A m e r i c A n A c A d e m y o f A c t u A r i e s m A r | A P r 2 012

Solvency II: An Update for U.S. Practitioners

WELCOMEto the 2012 issues of Contingencies, the magazine of the American Academy of Actuaries.Since 1989, Contingencies has been an important resource for actuaries and other professionals interested in financial and social concerns and in the Academys public policy and professionalism work.READING CONTINGENCIES ONLINE IS EASY. If you have a question, need

navigation tips, or require assistance in customizing the digital edition, simply click the red HELP tab. Other Academy media make it easy for you to follow the actuarial profession and the public interest work of the Academy:n n

The Academys website, www.actuary.org; Actuarial Update, an online monthly newsletter for Academy members; Enrolled Actuaries Report, a quarterly online newsletter focusing on the concerns of pension actuaries; 2011 Record, the Academys annual report.

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You also can follow the Academy on Twitter @Actuary_Dot_Org and watch Academy videos on its YouTube channel ActuaryDotOrg. Contingencies is always evolving to meet the needs and expectations of its readers. If you have any comments or suggestions, Id love to hear from you. Email me at Mallon@actuary.org.

Linda Mallon Editor

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RETAINED: Assistant Vice President, Northeast, USA: Insurer seeks ACAS, FCAS or MBA to lead a team of Research Analysts. Should have experience with Commercial Lines and managing a technical staff. Advanced degree in Statistics or Actuarial Science preferred. (#34991) RETAINED: Casualty Actuary, Bermuda: Regional firm seeks FCAS/FIA with 10+ years of experience. Strong background in risk and capital modeling required. Underwriting skills a plus. (#34028) RETAINED: Life Actuary, Multiple Locations, USA: Leading global consultancy seeks a direct entry Partner for its Life Advisory Services. Candidates will be seasoned consultants who are excited about business development and have high-level client management experience. Location could be in a number of major US cities. (#32429) RETAINED: Actuarial Consultant, Midwest, USA: Global consulting firm seeks ASA or FSA for a health pricing role. Must have 5 or more years of experience and knowledge in medical, dental, life and disability insurance. (#33993)

RETAINED: Direct Entry Partner/Managing Director: Leading global consultancy seeks a direct entry Partner and Managing Director to build out a Predictive Modeling - Analytics Practice for its Property & Casualty Advisory Services. Candidates will be seasoned consultants and/or industry-focused experts in predictive modeling. Location flexible: New York, Chicago, Atlanta, Dallas, Philadelphia and San Francisco. (#34557) RETAINED: Director, Midwest, USA: P&C insurer seeks ACAS/FCAS with 5-10 years of experience including Pricing, Product Development, Reserving and Forecasting. CPCU designation is desired. Exemplary communication and interpersonal skills are essential. Proficiency in MS Office is required. (#34841) RETAINED: Life Actuary, West, USA: Life insurance company seeks FSA with 10+ years of product pricing experience for Life and Health lines of business. Strong background in Valuation and Reserving is needed. Exceptional oral/written communication skills and strong interpersonal skills are necessary. (#34207)

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Contents18Solvency II: An Update for U.S. PractitionersIts coming to the European Community in 2014. Are you ready?tony dardis

mAr | APr 2012

Features

While the position of corporate chief risk officer is relatively new, the attributes that could contribute to successful leadership in that role are timeless.tim cardinal and Jin Li

26

Follow the Leader

36

Come TogetherHolding longevity risk continues to be a major challenge for pension funds, insurers, and governments. By combining resources, can we do better?daniel ryan

Building a Better mortality model

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Health Care Reform: Learning From Others

A Global Perspective on financing Long-term careyair Babad, Alex Leung, Al schmitz, and Jennifer Vandeleest

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DepartmentsINSIDE TRACK . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . History LessonLinda mallon

6 8

Published by

PRESIDENTS mESSAgE . . . . . . . . . . . . . . . . . . . . . . Past as Prologuedave sandberg

President

dave sandbergexecutiVe director

LETTERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Reinsuring Catastrophic Health CareHo bso n d . c a r r o ll

10 COmmENTARy . . . . . . . . . . . . . . . . . . . . . . 12UP TO CODE . . . . . . . . . . . . . . . . . . . . . . . Am I Qualified?robert J. rietz

mary downscommunicAtions director

mark cohen

16 50

editor And AssistAnt director for PuBLicAtions

Linda mallonPuBLicAtions & mArketinG Production mAnAGer

cindy JohnsAdVertisinG

WORKSHOP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . The Family Connection in Exceptional LongevityVal rie Jarry , A la in G a gn o n , and r o bert B o u r be a u

mohanna sales representatives (972) 596-8777dePArtment editors

TRADECRAFT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Improving Claims Handling With Predictive Analyticsr o bert J. wal lin g iii

54 58 60 62 65 66 68

thomas L. Bakos sam Gutterman robert J. rietz mark danburg-wyldPuBLicAtion desiGn & Production

BOOKLINKS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Ed Kingr ev iew by dan skw i r e

Bonotom studio inc. www.bonotom.comeditoriAL AdVisory BoArd

STATISTICAL mISCELLANy . . . . . . . . . . . . . . . . . . . Face-to-Face Versus Virtual Meetingsed ward scher

CRyPTIC PUzzLE . . . . . . . . . . . . . . . . . . . . . . . . . . Pyramid Schemetom toce

Julia t. Philips, chair dwight k. Bartlett iii robert L. Brown frederick w. kilbourne Barbara J. Lautzenheiser Bruce d. schobel susan e. witcraftinternet Address

PALINDROmIC PUzzLE . . . . . . . . . . . . . . . . . . . . . Fishing ExpeditionJerry Levy

www.contingencies.orgContingencies (issn 1048-9851) is published bimonthly by the American Academy of Actuaries, 1850 m street, nw, suite 300, washington, dc 20036-5805. for subscription information and customer service, contact the Contingencies subscription department at the address above or (202) 223-8196. Advertising offices: mohanna sales representatives, (972) 5968777, info@mohanna.com. Periodicals postage paid at washington, dc, and at additional mailing offices. BPA circulation audited. (Basic annual subscription rate is included in dues. nonmember rate is $24.) copyright 2012. All rights reserved. this magazine may not be reproduced in whole or in part without written permission of the publisher. opinions expressed in signed articles are those of the authors and do not necessarily reflect official policy of the American Academy of Actuaries. Postmaster: Please send change-of-address notices for Contingencies to Contingencies, Po Box 16976, north Hollywood, cA 91615-6976. ride along enclosed.

PUzzLES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . National Mathematics Yearm ark danbu rg-wy ld

END PAPER . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . On Regulationsam Gu tterman

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Inside Track

LINdA MALLON

History LessonITS OFTEN HARd TO IMAgINE PEOPLE WHO LIVEd IN THE PAST as being like usreasonably smartfolks who just put on their pants (or togas, or saber-toothed tiger skins) one limb at a time. On an intellectual level, we know this is ridiculous. But changes in fashion, combined with the widespread fantasy that the world before color photography was monochromatic, conspire to perpetuate this gulf.This is one of the reasons that I love literature. By reading the classics (and lots of other stuff that hasnt yet made the cut) its possible to imagine what it was like to walk under the stars when the stars were a lot younger. Theres also some consolation in discovering that the ancient Hebrew writers of the book of Ecclesiastes pretty much had it right: Theres nothing new under the sun. On Page 58, Dan Skwire, who has made a lively avocation of looking at how the actuarial and insurance fields are portrayed in literature, reviews a modern retelling of the myth of Oedipus Rex in which the main character (Ed Kingget it?) is an actuary. Skwire has a lot of fun pointing out the places where the author gets it right about both the technical and quotidian details of life as an actuary (and while Guterson occasionally gets it wrong in Ed King, Skwire notes approvingly that there are surprisingly few howlers). Rather than treating the career as an archetype of grayflannel-suited boredom (a favorite approach of other authors), Skwire writes, Guterson uses it as a deliberate device to illustrate a major theme of the Oedipus storythe blindness of humans with respect to their fates. In their article on Page 26, Tim Cardinal and Jin Li put a different spin on the same game by picking out attributes in historical leaders that would make them good chief risk officers (CROs)a relatively modern job title that would have been wildly exotic, if not incomprehensible, to most of the examples Cardinal and Li cite. Many of these attributes are familiar across the ages and common to good leaders and managers in all fields of endeavor. They include initiative, adaptability, vision, energy, self-confidence, and persuasiveness. There are other traits, however, that seem particularly suited to managers of enterprise risk. These include integrity, intelligence, insight, judgment, tact, and communication skills. CROs, despite the importance of the work they do, often fly under the radar in terms of corporate acknowledgment and common acclaim. This is because if they are doing their jobs right, nothing happens. As Cardinal and Li point out, Although we want a CRO to guide us through financial crisis, a great CRO excels at the art of prevention. After all, what looks better on a rsum: Guided my company through a storm or Made decisions that kept the waters calm? Ive just finished reading Walter Isaacsons compelling new biography of Steve Jobs. Isaacson, who also has written bestselling biographies of Benjamin Franklin and Albert Einstein, paints a nuanced portrait of a complex man. While Jobs was a brilliant visionary, a dynamic businessman, and an influential leader in the technology sector, his management style often left co-workers furious and demoralized. Jobs achieved amazing things but in the process created wasteful and unnecessary storms for the companies he ran. The personal costto his colleagues and co-workers but also, ultimately, to himselfwas extraordinarily high. If case studies of Jobs leadership make it into business school textbooks of the future, they should be read as both a template for success and a cautionary tale. Sure, theres nothing new under the sun. And sometimes we learn as much from other peoples mistakes as we learn from their achievements.

