This issue of The Actuary asks how actuaries can continue to have a voice in the design and regulation of insurance products. But there are other critical questions, too. How can actuaries meet the challenges of upcoming regulation in today’s workplace with constantly changing technology? Can insurance and regulation symbiotically coexist?
After decades of working with regulators, actuaries are well positioned to deal with such future challenges—historical actuarial involvement with regulation provides important guideposts for continued relevancy. In particular, health actuaries have a difficult task of dealing with products that immediately impact lives, but for which there is limited common understanding—or at least complete agreement—as to basic product dynamics. Regulation of health products has evolved with the times to address emerging public concerns. The role of the actuary in meeting the challenges of future regulation and changing technology will depend on bridging the gap between public sentiment and workable solutions.
The roles of the regulator and the actuary not only exist symbiotically; actuaries are, to some degree, creatures of regulation. The formal role of the actuary is part of the implementation of many regulations. Actuarial and regulatory roles usually are brought together with the shared goal of solving technical problems when market-driven initiatives call for a change. While discussions might sometimes seem contentious, or even adversarial, this is most often the result of different perspectives as to how the desired outcome might best be achieved. Appropriate focus on the shared goal of a working solution, and recognition of differences in perspective, will allow actuaries to continue to play an important role as a reliable resource for regulators.
Years ago, actuaries seemed to be the only mathematicians working at a health insurance plan. Rumor had it you could find actuaries studying for some mysterious examination, excited about an elegant, new mainframe program or playing bridge during lunch in the cafeteria. The education of the actuary included obscure topics such as commutation functions, interpolation and graduation theory—all focused on workarounds for limited computational power. But as analytical power moved beyond mainframes and 10-key calculators and into corporate hands, the nature of the actuarial role evolved. While retaining technical understanding and expertise, actuarial training embraced a focus on more fundamental skill sets needed to remain relevant: collaboration, professionalism, transparency and communication.
While the examples in this article primarily deal with health care regulation, the observations as to what works and what doesn’t are relevant to all regulated products. Understanding the special context in which health care plans operate, however, can help guide actuaries as they respond to the nature of the demands on regulators:
- Health care coverage stems from services that policyholders encounter on an almost-daily basis. However, these encounters involve a medical delivery system that employs complex technology and expertise—and this is combined with a process that often suffers from a lack of transparency. Additionally, many times there can be multiple options for treatment, but there is a lack of absolute outcome guarantees.
- Expertise involved in medical coverage is often viewed as biased. Providers of services, health organizations and pharmacy vendors are often for-profit enterprises. It is difficult to sort out whether an argument about reimbursement is motivated by medical necessity or profit incentive. Conversely, experts from insurers or health plans also are viewed as having similarly tainted underlying motivations. Skepticism even finds its way into assigning bias in the motivation of the courts and regulators assigned to resolve politically charged disputes.
- Regulatory changes often fall prey to unintended consequences. Solving one problem frequently leads to a different problem. Fixing problems with budgets and cost often leads to issues regarding access to services. Changing reimbursement for services rendered often leads to changes in the delivery or packaging and documentation of such services.
- The degree to which health insurance straddles the line between an essential right and a regulated commercial product is being debated vigorously. Part of the problem with regulating health care is the lack of a common definition of the objectives to be met.
Despite these daunting issues, actuaries provide a valuable service to insurance regulators and government officials. Whether assessing appropriate performance of a private insurance enterprise or setting guidelines for a public program, actuaries continue to offer needed expertise to those in charge of managing or regulating the delivery of health services.
Regulation and the Appointed Actuary
The most obvious example of regulatory involvement for actuaries is the role of the appointed actuary. In this case, the actuarial role was codified to address several of the potential shortcomings encountered in achieving public confidence in regulation.
Regulators were faced with the need to review annual and quarterly Statements of Operation that reflect the balance sheet, current earnings and financial strength indicators for insurers and health care entities. Review of such financial statements, however, includes accrual entries dependent on actuarial projections for future liabilities and assets. By their very nature, such projections are subject to an unavoidable error of estimation. Collaboration between regulators and actuaries was required to understand the nature of such estimates and create confidence in the resulting reported outcomes.
