What is an Actuarial Opinion For? as answered by HB Actuarial Services, Inc.
Complex Calculations Made Easy to Understand
I am including this topic in our library for a few reasons:
1) There is very little material on this topic written with the client in mind. Most of the resource material on actuarial opinions is written with the actuary or regulator in mind.
2) I have noticed that several of my clients and prospects do not have a clear understanding of the goal, scope, purpose, or work product of an actuarial opinion. This article is written to clarify that understanding.
The client’s goal for the actuarial opinion should be to have the opinion contain the following paragraph about “Exhibit A” (Exhibit A lists several loss reserve items appearing in an insurance company’s financial statements):
“In my opinion, the amounts carried in Exhibit A on account of the items identified:
Meet the requirements of the insurance laws of (state of domicile).
Are computed in accordance with accepted actuarial standards and principles.
Make a reasonable provision for all unpaid loss and loss expense obligations of the Company under the terms of its contracts and agreements.”
(Underline emphasis is mine)
The above wording is boilerplate language communicating to the client and other readers of the actuarial opinion that the actuary believes that the reserves on the books are OK, and can be arrived at using actuarial methods and assumptions that are reasonable. The actuary will need to have support for this opinion in the form of an actuarial report that shows the actuary’s calculations of reserves and his range of reasonable estimates.
One interesting subtle point to notice about the above paragraph is that the actuary is not stating that he agrees with the booked loss reserves, nor is he stating that he believes that the booked loss reserves are the most likely result of ultimate liabilities. It is just stating that the booked loss reserves “make a reasonable provision”. The booked loss reserve is chosen by company management alone. Indeed the booked loss reserves are often different from the actuary’s best estimate.
Let’s revisit Exhibit A. Exhibit A displays the company’s booked loss reserve items (both gross and net of reinsurance) that’s it. It does not contain any information on booked asset values, other liabilities, surplus, equity, profitability, or even viability of the company. The actuary does not review these items at all and expresses no opinion on these items. The actuarial opinion may be favorable (i.e. containing wording similar to the above) even though the company does not have the cash flow to support its operations. This can occur for several reasons including: loss development not reasonably expected by the actuary, improperly valued assets, inadequate assets, and several other reasons. Yes, I included “inadequate assets”. A company can have inadequate assets, or even a negative net worth, and still obtain a favorable actuarial opinion. However, in that case, the regulator will likely take action to prevent the insurance company to continue to operate freely.
The purpose of the actuarial opinion is to communicate to the regulator that the actuary believes the company estimated its loss reserves in a reasonable manner. Regulators seek additional comfort regarding the reasonableness of a loss reserve because loss reserves are by far the largest liability for an insurance company. In addition, loss reserves are merely estimates and it can take several years until it is known whether a loss reserve estimate was adequate. For many insurance companies, a 25% move in loss reserves can be the difference between viability and bankruptcy.
Regulators required a credentialed actuary to certify loss reserves because credentialed actuaries are experts in using the techniques required to reasonably project an adequate reserve. Regulators often rely on the actuarial opinion to give them comfort that loss reserves are adequate. A regulator’s comfort with loss reserves helps a great deal towards giving the regulator confidence that the insurance company is viable in the state.
In almost all cases, the actuary’s work product for an actuarial opinion assignment will consist of an actuarial report accompanying the actuarial opinion. The actuarial report usually contains many pages of text, graph, and exhibits. The text of the report has a lengthy discussion of the company, its risks, and the actuarial techniques used. The exhibits and graphs show the actuary’s best estimate of the insurance company’s loss reserves and all of the calculations the actuary made leading up to that “best estimate of reserves”. As a reminder, the actuary’s best estimate of loss reserves may be different from the loss reserves that are booked by the company. The actuarial report is generally provided to only company management and the board of directors. Even for a small insurance company, the actuarial report will be dozens, or maybe even hundreds of pages.
The actuarial opinion document is a much shorter document, usually 5 to 10 pages. It is included with the insurance company’s Statutory Annual Statement and distributed to regulators.
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Complex Calculations Made Easy to Understand