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Presidents MessagePast as Prologue

dAVE SANdBERg

AS I WRITE THIS, President Obama is about to give his State of the Union speech, three-fourths of the waythrough his first term in office. I realize with a small start that I am already one-fourth through my own term in office and that the past three months are my prologue for the rest of the year.In my first column (From Black Box to Glass House, November/December Contingencies), I stated that to successfully serve the profession and the public we need to focus on three questions: What is the appropriate governance structure for the Academy (and the U.S. actuarial profession)? What value does the Academy provide to its members? Is the U.S. profession prepared to address future political discussions about private- and public-pooled risk systems? My core policy bet (or initiative that Im championing) was that an enterprise risk management (ERM) methodology would be the most valuable way to address and respond to these questions. So how are we doing? facilitate clearer communication of that with leadership and members. One of our communication challenges is that the Academy is functionally a flat organization. Our public policy work is spread through five practice councils and nearly 150 committees and task forces. These are the groups that speak to regulators through a disciplined and collaborative process, involving both staff and volunteers, to ensure communications are objective and professional. The Council on Professionalism acts as a liaison, coordinating priorities and work products with representatives from the four other U.S. actuarial organizations, the Actuarial Standards Board, and the Actuarial Board for Counseling and Discipline. To address this diversity and better coordinate strategic planning, we have reconstituted our Communications Review Committee with representatives from each of these groups.

governance and ValueThe bet aspect is the challenge of creating risk metrics and objective measures of performance for a volunteer organization that doesnt have traditional, objective, bottom-line, corporate measures. To address this, I attended the year-end annual planning meetings of five of the six councils and participated in their discussions of how to measure their effectiveness in 2012. Council members recognized that a healthy professional organization creates and welcomes transparency for what it is accountable to deliver. Planning discussions for 2013 will then evaluate the effectiveness of these prototyped measures. Measures of effectiveness at the council and committee level need to be easily aggregated into a risk dashboard that will allow us to evaluate and manage future performance. At its January meeting, the board of directors approved the formation of a presidential risk committee, to be led by Steve Preston, a former chief risk officer for ING. One of the committees major tasks for 2012 is to create a standardized, highlevel performance reporting process for 2012 Academy priorities. Another objective is to initiate a communication process to clarify the Academys ERM practices and

Visible Public EngagementThe Academy filed an amicus curiae brief in January with the U.S. Supreme Court on whether to overturn a lower court ruling that the individual health insurance mandate included in the Affordable Care Act can be severed from the guaranteed issue and modified community rating provisions. The Academys brief provides actuarial input to the court on the consequences of severing the mandateshould it be invalidated by the courtand allowing the market reforms to remain in effect. The Academy isnt taking a position on the law itself, on the constitutionality of the mandate, or on whether the mandate is severable from any provisions in the law other than those related to guaranteed issue and community rating. I was pleased to see the Health Practice Council contribute sound actuarial input on what is a very divisive legal and political issue. There is more to do in all of these areas. But we have taken solid steps forward. On behalf of the Academy, I would like to thank all who have helped advance this work in these past three months and will continue to do so.

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LettersElementary Errorshe author of the puzzle Elementary Economics in the January/February 2012 issue tells the story of Wolfgang, his daughter Angelika, and Wolfgangs desire that his daughter learn the virtue of thrift. Mark Danburg-Wyld writes, This was long ago, of course, when interest rates did not produce negative real returns. (If Angelika were born now, hed want her to learn the virtue of spending it while youve got it.) I am not much of a puzzle solver, but I am as good as the next person in spotting elementary economic errors when I see themand the above statement contains two elementary errors: This was long ago, of course, when interest rates did not produce negative real returns. At least since World War II, we can find numerous examples of timesin the United States and other countries when the nominal interest rate paid to savers has been below inflation rate, resulting in negative real interest rates. If Angelika were born now, hed want her to learn the virtue of spending it while youve got it. In other words, you should contemplate saving a portion of your income only when the anticipated real interest rate is positive. To see the error of this thinking, consider the following example: In August, a farmer harvests enough wheat to feed his family for the rest of the year. But the farmer does not have a proper storage facility, and the wheat will rot. There is a proper storage facility nearby, but the storage company charges a fee that is equal to 10 percent of the total wheat that it stores. The farmer has a choice: either save the harvested wheat and earn a negative 10 percent interest rate or let the harvested wheat rot and risk his seeing his family starve in the winter months. What would you advise the farmer to do?Ali zaker-Shahrak Los Angeles

T

Angelika collected all her five euro rewards before the end of 1923. It should be noted that there were no euros in circulation in Bavaria in 1922that was another attempt at humor. All farmers who read Contingencies should follow Ali Shahraks advice on savings. All others can make up their own minds. Personally, I trust him over me in this matter.

Of the Peoplen his letter to the editor in the January/ February Contingencies responding to Heather Jerbis article on the need for end-of-life counseling (A Good Death, November/December Contingencies), Fritz Busch expresses concern about governmental overreach. As Abraham Lincoln urged in 1863, we should be devoted to the cause that government of the people, by the people, for the people, shall not perish from the earth. Continuing to view government as something separate gets you nowhere.Steven Rubenstein Antioch, Tenn.

I

mark Danburg-Wyld responds: Almost everything in the puzzle column, aside from the puzzle itself, is written with tongue in cheek and is meant to be amusing. Based on objective studies conducted over many years by my youngest daughter, things that I say in an attempt to be amusing are only about 2 percent likely actually to be amusing. But I consistently amuse myselfand thats something. The actual time and place of the conversation reported in the puzzle was Bavaria, 1922.

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Commentary

BY HOBSON d. CARROLL

reinsuring catastrophic Health careMARgARET PARTICIPATES IN HER EMPLOYERS MEdICAL BENEFIT PLAN. Two months prior to the renewal of that program,Margarets covered dependent son is diagnosed with acute lymphocytic leukemia with complications that will require transplant procedures in the coming 18 months.The emotional shock to Margarets family is only one of the changes that expand like ripples from this unhappy event. One of those ripples triggers a chain of events related to Margarets health insurance coverage and her employers financing of that coverage. Her employer is faced with a cliff-edge dilemma, caught between a punishing renewal offer and the choice to continue coverage at all. The traditional approach to medical insurance and reinsurance renewals is problematic. I believe theres an alternative that better aligns the needs of society, patients, providers, and the system necessary for financing appropriate care. benefit period starts. The potential liability for health insurance claims is triggered when medical expenses are incurred, filtered through contract limitations of what is eligible, allowable, and payable coverage. Its a continuous process with each daily claim standing on its own. Group LTD and workers comp obligations are based on the continuation of a health statusthere dont have to be new events to trigger benefits. The benefit period begins immediately in the case of workers comp, while group LTD requires an elimination period that must be satisfied to reach benefit status. The critical feature of these two coverage types, however, is that the insurers obligation ends only when the benefit status of the individual claim endsnot when the policy ends. Contrast this with what happens in health insurance, whether fully insured, self-funded stop-loss, or reinsurance. The benefit period for an underlying originating claimant (in Margarets case, the beneficiary in an employersponsored plan) may start during the insurance policy year but ends when that policy year ends, not when the beneficiary has stopped being in benefit status. In this context, benefit status means the individual has a diagnosis that generates a predictable course of treatment extending for some time into the future. It also may be used to describe someone who already has accrued significant expenses and is expected to generate substantial further expenses in the coming policy year. Because the presence of potential ongoing large claim payouts on existing claimants can be factored into the renewal action of the current or any competing carriers, a plan sponsor is faced with a Hobsons choice when the time comes for policy renewal. With workers comp and group LTD, claims that are already in process belong to the prior periods

