Actuarial standards

What Are Actuarial Standards?

Actuarial standards are a set of professional guidelines and principles that actuaries must follow when performing their work, particularly in the field of risk management and financial analysis. These standards provide a framework for the sound application of actuarial science, ensuring consistency, reliability, and transparency in the assessment of future uncertain events. They are crucial for maintaining public confidence in the actuarial profession and protecting stakeholders like policyholders and pension beneficiaries. The overarching aim of actuarial standards is to guide actuaries in developing informed analyses and conclusions across various financial contexts.

History and Origin

The foundation of actuarial science can be traced back to the mid-17th century in Europe, with early work on probability theory and mortality tables. The demand for a formal profession emerged as concepts like the level premium system for life assurance gained traction in the 18th century, notably with the formation of the Equitable Life Assurance Society in London in 1762. In North America, the actuarial profession began to formalize in the early 19th century, though initial attempts to form an organization in the mid-1800s were hindered by professional mistrust and secrecy.²⁶

The Actuarial Society of America was established in 1889, with fewer than 100 actuaries in North America at the time.²⁵,²⁴ This society, along with the American Institute of Actuaries (formed in 1909), merged in 1949 to create the Society of Actuaries (SOA), a global professional organization for actuaries.²³, The need for formal, binding actuarial standards became increasingly apparent as the profession grew and its influence on financial sectors, especially insurance and pension plans, expanded.

In the United States, the Actuarial Standards Board (ASB) was established to set and improve standards of actuarial practice. The ASB promulgates Actuarial Standards of Practice (ASOPs), which outline the procedures an actuary should follow and the disclosures required when providing actuarial services.²²,²¹,²⁰ Internationally, the International Actuarial Association (IAA), founded in 1895, works to promote a globally recognized and reliable actuarial profession by developing International Standards of Actuarial Practice (ISAPs).¹⁹,¹⁸

Key Takeaways

• Guidance for Practice: Actuarial standards provide a comprehensive framework guiding actuaries in their professional duties, ensuring consistency and adherence to best practices.
• Public Protection: These standards are vital for safeguarding the interests of the public, particularly policyholders and beneficiaries, by promoting reliable financial assessments.
• Professional Judgment: While setting clear guidelines, actuarial standards emphasize the importance of professional judgment in applying methodologies and assumptions.
• Regulatory Compliance: They ensure that actuarial work complies with relevant regulatory frameworks and legal requirements, enhancing financial stability.
• Transparency: Actuarial standards mandate clear documentation and disclosure of methods, assumptions, and results, fostering transparency in actuarial communications.

Interpreting Actuarial Standards

Interpreting actuarial standards involves understanding their intent and applying them judiciously within specific contexts. These standards are not rigid rulebooks but rather provide a principled approach, allowing actuaries to exercise professional judgment. For instance, ASOP No. 1, the Introductory Actuarial Standard of Practice, clarifies that ASOPs offer an analytical framework for exercising professional judgment, acknowledging that different actuaries may reach reasonable, yet different, conclusions when faced with the same facts.¹⁷,¹⁶

The language used in actuarial standards often distinguishes between "must" and "should." "Must" indicates a course of action the Actuarial Standards Board (ASB) expects an actuary to follow without reasonable alternative, while "should" signifies what is normally considered appropriate practice.¹⁵,¹⁴ This distinction grants actuaries flexibility while still requiring adherence to professional expectations. Proper interpretation necessitates a deep understanding of the standards themselves, coupled with the actuary's training and experience in financial modeling and risk assessment.

Hypothetical Example

Consider an actuary working for a life insurance company who is tasked with calculating the technical provisions for a new annuity product. Actuarial standards would guide this process. The actuary would first refer to relevant ASOPs or international standards that apply to the valuation of such liabilities. These standards would specify requirements for selecting appropriate mortality rates and interest rates, as well as guidelines for economic and demographic assumptions.

For example, the standards might require the actuary to use prudent assumptions that reflect current market conditions and reasonable expectations for future experience. They would also stipulate how to account for various risks, such as longevity risk or investment risk. The actuary would need to document all assumptions and methodologies used, justifying their choices based on the standards and available data. If the actuary deviates from a "should" statement in the standard, they would need to explicitly disclose the deviation and explain the rationale, ensuring transparency and accountability in their actuarial valuations.

Practical Applications

Actuarial standards are integral to various aspects of finance and business, ensuring sound practices in risk quantification and financial reporting.