Regulations created the role of the appointed actuary to be responsible for such projections, and they also established disclosure parameters for the estimation process. An Actuarial Opinion must be filed to attest to the sufficiency of the financial statement estimates. An Actuarial Memorandum must disclose the details behind the calculations and the overall context for the financial statements. This allows the regulator to accept these important estimates, with some degree of control over the processes and disclosure of the outcomes.
The collaboration works because regulators can rely on professional actuarial standards. The actuarial profession embraced its responsibility by providing specific professional training, education and guidance. Actuarial accreditation tests the knowledge of basic principles and specific topics, which then allows regulators to point to actuarial expertise as reliable. Actuaries are guided by Standards of Practice and bound by the Code of Professional Conduct. As a result, regulations specify the professional credentials required, the nature of the actuarial role, required language in the certifications and guidelines as to disclosures. This actuarial responsibility is codified further in a somewhat unique role, with the appointed actuary reporting directly to the board of directors and not the management of the reporting entity. Regulations additionally demand a one-on-one conversation regarding the financial statement estimates between the appointed actuary and members of the board. The regulation even allows for a Qualified Opinion—or potentially an Adverse Opinion if the data are deemed insufficient to form an opinion or the actuary cannot agree with the report entries.
Overall, the role of the appointed actuary exhibits the specific elements critical to collaboration with regulators: ability to rely on professional standards, transparency in reporting and clear lines of communication.
Risk-based Capital and Cash Flow Testing
Regulators have the responsibility of monitoring the current and projected surplus levels of insurers to determine whether they can meet the promises made for future obligations. Review became increasingly difficult as modern life and annuity products came to rely on an investment component and the matching of assets against liabilities. At about the same time, many newly formed health maintenance organizations (HMOs) and risk-sharing health care startups learned that relatively thin margins and inherent variability in health care operations could pose a longer-term solvency challenge.
Regulators again collaborated with the actuarial profession to create modeling solutions and benchmarks for surplus adequacy. Detailed analysis of historical data and stochastic modeling helped develop an understanding of surplus strain as well as sensitivity to interest scenarios. Risk-based capital (RBC) analysis helped differentiate between various types of risk—including investment risk, insurance risk and specific types of operational risks. Factors were developed to help establish the overall capital requirements needed to avoid insolvency. The resulting actuarial work formed the basis for RBC and cash flow testing regulations.
Professionalism was again an important aspect in creating confidence in the regulations. In addition to professional actuarial involvement, this work was done in conjunction with the National Association of Insurance Commissioners (NAIC) to translate modeling outcomes into guidelines for monitoring surplus levels. Regulators needed the industry to embrace benchmarks for monitoring surplus and the potential for interventions.
Communication and transparency were needed from both actuaries and regulators to create a broad understanding of the impact of various risk factors. The result was not just flagging a concern, but also a basis for an action plan to address any emerging problems. Clear communication of the strengths and weaknesses of projection models was extremely important. Regulation of surplus levels was not a one-size-fits-all determination—some regulators chose to implement the NAIC model while other states created different solutions (e.g., variations for HMOs and California Knox-Keene). However, all regulations share the same understanding about relative risk factors and model outcomes. Statutory regulators worked with various actuarial organizations in both the development and dissemination of the modeling solutions and regulations.
The RBC and cash flow testing modeling solutions provide another example of successful cooperation between regulators and actuaries. In this case, a broad policy problem required the development of a specific complex analysis. Such analysis required transparent explanations as to how the models worked, as well as the sensitivities to formula and available data being applied.
Another example of effective regulation is the small-group reform laws implemented in many states in the early 1990s. At that time, the small-group market had many characteristics similar to the pre-Affordable Care Act (ACA) individual market. Policies were issued subject to medical underwriting requirements, and preexisting conditions often were excluded or resulted in coverage being unavailable for some employer groups. Durational rating and risk-pooling strategies resulted in issues with rate spirals in closed blocks of business, with groups that could no longer satisfy medical underwriting requirements facing large rate increases and sometimes unaffordable premiums.
The intent of small-group reform laws was to reduce or eliminate many of the perceived problems with durational underwriting and block rating practices while maintaining a competitive small-group market. The NAIC worked with industry stakeholders and state regulators, including actuaries, to develop a model law that effectively addressed these issues. Including representatives from both sides, especially actuaries, when dealing with a challenging and technical set of problems resulted in a solution that avoided many of the unintended consequences that might have occurred otherwise. While not a perfect solution, the NAIC small-group model law was eventually adopted in whole or in part in most U.S. states by the mid-1990s.