Hobsons ChoiceConsider the basic difference between how group long-term disability (LTD) and workers compensation and health insurance and associated reinsurance programs operate. Group LTD and workers comp function on a claim-occurred, or event-style, basis in which theres an identifiable point when the potential

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Commentary co nt inue d

accountability. If the carrier attempts to recover such expected losses through renewal rate action, the employer is able to move the coverage to a competitor that starts with a clean slate. The current carrier is compelled to offer a renewal on a similar unknown contingency basis to maintain the account. With medical insurance, stop-loss insurance, and reinsurance renewals, the existing carrier has the ability to rewrite the expected losses into its renewal action, even though underlying health plan beneficiaries are in the middle of treatment plans and regimens for existing conditions. This renewal cliff-edge dilemma is most problematic in stop-loss coverage for self-funded employers. The cost that specific stop-loss coverage represents stands out dramatically for the selffunded employer. Anything the stop-loss carrier does is magnified in relation to large claim expectations. The impact of bundling surcharges for ongoing large claimants inside the total premium is far less obvious in fully insured proposals. Specific stop-loss insurance is pure unknown contingency coverage and generally is presented on a one-year term basis. How does this allow for handling Margarets situation, in which predictable ongoing treatment not only will breach the specific deductible but also can be expected to accrue catastrophic levels of expense within the coming policy year? Current industry solutions include pooled coverage, guaranteed rate renewal options, lasering individual claimants (the practice of excluding or modifying the stop-loss coverage of particular individuals, such as Margarets son), or using aggregating deductibles. None of these approaches, however, properly deals with the cliff-edge renewal problem. None of them addresses the need for a product that provides protection for the underlying durational risk of appropriate anticipated medical treatment.

How long should the employer/carrier/ reinsurer that initially shoulders the cost of a random catastrophic event hold the financial burden before it becomes societys responsibility?

Sharing the BurdenUnderwriting and renewal rating restrictions in the Affordable Care Act passed

by Congress in 2010 may mitigate some of the anxiety that exists in the current small group marketplaceat least for the employer. But this ambiguous attribution of responsibility certainly prompts a series of fundamental questions. Who within our society should be financially responsible for episodes incurring catastrophic medical expense (such as a serious burn, trauma, or transplant) or catastrophic chronic medical situations (such as hemophilia)? How long should the employer/carrier/reinsurer that initially shoulders the cost of a random catastrophic event hold the financial burden before it becomes societys responsibility? How best should we structure a financial tool for dealing with the cost of a medical expense once it exists? In my home state of Texas, theres been progress in the past two legislative sessions toward passage of a mandatory reinsurance program, known as TexMedRe. While politics and more pressing economic issues have delayed full consideration, the proposals concept of using underlying reinsurance has generated substantial interest. The program would provide not only excess reinsurance coverage to health plan carriers but also an extension of coverage for up to two additional policy years depending on a continuation of the original claimants benefit status. As long as the employer provides continuous eligibility for the claimant in a qualified underlying plan, the reinsurance

(including the extension feature) would transfer to any new carrier assuming coverage. Reinsurance such as this would serve to mitigate substantially the renewal cliff-edge dilemma for covered employer plans. Is a state-mandated reinsurance program the only way to go? I think not. Through the creation of products that supply more longitudinal event-related coverage, the private reinsurance industry can provide a welcome alternative for commercial employer-based medical insurancefully insured as well as self-funded. The distortion in selection between underwriting in the insured arena and what stop-loss carriers are allowed to do in the self-funded industry creates the need for a product that eliminates arbitrary renewal dates at the same time that it mitigates the risk of requiring unlimited lifetime protection. Such a product could revitalize the marketplace, creating a fair and competitive environment that encourages innovation in policy design and provider compensation. Fulfilling this need with private variations of the TexMedRe concept also will encourage new entrants to the carrier marketplace, allowing them to be competitive in evaluating initial risk by protecting them against ongoing claimants covered by extended reinsurance. The private reinsurance industry must develop products that mirror TexMedRes design for handling the risk profile of catastrophic medical expense costs. These could incorporate elements of three-year-accumulation, five-yearbenefit-period, per-cause-style policies of the past. In the absence of any new products, the distress experienced by Margarets employer and others in similar situations is likely to force all of us toward a single-payer model.H o B s o n d. c Ar r o L L , a fellow of the Society of Actuaries and a member of the Academy, is president of Entrust Risk Management Services Inc. ResourceLegislative Reference Library of Texas, H.B. 1578 http://tinyurl.com/6o5g7tl.

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Up to Code

BY ROBERT J. RIETz

Am i Qualified?IF THE HEAdLINE PIQUEd YOUR INTEREST, you probably alreadyknow that Precept 2 of the Code of Professional Conduct governs an actuarys qualification to provide actuarial services and that Precept 2 requires continuing education (CE): An Actuary shall perform Actuarial Services only when the Actuary is qualified to do so on the basis of basic and continuing education and experience, and only when the Actuary satisfies applicable qualification standards.Annotations 2-1 and 2-2 of the Code of Professional Conduct elaborate further on qualification requirements. Precept 2 contains two requirements, and actuaries need to comply with both of them before they can perform actuarial services. I wont address the second clause of Precept 2 ( and only when the Actuary satisfies applicable qualification standards) in detail. That topic was covered expertly by Sheila Kalkunte in her article that ran in the January/February issue of Contingencies, Which CE Requirement Applies to Me? Rather, I will highlight some aspects of CE requirements, including those of the U.S. Qualification Standards promulgated by the Academy. This is because actuaries appearing at a hearing of the Actuarial Board for Counseling and Discipline (ABCD) many times are somewhat fuzzy as to how they satisfied their CE requirements. ABCD members also have responded to requests for guidance from actuaries who are unsure if they are qualified to perform specific actuarial services. The first requirement of Precept 2 commonly is referred to as the look in the mirror test. An actuary must be qualified by basic education (exams or equivalent), CE (more on that in a bit), and experience. Precept 2 doesnt define experience, but the current U.S. Qualification Standards describe experience as three years of responsible actuarial each year (check), and have more than 30 years of responsible actuarial experience (check). Can I perform actuarial services involving life insurance nonforfeiture values? The answer is a resounding no! One look in the mirror and I know that Im not qualified to provide that actuarial service. I would have the same response on a multiemployer pension plan assignment. Although Im a pension actuary, I dont practice in the multiemployer arena. Im not familiar with that areas unique methods and assumptions, nor am I familiar with the section of the Employee Retirement Income Security Act that contains special funding requirements for multiemployer pension plans. Some pension actuaries are qualified to practice in both the private-employer and the multiemployer disciplines, but I look in the mirror and decide Im not qualified. CE is a major factor in my decisions. I primarily attend private and public pension plan CE sessions each year. I dont attend CE sessions related to life insurance or multiemployer plans. As a result, I cant satisfy the CE portion of the first requirement in Precept 2. Even if I attended these types of sessions, I might not satisfy the first requirement of Precept 2. Does my experience include responsible actuarial life insurance or multiemployer pension plan experience? The answer is no, and thats another reason that I fail the look-in-the-mirror test of Precept 2 for these two areas. An actuary also must satisfy the second requirement of Precept 2, involving applicable qualification standards. This phrase refers to the revised U.S. Qualification Standards, approved by the Academys board of directors and

experience, which is defined as work that requires knowledge and skill in solving actuarial problems. Actuaries who provide actuarial services in more than one area of practice should apply the look-in-the-mirror test to each area in which they practice. They also should read Section 2.3 of the U.S. Qualification Standards very carefully.