• Insurance Pricing and Reserving: In the insurance sector, actuaries use these standards to calculate fair premium rates and sufficient reserves for claims, covering everything from life insurance to property and casualty insurance. They dictate how to assess risks like mortality, morbidity, and catastrophe, ensuring the financial solvency of insurers.
• Pension Scheme Valuation: Actuarial standards guide the valuation of pension plans, ensuring that sufficient funds are set aside to meet future obligations to retirees. This involves projecting future benefits and contributions, often influenced by regulations such as the Employee Retirement Income Security Act (ERISA) in the United States. ERISA, enacted in 1974, sets minimum standards for most voluntarily established retirement and health plans in private industry, providing protections for individuals in these plans by outlining fiduciary responsibilities and funding standards.¹³,¹²
• Enterprise Risk Management (ERM): Actuaries apply standards within enterprise risk management frameworks to identify, measure, monitor, and manage risks across an organization. This includes assessing capital adequacy, conducting stress tests, and developing risk models.
• Regulatory Compliance: Actuarial standards are often embedded in or underpin financial regulations. For instance, in the European Union, the Solvency II framework, which is a comprehensive regulatory framework for insurance companies, heavily relies on actuarial principles for calculating capital requirements and technical provisions.¹¹,¹⁰ This framework mandates a risk-based approach to insurance regulation, aiming to enhance policyholder protection and improve financial stability.⁹,⁸ Information regarding Solvency II standards can be found from European actuarial bodies.⁷

Limitations and Criticisms

Despite their critical role, actuarial standards face certain limitations and criticisms. One significant challenge is dealing with data quality and availability issues. Actuaries rely on robust data for their models, but incomplete, inaccurate, or inconsistent data can lead to unreliable results, impacting decision-making.⁶,⁵ This necessitates rigorous data governance practices and cleaning techniques.

Another area of challenge stems from the inherent complexity of financial models and the evolving nature of risks. While standards provide guidance, applying them to novel or highly complex situations, such as those involving emerging technologies like generative AI, requires careful consideration and interpretation.⁴,³

Furthermore, actuaries may encounter pressure from management or clients to adopt assumptions or methodologies that could compromise professional integrity.²,¹ This highlights the continuous ethical challenges within the profession, where balancing business goals with adherence to actuarial standards and the Code of Professional Conduct is crucial. The reliance on models can also lead to criticisms regarding transparency and interpretability, particularly when complex calculations or proprietary models are used, making it difficult for non-technical stakeholders to fully understand the underlying assumptions and outcomes.

Actuarial Standards vs. Actuarial Valuations

Actuarial standards and actuarial valuations are closely related but represent different concepts within the actuarial profession.

Actuarial standards serve as the foundational rules and ethical framework that govern how an actuary conducts their business. They prescribe the level of due diligence, the types of assumptions to consider, and the communication requirements. In contrast, an actuarial valuation is a specific type of actuarial service, which involves the actual calculation and assessment of financial liabilities or assets, most commonly for pension plans, insurance policies, or other long-term financial commitments. The valuation is the result of applying the actuarial standards to a particular set of facts and data.

FAQs

What is the primary purpose of actuarial standards?

The primary purpose of actuarial standards is to ensure that actuaries perform their professional services with competence, integrity, and objectivity, leading to reliable and transparent financial analyses and advice. They protect the public interest by ensuring consistent and sound practices in areas like insurance and pension plans.

Who sets actuarial standards?

In the United States, the Actuarial Standards Board (ASB) sets Actuarial Standards of Practice (ASOPs). Globally, the International Actuarial Association (IAA) develops model International Standards of Actuarial Practice (ISAPs) which national actuarial associations are encouraged to adopt or be substantially consistent with.

Are actuarial standards legally binding?

While actuarial standards themselves are professional guidelines, their observance is often mandated by professional codes of conduct, which are binding on members of actuarial organizations. Additionally, regulatory bodies may incorporate or reference these standards in their legal requirements for industries like insurance and pensions, making adherence to them indirectly or directly legally enforceable in certain contexts.

How do actuarial standards ensure public protection?

Actuarial standards ensure public protection by requiring actuaries to use sound methodologies, make reasonable assumptions, adequately disclose potential limitations, and maintain independence and objectivity. This promotes the financial soundness of institutions like insurance companies and pension funds, which directly impacts consumers and beneficiaries.

Can actuarial standards change?

Yes, actuarial standards are periodically reviewed and updated by standard-setting bodies to reflect changes in economic conditions, regulatory environments, industry practices, and actuarial science itself. This ensures that the standards remain relevant and effective in addressing current and emerging risks and challenges.