Actuarial opinions

on underwriting and
reinsurance strategy
Jenny Wong and Graham Fulcher discuss some
changes and challenges ahead for actuaries.
“Where do you see yourself
in five years time?” This is
a question often asked at
job interviews, but it is also
one that actuaries should be
asking themselves now in the
new Solvency II world.
Nine key areas of responsibility
required of the Actuarial Function
were laid out in Article 41 of the
Solvency II Directive, with follow up
advice on implementation provided
in Consultation Paper 33 (CP33)
in March.
Typically, actuaries have been involved
in the calculation of technical reserves
and the Standard Capital Requirement
(SCR) – both of which are Pillar I
related items – where they have been
able to use modelling and analytical
skills. However, Article 41 also
introduced requirements to express
an opinion on the overall underwriting
respondents thought it would be
‘very difficult’ – a much higher
proportion compared to the other
eight responsibilities.
Opinion on underwriting
and policy
Any actuary who has worked with
underwriters will know the challenges
this presents. Underwriters often have
a very different skill-set to actuaries,
and being on the ‘front line,’ they may
believe actuaries to be too ‘ivory tower’.
However, where actuaries can add the
most value to a company is in working
closely with underwriters for example,
developing pricing models and
reviewing performance of accounts to
help guide the company’s strategy.
Figure 1 | Actuarial requirements under Solvency II
Actuarial responsibilities
So how might the actuary/underwriter
relationship change if the actuary
has to give an opinion on underwriting
policy? On one hand, this could
possibly alienate underwriters if they
perceive the actuary as having a
‘big brother’ role, creating a culture
of mistrust and segregation which
will ultimately be counter-productive.
On the other hand, having to express
an opinion on underwriting will require
a detailed and close understanding
Pillar 1 Pillar 2

policy and the adequacy of the Coordinate calculation of technical provisions Y

reinsurance arrangements. These
areas are likely to be new ground for
many actuaries, but will be increasingly
important under the Own Risk and
Solvency Assessments (ORSA)
regime introduced as part of Pillar 2.
Figure 1 shows how the actuarial
responsibilities align with the
requirements of the new regime.
Our view is that expressing an opinion
on underwriting will be the main
 nsure appropriateness of methodologies, models
E
Y
and assumptions used
Assess sufficiency and quality of data used Y
Compare best estimates against experience Y
Inform management of reliability and accuracy
Y
of calculations of technical provisions
Oversee calculation of technical provisions for areas
Y
not susceptible to actuarial analysis
Express an opinion on overall underwriting policy Y
Express an opinion on adequacy of reinsurance arrangements Y

challenge for many actuaries, a view Contribute to effective implementation of a risk management
system in particular with respect to risk modelling for:
which is supported by findings from a
n Solvency Capital Requirement (SCR) Y
recent Watson Wyatt Solvency II
n Own Risk and Solvency Assessment (ORSA) Y
survey in which 40 per cent of