Case in PointIm a pension actuary. Lets look at how I might try to satisfy these requirements for determining life insurance nonforfeiture values. I passed the Society of Actuaries (SOA) fellowship exams (check), engage in continuing education

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CE ScorecardThe Conference of Consulting Actuaries adopted a CE requirement for its members effective Jan.1, 2004. The Society of Actuaries (SOA) has required CE compliance and acknowledgment for its members since Jan.1, 2009. The Casualty Actuarial Society (CAS) also adopted similar CE compliance and acknowledgment for its members beginning in 2011. The latter two organizations maintain separate and different CE requirements to cover their respective members who render actuarial services outside the United States or dont issue statements of actuarial opinion in the United States. Both the SOA and the CAS CE requirements provide that members who satisfy the U.S. Qualification Standards CE requirements will have satisfied those organizations CE requirements and must attest to the same annually. Its important to note, however, that the converse isnt true. If you are required to meet the U.S. Qualification Standards because you issue statements of actuarial opinion in the United States, you must meet the U.S. Qualification Standards CE requirements. The Joint Board for the Enrollment of Actuaries also maintains separate CE requirements.effective Jan. 1, 2008. All five U.S.-based actuarial organizations adopted the same Code of Professional Conduct, which became effective Jan. 1, 2001. Even if you arent a member of the Academy, if youre a member of any of the other four U.S.-based actuarial organizations, Precept 2 of the Code of Professional Conduct requires you to satisfy the U.S. Qualification Standards before you perform actuarial services. (For information on the history of the U.S. Qualification Standards and their CE requirements, I refer you to Sheila Kalkuntes article in the January/ February issue of the magazine.) Section 2.2.2 of the U.S. Qualification Standards reads, in part, To satisfy the General Qualification Standard, actuaries are required to complete and document at least thirty (30) hours each calendar year of relevant continuing education In other words, not only must you complete a sufficient amount of CE each year; you also must document it. The U.S. actuarial organizations all help actuaries document CE: Academyoffers TRACE, an online tracking tool at www. actuary.org/trace.asp that is available to members and nonmembers; American Society of Pension Professionals and Actuaries (ASPPA)offers CE reporting forms at www.asppa.org; Casualty Actuarial Society (CAS)recommends members use TRACE; Conference of Consulting Actuaries (CCA)offers a CE tracking tool that is available to its members at www. actuarialcpd.org; SOAoffers online forms at www.soa.org/professionaldevelopment/cpd-requirement/default.aspx. Actuaries may maintain CE records personally, such as on a spreadsheet with corresponding attendance certificates, if applicable, attached. But its critical to remember that documenting CE is as much a requirement of the U.S. Qualification Standards as the CE itself. The ABCD has conducted more than one hearing in which the actuary claimed to have satisfied CE requirements but was unable to document it satisfactorily. I used the word relevant earlier. Its defined in Section 2.2.7. Relevance is the reason that Im not qualified to perform actuarial services involving life insurance nonforfeiture values or multiemployer pension plans. The CE sessions I attend dont cover these areas and arent relevant to life insurance nonforfeiture values or multiemployer plans. Determining whether you are qualified clearly isnt as simple a process as it might appear at first glance. Your answer will depend on a combination of subjective and objective determinations. And it will reflect careful record keeping. Remember that just because youre an actuary doesnt mean youre qualified to perform all actuarial services.roBert J. rietZ, who is retired from deloitte Consulting LLP is , vice chairperson of the Actuarial Board for Counseling and discipline. ResourcesKalkunte, Sheila, Which CE Requirement Applies to Me? Contingencies, January/February 2012. http://www.contingenciesonline.com/contingenciesonline/20120102#pg27

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Solvency IIBy t o n y dard is

An Update

Solvency II, which updates regulatory requirements for insurance firms operatingin the European Union, is attracting a lot of attention in the United States. The current expectation is that Solvency II reporting for insurers will start on Jan.1, 2014. Many insurersnot just those that are subsidiaries of European parentshave questions about how it will affect them. Although there are many complex and unresolved side issues related to the implementation of Solvency II, in this article Ill limit my discussion to some of the main elements of the new regulatory framework, looking at compliance with statutory solvency requirements but also at the wider implications of Solvency II for how insurers manage their business.

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for U.S. PractitionersIts coming to the European community in 2014.

ARe you ReAdy?Calculations and methodologiesThe implementation of Solvency II is being overseen by an umbrella group of regulators, collectively known as the European Insurance and Occupational Pensions Authority (EIOPA). This includes bodies such as the U.K.s Financial Service Authority and BaFin, Germanys financial regulatory agency. Solvency II calculations will have two key parts: Technical provisionsa market-consistent liability valuation; Solvency capital requirement (SCR)a one-year forwardlooking 99.5th value at risk (VaR) for the market value balance sheet (see Figure 1); the SCR will be assessed using standard formulas or internal models. A number of methodology issues have yet to be resolved for both the technical provisions and the SCR. As noted above, the technical provisions require market-consistent liability valuation. Although theres often a perception that market-consistent valuation doesnt involve any judgment (because what youre doing is just calibrating to what the market says), this is actually far from the case. Many subjective decisions must be made. How, for instance, do you handle ultra-long durations? And what, if anything, should be done to account for the fact that insurance liabilities generally arent liquid? Insurance liabilities often have durations that exceed the maturities of observable market prices. This in turn raises difficulties for calculating the market-consistent value of ultra-long liabilities. How long, for instance, is the longest maturity market instrument, and what can be done when its necessary to have market prices beyond that maturity? Some practitioners, for example, have assumed that forward rates are constant beyond the longest observable maturity. But as can be seen in Figure 2, this occasionally can give extended curves that look quite reasonable but that, at other times, really dont fit well with the data. To address these issues, three factors must be considered: What is the longest forward interest rate? Determining this isnt merely a matter of taking what we observe in the market to be the longest point and making that the starting point for extrapolation. The general market consensus is that ultra-long swap rates may be quoted but theres little or no liquidity available at these very long ends of the market. While theres definitely a case to be made for pruning back the data, there are some significant judgment calls in deciding how far to go. Liquidity, for example, often is defined as the ability to execute a large transaction. But is it the ability to transact a deal of normal market size without moving the price, or is it the ability of the entire insurance industry to undertake large-scale hedging without moving the price? This is an area that needs closer examination. The latest proposal from EIOPA is to use a forward cut-off point of 30 years for British pounds and U.S. dollars and 15 or 20 years for the euro. What should be assumed for the very long term unconditional forward rate? This is another fascinating area around which there is still no agreement. EIOPA currently is looking at a target unconditionalFIgURE 1

Solvency II SCR Looks at VaR for the market Value Balance Sheet

Probability Distribution Forecast

99.5%

SCR Capital

0 PV of Assets minus Liabilities @ one-year HorizonSource: Author

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Solvency II c ont inue dFIgURE 2

government Interest Rates in U.S. Dollars Assuming a Constant Rate Beyond the Longest (30-year) maturity End, December 1985December 200712% 11% 10% forward interest rate 9% 8% 7% 6% 5% 4% 3% 2% 0 10 20 30 40 50 60 maturity (years) 70 80 90 100

Source: Hibbert, John, Market-Consistent Valuation of Ultra Long-Term Cash Flows

FIgURE 3

government Forward Interest Rates in U.S. Dollars Extrapolated from year 15 to Adjust Toward a Fixed Long-term Level11% 10% 9% forward interest rate 8% 7% 6% 5% 4% 3% 2% 1% 0 10 20 30 40 50 60 maturity (years) 70 80 90 100

Source: Hibbert, John, Market-Consistent Valuation of Ultra Long-Term Cash Flows

forward rate (UFR) of 4.2 percent, which seems reasonable in the current environment. But while we now are living in times of extremely low interest rates, as recently as the early 1990s dollar swap rates were 10 percent to 15 percent. In setting its target, EIOPA basically has used central banks targets. A more robust approach would take other considerations into accountincluding historyand would recognize the fact that central banks in the long term may revise or abandon their targets altogether. EIOPAs target also could have a bias on the low side because it doesnt

incorporate anything that allows for a term premium effect at extremely long ends of the market. Theres intuitive logic behind the existence of term premium in ultra long-term bonds. Economic theory tells us that investors demand a premium for locking into an extremely long-term investment. While investors may accept a lower (or even negative) term premium on long bonds because they offer a closer match to liabilities, this only holds up to a certain horizon. At ultra-long horizons there are no liabilities that need hedging, and so we return to a situation in which investors demand additional return.