Because the rating regulations under small-group reform included various limitations on overall rate relationships and annual rate changes for small employer groups that might have been difficult to regulate otherwise, the model law utilized an annual actuarial certification process to demonstrate compliance with the many requirements of the law. Under this requirement, a qualified actuary certified each year that each company participating in the small-group market had met all of the rating requirements. Like the appointed actuary example described previously, this is another way the professionalism of actuaries facilitates indirect regulatory oversight. While this requirement did not completely eliminate the role of regulators in the small-group market, it certainly reduced some of the direct oversight in a complex regulatory environment.
While the implementation of small-group reform resulted in short-term disruption for insurance carriers, groups and markets, the end result was largely successful. The worst elements of prior rating practices were reduced or eliminated, and the overall market remained viable and competitive in the long term. The involvement of the actuarial profession was a success—both in the development of the model law itself and in the long-term administration of the resulting regulations via the actuarial certification process.
One of the more difficult and controversial public policies regulators faced was implementing the ACA. Opinions about the overall degree of ACA implementation success will vary, but it should be clear that regulatory solutions fell short of full success in terms of seeking a collaborative solution. The ACA attempted to tackle a wide variety of initiatives on an aggressive timeline. While broad objectives were publicly supported, execution within a regulatory framework proved difficult—and, in fact, issues are still being debated and litigated today.
While there are several positive examples of applying actuarial expertise to implement aspects of the ACA, a number of tactical implementation issues did not find uniform public acceptance once examined in detail. It’s not productive to become sidetracked by itemizing ACA objectives vs. outcomes; however, regulatory implementation was hampered by the failure to achieve our ultimate goals of transparency and communication. The ACA offers an example of problems that can befall regulation for which explanations of significant technical issues can become too muddled to assure a broad base of support.
We can meet the challenges of future regulation and advances in technology by applying strategies that were successful in the past:
- Actuaries can assist in the important foundational step of brokering a well-structured working definition for proposed solutions. Too often it is easy to agree a problem exists and define broad sets of objectives. However, practical solutions require a structured exposure of the pros, cons, limitations and unintended consequences, and an in-depth understanding of potential outcomes. This collaborative framework approach is characteristic of actuarial problem-solving.
- Proposed solutions, while often complex and technically dense, require as much transparency as possible. It is usually a painstaking exercise to achieve full transparency when dealing with complex issues, and it can be frustrating for all involved when proposed solutions are derailed by inconvenient complications. However, full disclosure of the underlying assumptions, supporting data and analytical shortcomings avoids the problem of losing credibility if later results differ from the broad expectations.
- The most important follow-through for transparency and structured solutions is full and careful communication. In addition to all of its benefits, modern technology provides communication avenues for just about anyone to broadly weigh in on virtually any topic. All too often, a lack of immediate transparency in complex situations allows an observer to replace a technical explanation with a more sinister storyline. As we have seen in recent communications related to COVID-19, message consistency instills confidence that full and fact-based solutions are being vetted. Actuaries offer regulators the well-reasoned “science” needed for convincing communications.
- Regulators value actuarial professional standards because they provide credibility for even the most transparent and skillfully communicated solutions. By identifying actuaries as professionals guided by independent standards, the issue of industry bias can be minimized. Actuarial credentials, Standards of Practice and the Code of Professional Conduct allow regulators to describe actuarial analysis as independent and unbiased. Credibility also is increased through collaboration with an established, broadly based organization such as the NAIC or other structured regulatory entities. Just as actuarial credentials reinforce the standing of professional actuarial analysis, open public discourse offered through such regulatory organizations helps avoid solutions being cast merely as support for a narrow political agenda. Those of us who have participated in drafting and reviewing exposure drafts of an Actuarial Standard of Practice (ASOP), or who have worked with an NAIC Task Force, often find it a slower process than we might wish. However, the methodical process of achieving a consensus helps convince the public that the regulation is well designed and unbiased.
Future regulation, regardless of technology, will always benefit from a transparent development process and careful communication of proposed solutions. The process is greatly enhanced by the collaboration between actuarial professionals bound by well-established standards and regulatory organizations that offer open and well-documented processes. Such collaboration offers actuaries and regulators the opportunity to address future solutions successfully.
Copyright © 2021 by the Society of Actuaries, Schaumburg, Illinois.