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 of how underwriters operate. The
opinion does not need to cover every
single policy, but the underwriting
policy in general.
Underwriting can take many forms
(for example, taking a following line,
writing treaty business, using rating
tools/book rates with and without
applying judgemental adjustments,
individual large case underwriting
and consideration of portfolios
to monitor aggregations). The
actuary’s level of involvement may
therefore range very significantly
in each of these areas (from the
development of rating tools for use
by underwriters requiring significant
judgement to setting book rates with
no underwriting involvement at all).
Consequently, the level of data and
information available for giving the
opinion could vary considerably.
The opinion is expected to be in
the form of a written report, at least
annually, that highlights the possible
shortcomings of the policy and
possible consequences, as well as
recommendations for improvement.
This will include an analysis of the
sufficiency of the premiums to cover
future losses, including expenses
directly associated with future claims,
and of unallocated loss adjustment
expenses. Surprisingly, there is no
mention of capital requirements
8  |  insurance matters 2009
or investment income in the CP33
guidance. A 95 per cent combined
ratio gives a very different return to
shareholders if it is on Personal lines
motor than on Excess Casualty, for
example. Any evaluation of rating
therefore needs to consider these
wider issues, something with which
an internal model can assist.
Watson Wyatt feels it would be
useful for some clarification as to
what kind of business the opinion
refers to: already written and earned
business, unexpired exposure on
already written business, or the next
year’s prospective new business. In
our view, the first of these is covered
by technical provisions, the second
is effectively an assessment of the
need for an additional unexpired risk
reserve (AURR) which is normally
an accounting assessment and
in any event sits within technical
provisions. Therefore, we feel that
this assessment should be for one
year’s future new business (which
fits well with the Pillar 1 time horizon
for capital assessment), and that this
opinion could usefully be provided as
part of the annual business planning.
Opinion on reinsurance
adequacy
The involvement of actuaries in
reinsurance purchasing has increased
over the last decade – particularly
in major reinsurance brokers and
increasingly in companies using
actuarial modelling to assist in
their reinsurance purchase
decision-making. Commonly, this may
include a combination of a full ICA
model to guide strategic decisions
and bespoke deal-specific models to
guide more tactical purchases.
However, the actuaries’ involvement
is still often subsidiary to the
reinsurance manager and commonly
does not cover areas such as choice
of broker, design of the reinsurance
panel, or wording issues. It is not
clear if the opinion will be required
to cover some of these areas, and
therefore if this may lead to an
extension of the actuary’s role.
CEIOPS’ guidance suggests this
opinion should include the adequacy
of the calculation of the technical
provisions arising from reinsurance.
In our view, such an assessment
forms part of the assessment of
technical provisions (for example,
including the assessment of
whether a full stochastic reserving
exercise is required or whether proxy
methods for the expected losses
are appropriate). We feel that an
assessment of reinsurance adequacy
should be forward looking based on
future exposures.
The opinion on reinsurance will also
be a report, at least annually, that
needs to include comment on the
adequacy of reinsurance including
the expected cover under stress
scenarios. This is an interesting
concept and similar to some of
the Realistic Disaster Scenarios
developed by Lloyd’s, which have
been specifically designed to stress
reinsurance covers (for example, the
two loss scenario which tests the
horizontal cover available during
the wind season).
Who can give the opinion?
The role of the Actuarial Function
is not (at least currently) intended
to be the same as the Responsible
Actuary role which some European
states have adopted. As drafted,
the regulations do not refer to an
individual, but rather a function
and there is no requirement for
‘actuaries’ to have gained a formal
actuarial qualification.
Instead, the requirements relate
to the skills and experience of the
individuals undertaking the function,
such as having an understanding
of the nature of the risks and the
ability to comment on the adequacy
of the methodologies used, including
statistical models, where appropriate.
Possible issues and
considerations involved in
undertaking these two opinions
Independence
If the pricing actuary undertakes the
underwriting opinion, the advantage is
that the actuary is close to the issues
involved. However, this also raises
the issue of lack of independence.
We think that the guidance in CP33
appears somewhat contradictory
in relation to this. It states that the
actuarial function should be “objective
and free from influence of other
functions or the administrative or
management body”. However, it also
recognises that the actuary can be
involved in the original decisions.
Surely if an actuary’s role is pricing
then it will be very difficult to
have true objectivity over the
underwriting policy?
The Consultation Paper also requires
the Actuarial Function to be made
up of persons who are sufficiently
independent of each other in order
that each person can form his own
view. In reality, independency within
the function will be difficult to achieve
and indeed to demonstrate.
Asking a non-pricing actuary to carry
out the opinion could overcome the
independence issues. However, the
actuary may not have the relevant
experience and expertise to meet the
requirements of the role.
Structure of the Actuarial Function
Generally, actuarial teams are
structured either along tasks (for
example, pricing or reserving) or
by product lines where actuaries
provide support on all areas related
to that product. Either structure could
present issues of independence or
lack of expertise depending on who
undertakes the opinions. One option
could be for one product team actuary
to give an opinion for another product.
Resources
Undertaking these two opinions will
add to the workload of actuaries.
Firms may not be adequately
resourced, particularly smaller firms,
and in these situations the function
could be outsourced to alleviate this
problem. Outsourcing could also
provide the required independence
and expertise in addition to bridging
the resource gap. Guidance on
outsourcing is also covered in CP33.
Relationship with Risk
Management Function
The new system of governance
also requires the risk management
function to have written policies
on underwriting and reinsurance,
amongst other items. Potentially,
there could be an overlap between
the actuarial opinions so close
communication between these two
functions will be required. Indeed,
full or partial integration between the
two functions is an option that CP33
mentions as an acceptable approach.
What happens to the opinion?
The opinions are submitted to
management who are required to
document the decisions taken in view
of the findings and recommendations
of the actuarial function. CP33
only states that there is detailed
monitoring of the implementation of
these recommendations, but we feel
there needs to be further guidance
on this. Some questions which need
answering are:
Who is responsible for this
n Graham Fulcher
monitoring? Actuarial or
Risk Management?
n What happens if there are
disagreements over the
recommendations made?
n What are the time
scales for following up
on the recommendations?
Summary
The scope of an actuary’s role
will be much wider in the future.
The relationships the actuary
has with management, risk
management and underwriting
functions will also be redefined
under the new responsibilities
and ORSA framework.
Relationships are not formed
overnight and it is important to
engage with all relevant parties
in working towards Solvency II
now. This is particularly true of
underwriters who may feel that
the system is of no direct benefit
to them, only a burden and
restriction on their work.
The new regime also raises
the questions of the most
appropriate structure for the
actuarial function, allocation of
responsibilities, who provides
the opinions and the level of
resources required in order to
meet the requirements.
There will be many changes and
challenges ahead for actuaries
in all roles.
Further information
For more information, contact:
Jenny Wong
+44 (0) 20 7227 2691
jenny.wong@watsonwyatt.com
+44 (0) 1737 284869
graham.fulcher@watsonwyatt.com
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