the longest market rate and the unconditional forward rate? This gets into yield-curve extrapolation methodologies, and theres no universal agreement as to which approach is best. The CRO Forum, which comprises chief risk officer representation for the largest European insurers and focuses on developing and promoting industry best practices in risk management, has adopted a Nelson-Siegel extrapolation methodology. Regulators, on the other hand, have chosen a somewhat simpler methodology known as the Smith-Wilson approach. While less complicated, the Smith-Wilson approach has limitations that can mean compromising between a good fit with the available data and the flexibility, speed, and smoothness in moving from the observed market path to the extrapolated value. The extrapolation approach gets to a UFR quickly, but the transition isnt smooth. One solution is to set the speed of reversion so that the targets are matched for the volatility of forward rates. Put another way, given the volatility of observable forward rates, you can derive estimates of volatility for unobservable rates. Figure 3 repeats the extrapolation of Figure 2 but in which we allow the 15-year forward rate to adjust toward a fixed long-term level along a path designed to produce a reasonable level of forward rate volatility. As a final point, what Ive described isnt limited to yield curve extrapolation. It also applies to option implied volatility extrapolation. And in many markets, there is a lack of relevant prices not only in ultra long-term durations but also at any other duration (for example, volatility in real estate).

What path should be set between

Liquidity PremiumInvestors will pay a premium price for something that is liquid. Instruments that offer identical cash flows, for example, sell at different prices as a result of their trading liquidity. And hard-to-trade instruments sell at a discounted price.

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Liquidity premium isnt a myth. Theres a large body of theoretical and empirical evidence supporting the view that liquidity premium is real and measurable, that it can be substantial, and that it can vary significantly over time.The concept typically is considered in the context of corporate bonds, in which spread can be deconstructed as: The expected default loss on bonds; A credit risk premium component that can be split between risk premium for unexpected default and a liquidity premium (see Figure 4). Insurance liabilities typically are much less liquid than assets that have similar cash-flow characteristics with observable market prices. So what market value discount is associated with illiquidity? Because theres no consensus yet on how liquidity premium should best be treated, this continues to be one of the gray areas of Solvency II implementation. Many experts, in fact, question whether it exists at all. Liquidity premium isnt a myth. Theres a large body of theoretical and empirical evidence supporting the view that liquidity premium is real and measurable, that it can be substantial, and that it can vary significantly over time. An array of measurement techniques have been used by different practitioners. For assessing liquidity premium in corporate bonds, four approaches stand out: Microstructure approachesthese dont lend themselves well to empirical estimation, but they provide valuable insights into which fundamental factors should be linked to liquidity premium; Direct approachesthese involve choosing a pair of assets or portfolios that are equivalent in all ways except for liquidity and comparing prices, expected returns, or yields; Structural model approachesthese are similar to the direct approach and use the Merton model but compare a corporate bond with the cost of manufacturing an approximately equivalent synthetic position from a risk-free liquid bond andFIgURE 4

an option on the issuing firms total assets; Regression-based approachesthese involve regressing one or more measures of asset liquidity and trading costs against observed asset prices or yields. Until now theres been a tendency among European regulators to take a conservative position on liquidity premiumbecause its difficult to estimate, it should be excluded from the valuation of liabilities. Estimation challenges do exist, but thats no reason to ignore liquidity premium, particularly when there are excellent techniques (such as those listed above) for assessing them. The latest proposal from EIOPA restricts the use of a countercyclical premium (essentially a liquidity premium adjustment to the Solvency II discount rate) to times of stressed markets (as declared by EIOPA). EIOPA also is suggesting a matching premium that will apply only to a highly restricted range of liabilities that are exposed to a limited range of uncertainties (typically, longevity will be the major risk) and in which the backing assets are closely matched to the liabilities and are ring fenced from the insurers other assets. The matching premium structure has many characteristics of a held to maturity approach. In determining the discount rate for the matching premium structure, the insurer must consider the cost of turnover (from downgrades and defaults) in the asset portfolio. The countercyclical premium and the matching premium suggest that while the existence of a liquidity premium in asset values has general acceptance, theres still work to be done on its recognition in a liability valuation.

Solvency Capital RequirementThere are specific and significant methodology issues with theFIgURE 5

Deconstruction of Corporate Bond Spreads30 20 one-year xs return (%) 10 0 10 20 30

Analysis of One-year Excess Returns 95th percentile mean

Liquidity Premium

market Spreads

Credit Risk Premium

Expected LossesSource: Barrie & Hibbert

40

All years

following worst 100

following worst 50

following worst 25Source: Barrie & Hibbert

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Solvency II c ont inue d

FIgURE 6

Comparison of Academy Calibration Criteria vs. 20th-Century One-year Equity Returns100% 90% u.s. equity total return (cumulative Probability) 80% 70% 60% 50% 40% 30% 20% 10% 0% 0.4 0.6 0.8 1.0 1.2 wealth factor 1-year u.s. equity returns (20th century) AAA percentiles 1.4 1.6 20th-century 2.5th percentile 1-year return of 28%; calibration criteria is 22%

Source: Barrie & Hibbert

SCR that apply both to the standard formula and to an internal model. The standard formula specifies a series of stresses and a correlation matrix to aggregate the risks but without any implied volatility stresses (this makes it inappropriate for the modeling of variable annuities, which EIOPA has acknowledged). It also specifies the use of dampeners. The equity dampener is of particular interest. Its purpose is to identify when markets are less risky following a market fall. But while empirical evidence suggests that higher mean returns are observed following a crash, its also evident that the tails are more severe. Figure 5 is based on historical analysis across 16 markets and more than a hundred years of data. What it shows are the worst annual excess returns (excess over cash) delivered by the equity markets and what happened in the year following the bad year. For the worst 100 returns, the mean excess return is -31 percent. This is somewhat less severe than the equity downturn of 2008 but comparable. The mean return in the year following for the worst 100 was 9 percenta nice recovery. Its confirmed when you look at the worst 50 and the worst 25. Those had year-following excess returns of 15 percent and 19 percent respectively. The arithmetic mean for excess returns over all countries and all years is 6 percent. Given that mean year-following returns look higher than the long-term average, the data might suggest that theres scope for reducing the stress after a market downturn. But lets remember were talking about a capital requirement, so its not the mean thats important but the tail. If we extend our analysis to look at the extreme percentiles of the returns in the year after a bad year, we see some interesting results. Looking at the worst 100 years, for example, the 95th percentile value of the distribution of the year-after returns is -31 percent (its interesting that this is the same value as the average of the 100 worst). A similar pattern is seen across the

worst 50 and worst 25 years, with 95th percentile levels of -37 percent and -33 percent respectively. This is much worse than the 95th percentile for all years, which is -25 percent. On this basis, it could be argued that an equity dampener is hard to justify for a risk-based capital calculation. If anything, the empirical evidence suggests that a more severe stress test is the better way to go. There are issues with internal models as well. In essence, an internal model is anything that isnt the standard formula, so it could encompass a series of stress tests similar to the standard formula. In practice, however, valuing complex path-dependent liabilities will imply a set of real-world stochastic simulations for the year ahead coupled with a set of market-consistent inner scenarios to value the balance sheet. As noted earlier, EIOPA already has recognized that the standard formula wont work for complex variable annuity structures. As a result, a type of complex nested calculation is necessary for such products. Companies are faced with some extremely difficult modeling choices, including how to make calculations manageable. This then leads into areas such as liability proxy modeling (including curve fitting), least squares Monte Carlo, replicating portfolios, and risk factor calibration (which raises questions around calibration targets). There are also questions of governance and of communications to board and senior management. Regulatory review is another issue. What will the regulators be looking for, and what can companies do to prepare? Its interesting that the U.K. Financial Services Authority has received 77 internal model applications and says it plans to review 10 to 20 of them before Solvency II goes live.

