' actuarial reports and the data it provided to the actuary. The new actuary may need access to the prior actuarial reports and the associated data. It also helps to develop a relationship with another external actuary, and consider engaging him to perform a second external review. Lastly, the company should ensure that actuarial reports contain complete documentation. The types of information that may be useful in facilitating an actuarial transition include data summaries, exhibits that detail the actuarial approach, key features of the historical insurance program and an explanatory report text.

10. Is the actuary providing more than just basic numbers?

If the company's actuary is providing just the basic estimates of reserves and future loss projections, it may be missing out on significant value. Actuaries can help the management of a company's self-insurance program in many ways. They can conduct "drill-down" analysis to identify items driving up self-insurance costs. They can provide cost estimates to help the company assess retention level and insurance coverage options. They can assist in collateral negotiations related to large deductible insurance programs. They can help allocate self-insurance program costs to business units. And they can provide industry perspective on trends and best practices.

Actuarial value is maximized when the actuary's role goes beyond providing just "the number" to becoming an important member of the company's risk management team.

Dorothy A. Woodrum is director, FCAS, MAAA, John F. Gibson is principal and Patrick K. Devlin is director at PricewaterhouseCoopers LLP.