Solvency II and U.S. RegulationWhile the National Association of Insurance Commissioners (NAIC) move to a principle-based approach (PBA) certainly has helped bring U.S. and European regulators into closer alignment, there are a number of key features that make PBA considerably different from what we are seeing in Europe. Solvency II and U.S. regulators seem to be asking two very different questions of insurers. The European view is to look at reserves and capital on a market-consistent basis, while U.S. regulators are taking a real-world runoff perspective. Both approaches have their pros and cons, but they elicit vastly different answers. In a market-consistent approach, capital is whatever is needed to fund the short-term transfer of liabilities and their risk to a willing third party, at a specified level of confidence. In a real-world runoff approach, capital is whatever is needed to fund all future liability cash flows from existing business as they fall due, again at a specified level of confidence. Some question whether the U.S. approach is truly principle based or rather something in between. For the NAICs VM-20,

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which defines the ways in which reserves are calculated for life products, it now looks as though there will be a prescribed scenario generator. Even under the NAICs AG 43/C3 Phase II, which defines variable annuity reserves and capital respectively, the so-called standard scenario, which acts as a floor on the PBA amount and is based on stresses defined by the regulator, typically has dominated in practice. There are also limitations on what internal models can do under AG43/C3 Phase II, specifically that projected equity returns are subjected to meeting certain calibration criteria. This may be an issue for a number of reasons, but two to note in particular: The equity risk modeling that forms the basis of the calibration criteria arguably understates historical U.S. equity volatility (see Figure 6); The modeling assumes that historical average total returns are expected in the future (despite todays low interest rate and inflation environment). The NAICs Solvency Modernization Initiative does offer hope. Set up to review international regulatory developments and better align the United States with the rest of the world, the work of the initiative now dominates NAIC meetings. As a result, C3 Phase III, which covers capital for life products, is on the back burner and timing for its implementation is uncertain. The Solvency Modernization Initiative eventually may lead to changes in the U.S. statutory approach that could culminate in equivalency with Europe. In the meantime, however, the granting of equivalency to U.S.-based insurers may come down to a political decision.to ny dA r dis, a fellow of the Society of Actuaries, member of the Academy, certified financial analyst, and chartered enterprise risk analyst, is head of insurance, North America, for Barrie & Hibbert, a firm specializing in the modeling of financial market risks and economic scenario generation.

AcknowledgmentsMany thanks to Craig Turnbull and Sandy Sharp for assistance in the preparation of this article.ReferencesCarlin, Stephen, Thoughts on QIS5 Yield Curves, Barrie & Hibbert Insights, July 2010. Hibbert, John, Market-Consistent Valuation of Ultra Long-Term Cash Flows, Barrie & Hibbert Insights, October 2008. Hibbert, John, Is There a Case for a Less Severe Equity Stress Test Following 2008 Returns? Barrie & Hibbert Insights, May 2009. Hibbert, John, Liquidity Premium: Myth or Reality, Barrie & Hibbert Insights, September 2009.This article is solely the opinion of its author. It does not express the official policy of the American Academy of Actuaries; nor does it necessarily reflect the opinions of the Academys individual officers, members, or staff.

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You see the world as either assets or liabilities. Which one is your software?

Twenty years ago, we embraced the ALM model. And weve never looked back. One question drives the Milliman team: what do our clients need? The result is dozens of enhancements, including nested stochastic modeling, grid computing, and our new user interface. No wonder so many companies rely on MG-ALFA. This is a solution you can count on. These days, thats no small feat. Milliman.com/mgalfa.

MG-ALFA

If you type In leadershIp books on Amazon, youll get

more than 60,000 hitsan indication that theres a large market out there of potential leaders looking for easily absorbed principles to guide their paths to fame, success, and financial reward.But the qualities that make a good leader can be fuzzy and elusive. Gen. George Patton memorably said, Leadership is the thing that wins battles. I have it, but Ill be damned if I can define it. Hes not alone. And the problem is magnified when attempting to define leadership traits in a relatively new field such as enterprise risk management (ERM). What are the attributes of an ideal chief risk officer (CRO)? Its an important question that many entities still are struggling to answer. A 2008 PricewaterhouseCoopers survey found that despite strong commitments to ERM, most companies were struggling to move beyond initial design and planning stages. Structure, process, and reorganization dont suffice to solve a business problem when leadership, firmness, confidence, and direction are wanting. Since the position of CRO is a recent creation, we thought it would be interesting to search history for military, political, and business leaders who practiced administrative techniques that are highly applicable to modern business risk management. While leaders at different levels have differing limitations, our exploration uncovered some common traits and leadership styles that a CRO would do well to emulate. The leaders we looked at demonstrated these traits and styles on each rung of the career ladder as they ascended to the top.

Keeping the Waters CalmERM is a complex people-centric process. It involves transparency and communication and is more effective in decentralized networks in which management is highly involved. Done right, ERMs soft sideprocess and peopleis valuable, rare, and hard to replicate. As a result, it often leads to a strong competitive advantage. The corporate leader most responsible for making ERM work is the entitys CRO. CROs must provide transformational leadership through extraordinary efforts or innovation, often in situations demanding performance beyond expectations. Transformational leaders communicate their vision through personal action and emotional appeals, delegate significant responsibility and authority, eliminate bureaucracy, provide developmental experiences, and encourage the open sharing of ideas and concerns and collaborative decision making.

OPENINg IMAgE: SHUTTERSTOCK; LEAdERSHIP PORTRAITS: WIKIMEdIA C OMMONS

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Follow the LeaderBy tim cardinal and Jin Li

While the position of corporate chief risk officer is relatively new, the attributes that could contribute to successful leadership in that role are timeless.

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Follow the Leader c ont in ue dA want ad for a CRO might describe a bevy of desired attributes, skills, knowledge, and experience. While companies dont need superheroes as their CROs, corporate scandals have illustrated time and again the importance of senior leadership that displays integrity, humility, responsibility, and a moral compass. In his last written speech, Franklin Delano Roosevelt paraphrased a verse from the Bible: From everyone who has been given much, much will be required; and to whom they entrusted much, of him they will ask all the more. A CRO certainly is entrusted with much. In a presentation at the 2011 ERM Symposium in Chicago, we conducted an exercise in which we asked attendees to pick five desired leadership traits in a CRO and then choose three military, three political, and three business leaders to hire as a CRO (see Page 29). As attendees moved through the exercise, we asked them to weigh a number of considerations: Do some traits screen out candidates while others select them? Is above average competence a screening criteria but brilliant competence a selection criteria? What if a leader is strong in some traits but weak or lacking in other traits (for example, lacking in tact)? Does the leader exhibit certain traits occasionally, frequently, consistently, and/or judiciously applied according to situation? Are quality and spanvertically and horizontally throughout the hierarchymanifested in behaviors and actions? Which traits are corollaries or precursors of other traits? (Our list didnt include character, for instance, because that encompasses many other traits); Do leaders need all, most, many, or some of these traits, and in extreme measures or not? The lists of leaders that we provided reflect the fact that in most popular leadership surveys, military rankings are dominated by conquerors, politics by charismatic leaders, and business by entrepreneurs and risk-takers. It is paradoxical that leaders who live during severe crises get the most press and thus the highest rankings from both historians and the public. Consider: George Washington during the formation of the United States, Abraham Lincoln during the Civil War, and Roosevelt during the Great Depression and World War II. Few are drawn to leaders who kept crisis at bay. In the Art Of War, Sun Tzu wrote, People see performance in crisis management, not the art of prevention. Although we want a CRO to guide us through financial crisis, a great CRO excels at the art of prevention. After all, what looks better on a rsum: Guided my company through a storm or Made decisions that kept the waters calm? Benjamin Franklins achievements are well-known. He was a scientist (the Franklin stove), a businessman and entrepreneur (the Pennsylvania Gazette), statesman, diplomat, and civic revolutionary who founded and supported libraries and city infrastructure. He was energetic, charismatic, curious, and persuasive. He was also a scholar, a servant leader, and a negotiator. Although blessed with many talents, Franklin identified traits (including resolution, order, industry, moderation, frugality, sincerity, justice, and humility) that he deemed vital to his success and then made a concerted effort to cultivate them. He worked diligently on one trait until he mastered it (more than one at a time was too difficult), and it took many years for him to complete the process (contrast that with todays promised 24-hour transformations). His advice on how to avoid arguments and persuade others was based on what he had learned: I made it a rule to forbear all direct contradictions to the sentiments of others, and all positive assertions of my own. The modest way in which I proposed my opinions procured them a readier reception and less contradiction. George Washingtons best trait, according to historian Paul Johnson, was his ability to face reality and see things as they were, not as he wished them to be. Washington displayed fortitude and was the bedrock of army morale, personally rallying his men in battle and planned withdrawals (its a trait he shares with other great generals, including Julius Caesar, Alexander the Great, Hannibal, and the Byzantine Flavius Belisarius). Washington communicated frequently with Congress, his staff, and his men. He kept the Continental Congress focused and productive. He had drive and ambition (an early life goal was to become a British aristocrat). He also made a list of traits he considered necessary to attaining his goals and worked diligently to acquire them. He learned from his experience and mistakes as a surveyor, in the army, and in politics. Contrast this with Civil War Gen. George McClellan, who saw risk everywhere and was paralyzed as a result, or Ulysses S. Grant, who was effective as a general but completely ineffective as president because of his poor personnel choices and his inability to build an effective team. Franklin D. Roosevelt ranks as one of the top three U.S. presidents in more than a dozen surveys. Insatiable curiosity and a boundless appetite for knowledge complemented a strong character that was tested when he contracted polio. Having conquered personal adversity with courage, tenacity, and hopefulness, he was well-equipped to tackle national adversity. This

Profiles in LeadershipOne way to pick the CRO of the future is to look at past leaders through an ERM lens. All of our historical candidates model some of the traits necessary for transformational leadership. Would they have made good CROs?

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You Be the JudgeHeres a simple exercise to get you thinking about personality traits and their function in successful leadership. First, choose from the following list five attributes that you would look for in an ideal chief risk officer.PERSONAL TRAITS Achievement drive Adaptability Aggressiveness Appearance Charisma Communication skills Compassion Competence Consistency decisiveness determination diplomatic skills Energy Enthusiasm Extroversion Fortitude Humility Idealism Initiative Insight Integrity Intelligence Interpersonal skills Inclusion of subordinates Judgment Leadership motivation Moral purpose Optimism Passion Persistence Persuasiveness Power Prestige Realism Responsibility Self-confidence Sense of humor Tact Tolerance for stress Verbal fluency Vision Other___________

Next, choose three military, three political, and three business leaders whose personal qualities you believe would make them effective chief risk officers. gREAT mILITARy LEADERS King david Alexander the great Hannibal Julius Caesar Constantine King Arthur Belisarius Emperor Taizong Charlemagne Richard the Lionhearted Saladin genghis Khan Toyotomi Hideyoshi Napoleon Bonaparte Horatio Nelson george McClellan Robert E. Lee Ulysses S. grant Bernard Montgomery george Marshall Chester Nimitz douglas MacArthur dwight Eisenhower george Patton george zhukov Norman Schwarzkopf donald Rumsfeld

gREAT POLITICAL FIgURES King Solomon Elizabeth I Catherine the great Frederick the great William Pitt the Younger george Washington Thomas Jefferson Alexander Hamilton Benjamin Franklin John Macdonald Henry Clay Abraham Lincoln Otto von Bismarck William gladstone david Lloyd george Herbert Asquith Franklin d. Roosevelt Winston Churchill Joseph Stalin William Mackenzie King Charles de gaulle Harry Truman John F Kennedy . Lyndon Johnson Pierre Trudeau Ronald Reagan Margaret Thatcher

gREAT BUSINESS LEADERS Sam Walton Walt disney Bill gates Henry Ford J.P Morgan . Alfred Sloan Jack Welch Ray Kroc William Hewlett david Packard Andrew grove Milton Hershey John d. Rockefeller Thomas Watson Jr. Henry Luce Will Kellogg Warren Buffett Col. Harland Sanders William Procter Thomas Watson Sr. Asa Candler Estee Lauder Henry Heinz daniel gerber Jr. James Kraft Steve Jobs Michael dell

Take a moment to think about your choices. Why did you select some leaders and not others? Did you consider their attributes or their accomplishments and the impact these had on industry or society? Did you take into account the means they took to achieve their goals? Did they build for the future, or was their legacy dismantled once they departed the scene? What criteria did you use in making your choice? Did you choose leaders who exhibited the five character traits that youd selected first? We performed this exercise in a presentation at the 2011 ERM Symposium in Chicago. Of the 45 personal character traits we listed, 42 received at least one vote. The choices for specific traits broke down as follows: integrity48 percent; intelligence43 percent; Judgment, competence, communication skills36 percent to 38 percent; responsibility, insight, realism, vision, tolerance for stress 20 percent to 23 percent; Persuasiveness, decisiveness, diplomatic skills, interpersonal skills, adaptability, fortitude, leadership motivation, and other10 percent to 15 percent. Among the military leaders, 26 of 27 received votes. The largest vote-getters were: eisenhower47 percent; Patton23 percent; marshall21 percent; Lee, Grant, Alexander the Great, charlemagne, king Arthur, and king david13 percent to 16 percent. Among the political leaders, 20 of the 27 we listed received one or more votes. those receiving the most votes were: Lincoln52 percent; churchill42 percent; franklin, washington, king solomon, reagan21 percent to 29 percent; roosevelt, Jefferson, kennedy, and truman10 percent to 18 percent. for business leaders, 20 of the 27 listed received votes. specifically: Buffett64 percent; welch, walton, Jobs, Gates 24 percent to 29 percent; sloan, rockefeller, ford, disney, morgan, kroc11 percent to 19 percent.

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Leadership is the thing that wins battles. I have it,was displayed in his first 100 days in the Oval Officenot only in dealing with the bank crisis but also in formulating the New Deal to advance economic recovery and social welfare. Roosevelt delivered his first fireside chat on March 12, 1933 (having been in office one week), to announce that the nations banks would reopen. Roosevelts performance, in which he didnt scold or name-call but instead appealed to his fellow Americans to seek greatness, had a direct impact on the nations confidence. George Marshall chose the right people in building his team. As chief of staff during World War II, Marshall selected the people who played significant roles in leading the Allies to victory. Most were unproven and without direct experience for the tasks and responsibilities at hand. Five days after Pearl Harbor, Marshall called in Dwight Eisenhower and asked him to recommend a strategy for the Pacific. Eisenhower returned a few hours later and presented a strategic concept with which Marshall agreed. Marshall ended the interview on an approving note, telling Eisenhower, The department is filled with able men who analyze their problems well but feel compelled always to bring them to me for final solution. I must have assistants who will solve their own problems and tell me later what they have done. George Patton also transformed the culture of those under his command, involving and encouraging subordinates. Never tell people how to do things. Tell them what to do and they will surprise you with their ingenuity, Patton said. He also wrote, There is a great deal of talk about loyalty from the bottom to the top. Loyalty from the top down is even more necessary and much less prevalent. A driven man, Patton was decisive and bold as he prepared goals, details, and plans. He wrote, One does not plan and then try to make circumstances fit those plans. One tries to make plans fit the circumstances. Patton studied everythingpast military leaders and battles, current resources and situations, contingencies, and, especially, the enemy. Studying past masters is a common characteristic of good leadership. Patton utilized his knowledge of the roads that William the Conqueror used in his operations in Normandy and Brittany to map his own maneuvers, writing, The roads used in those days had to be on ground which was always practicable. Therefore, using these roads, even in modern times, permits easy by-passing when the enemy resorts to demolition. Patton similarly wrote that it was quite natural that my speeches should sound like Napoleons because as you know I have studied him all my life. Patton is legendary for his leadership in the Battle of the Bulge. When Eisenhower asked how long it would take Patton to wheel his Third Army 90 degrees and attack the Germans, Patton shocked everyone by taking just six days to reach Bastogne and attack. This achievement was only possible because of Pattons earlier preparationstraining, planning for contingencies, and creating a culture that involved and utilized subordinates. Dwight Eisenhower exemplified honesty, self-reliance, determination, and hard work. Under Patton, he studied tactics intensively. Under Brig. Gen. Fox Conner, he studied Clausewitzs On War and Plato and discussed defects of the WWI allied command structure and the likelihood that the Versailles Treaty made another war inevitable. Under Marshall he outlined a basic approach that through its logical presentation refocused Allied efforts on a winning strategy. Achieving a consensus was more important to Eisenhower than winning an argument because success depended so heavily upon enthusiastic execution of the plan. He involved others and consistently won over those with different ideas by assuring them that their points of view had a full airing and fair consideration. He was rarely abrupt, never arbitrary, and applied the particular genius of his own personality to persuade other men to accept a common strategy. Which traits from our list would he have chosen? Eisenhower is on record saying that the supreme quality for leadership is unquestionably integrity, and that humility must always be the portion of any man who receives acclaim earned in the blood of his followers and the sacrifices of his friends. John F. Kennedys actions during the Cuban Missile Crisis highlight the perils of reactive versus preventive management. According to historian Paul Johnson, Kennedys biggest test, his biggest apparent triumph, and his biggest mistake, was his handling of Cuba. He was in a position to demand restoration of the status quo ante or even punishment without any concessions or pledges. Instead, Kennedy not only gave way over the Jupiters [missiles] in Turkey but acquiesced in the continuance of the communist regime in Cuba in open military alliance with Russia. It was a defeat. Donald Rumsfeld makes the Risk Management Hall of Fame for his statements, There are also unknown unknowns . . . things we do not know we dont know, and If you are not criticized, you may not be doing much. Rumsfeld earns failing

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but Ill be damned if I can define it.marks, however, for confusing an open-door policy with being accessible and approachable. He became isolated and took a flawed course of action. In a similar manner, Robert E. Lees earlier success and resulting confidence allowed him to ward off advice from his commanders, who became afraid to voice their opinions. At Gettysburg, Lee ignored subordinates views about his planned charge. When Lee began his military career, muskets had a range measured in the tens of yards with poor accuracy. With fair accuracy and a 1,000-yard range, the effect of modern guns at Gettysburg was devastating to Confederate troops. Because of Warren Buffetts investment genius and results, its easy to overlook his management of nearly 100 chief executive officers (CEO) and more than 200,000 employees. Buffett leads with integrity, transparency, and consistency and demands them of others. Buffett doesnt give direct orders but asks tons of questions, having learned that great managers give orders indirectly by making suggestions. He delegates not just a task but the entire job, admitting that we delegate almost

Gen. George Patton

to the point of abdication. The secret to Buffetts success lies in his insistence on acquiring good people and managing them well. Buffett believes managers benefit from candor, explaining, If a CEO is enthused about a particularly foolish acquisition, both his internal staff and his outside advisers will come up with whatever projections are needed to justify his stance. Only in fairy tales are emperors told that they are naked. He also said, Hire an adviser and his job likely becomes to advise you to do what you wanted to do in the first place. Advisers who voice dissent too often are soon out of a job. Most people dont keep no men around. Buffett says he evaluates closely his missed opportunities, noting, Since mistakes of omission dont appear in financial statements, most people dont pay attention to them. We rub our noses in mistakes of omission.

The Weight of HistoryOur review of great leaders illustrates the importance of studying a field of endeavor and working hard to acquire traits that will facilitate success. Many of our leaders were criticized frequently and severely. They confronted failure yet had confidence in their ability to prevail. They learned from their mistakes. They had

Enrolled Actuaries MeetingMarriott Wardman Park Hotel, Washington DCTM

March 25-28, 2012

rence of Confe s arie Con Actu sulting

American Academy of Actuaries

THE DRIVING SINCEPENSION PRACTICE 1975

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Follow the Leader c ont in ue dintegrity and strove to do the right thing. They valued their subordinates, remained at the scene, led by example, and listened to alternative points of view yet firmly exercised unity of command. They allowedrather than forcedpeople to follow their lead. But transformational leadership isnt delineated simply by a laundry list of traits. Pick a particular traitcompetence, vision, decisiveness, or fortitude, for instanceand you can find negative examples. Stalin was competent, decisive, and had fortitude and a strong vision, as much as or even more so than Lincoln, Churchill, Franklin, or Reagan. Like Roosevelt, Hitler used charisma and the radio to great effect. But its unlikely you would pick either Stalin or Hitler as a role model to follow. In our exercise at the ERM symposium, integrity topped the list of desired traits in a CRO, coming in at 48 percent. And while moral purpose, humility, and compassion received only between 3 percent and 5 percent of attendees votes, moral purpose coupled with drive and ambition is perhaps the differentiating characteristic for both Lincoln and Churchill. We also need to consider whether great leaders of one era (and in one area) would necessarily be great leaders in another era or in a different area of endeavor. Was their success just luck, a case of being in the right place at the right time? We believe the leaders we have discussed would be just as successful today. We suspect that their drive and sense of purpose would compel them to attempt and achieve great accomplishments regardless of the field. Precept 1 of the Code of Professional Conduct requires an actuary to act honestly, with integrity and competence, and in a manner that fulfills the professions responsibility to the public. The purpose of the actuarial standards of practice (ASOPs) is not to be narrowly prescriptive. Instead, ASOPs lay out principles of ethical and professional conduct. In the same way, ERM isnt prescriptive but requires judgment and leadership. In many recent corporate and government failures, elected officials, board members, and senior management have claimed they werent truly informed of the risks or didnt understand them, all with the intent of shifting the blame elsewhere. Assigning responsibilities, sadly, doesnt necessarily make individuals responsible. Operating as CROs, Lincoln, Churchill, Eisenhower, Patton, or Buffett would have immersed themselves in the details, seen the big picture, and been relentless in asking penetrating questions of everyoneparticularly those closest to the action. ERM entails two Rsrisk and reward. Entrusted with much, our historical CROs would inject a third R and be responsible and good stewards of that trust.ti m c A r dinA L is a member of the Academy, a fellow of the Society of Actuaries, and a chartered enterprise risk analyst. He is vice president at PolySystems Inc. and can be reached at tcardinal@polysystems.com. Jin L i is a member of the Academy, a fellow of the Society of Actuaries, a chartered enterprise risk analyst, and a chartered financial analyst. Resources and Suggested ReadingsAmbrose, Stephen, Eisenhower: Soldier and President (The Renowned One-Volume Life), New York: Simon & Schuster, 1991. Brownworth, Lars, Lost to the West: The Forgotten Byzantine Empire That Rescued Western Civilization, New York: Crown, 2009. Buffett, Mary and Clark, David, Warren Buffetts Management Secrets: Proven Tools for Personal and Business Success, New York: Scribner, 2009. Cannon, Lou, President Reagan: The Role of a Lifetime, New York: Simon & Schuster, 1991. Cardinal, Tim and Li, Jin, ERM and Business IntelligenceLessons From World War II Codebreakers, Contingencies, March/April 2011. Cardinal, Tim and Li, Jin, Strategic Organizational Behavior: Finding the Right ERM Fit, The Actuary, February/March 2011. Churchill, Winston, Memoirs of the Second World War, Boston: Houghton Mifflin, 1990. Collins, Jim, Good to Great: Why Some Companies Make the Leap and Others Dont, New York: HarperBusiness, 2001. Donald, David H., Lincoln, New York: Simon & Schuster, 1995. Franklin, Benjamin, Autobiography of Benjamin Franklin, New York: Collier, 1970. Gilbert, Martin, Churchill: A Life, New York: Henry Holt & Co., 1991. Hayward, Steven F., Churchill On Leadership: Executive Success in the Face of Adversity, New York: Gramercy Books, 2004. Hitt, Michael, Miller, C. Chet, and Colella, Adrienne, Organizational Behavior: A Strategic Approach, Hoboken: John Wiley & Sons, 2006. Johnson, Paul, Churchill, New York: Viking, 2009. Johnson, Paul, Heroes: From Alexander the Great and Julius Caesar to Churchill and de Gaulle, New York: Harper Perennial, 2008. Johnson, Paul, Napoleon: A Life, New York: Viking, 2002. Johnson, Paul, George Washington: The Founding Father, New York: Harper Collins, 2005. Keegan, John, Winston Churchill: A Life, New York: Viking, 2002. Mayo, Anthony and Nohria, Nitin, In Their Time: The Greatest Business Leaders of the Twentieth Century, Boston: Harvard Business Review Press, 2005. McCullough, David, Truman, New York: Simon & Schuster, 1992. McCullough, David, 1776, New York