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How can risk managers improve the use of actuarial work and leverage their relationships with actuaries?
Risk management deals with a wide variety of specialty functions, and risk managers must know them all well or have someone reliable he or she can depend on to cover on the ones they don't. Risk managers also must know all key aspects of their companies and their industries in order to fulfill their responsibilities.
Thus our plates are pretty full, and knowing something well still doesn't necessarily translate into being a subject matter expert. Consequently, actuarial science is likely to be one of those accountability areas in which we may not be as deep as we are expected to be.
If you manage a large company retaining sizable risk, you're probably well-versed in reading actuarial reports, if only because you have a captive -where actuarial evaluations are required by the domicile-or as a result of your own internal and/or external accounting rules.
Midsize to small companies, being more frequent users of traditional risk transfer arrangements, may never even have thought they had a need in this area.
But, regardless of your company size or program design, leveraging actuarial data and the relationship with an independent actuary or your insurer's actuary can lead to improvements in your program and your ability to design more efficient risk financing arrangements and sell risk in the marketplace, whether insurance or capital markets.
First, let me assure you that you don't need to be a mathematician to understand or effectively use actuarial reports. At first glance, the typical report may appear overwhelming and complicated. In fact, if done well it should be neither, though it should be comprehensive. A good actuary can make his work both readily understandable to the average risk manager and useful to accountants, auditors and our friends in tax, all of whom have some vested interest in actuarial outcomes.
While actuaries perform many tasks to meet a number of risk management objectives, risk managers most frequently rely on actuaries to:
Forecast their future losses.
Evaluate or measure the development of losses already incurred.
Risk managers should be aware of many other services actuaries provide and selectively use them to their advantage. Some of these include:
Budgeting and accruing for retained loss.
Designing and evaluating cost allocation and claim charge-back programs.
Assessing liabilities associated with mergers, acquisitions and divestitures.
Identifying loss trends that require special attention.
Contributing to captive and other alternative risk financing feasibility studies.
It's important to understand that the accounting organization will have much to say about and take great interest in the actuarial process, especially as it relates to substantial liabilities, both already incurred and likely to be incurred in the future.
In fact, you can expect that the actuarial approach of your firm may in large part be driven by two things: generally accepted accounting principles and the risk-bearing philosophy, be it liberal or conservative or something in between, of the senior team. Thus, in order to team with your actuary to work toward your organization's goals, you should develop a solid working relationship and a meeting of the minds about objectives and strategy with both your accountant and your chief financial officer, as well as key members of their teams.
You'll need at least a fundamental understanding of GAAP standards as they relate to casualty risks. Next, you'll need to understand what size unplanned liability is "significant" to your accountant and chief financial officer. Don't assume annual revenues, profits or net worth are necessarily the measures used to define risk-bearing capacity or philosophy.
In fact, earnings per share, or EPS, may be a much more important measure for a publicly traded company. In that case, a more conservative philosophy would suggest little or no tolerance for variance in EPS results against stated targets; therefore, management may want to assume little or no risk of an unplanned loss. This would tell you and your actuaries that risk retention per loss and in the aggregate would be small relative to the size of the company.
Similarly, this would dictate a very conservative forecasting and evaluation approach that will mean selecting actuarial methodologies that support these tactics and, for example, might mean forecasting to a much higher probability level that the actual values will not exceed the forecast values.
Clearly in order to accomplish these goals and put in place the necessary tactics to do so, it is critical to develop a solid relationship with your lead or supervising actuary. He or she must have as accurate and detailed an understanding of management's financial goals, objectives and risk tolerance as the risk manager. This means the risk manager must include the company's actuary in much of the strategic risk management planning discussions as would allow him or her to support these goals and objectives.
Integral to the actuary's effectiveness will be the accurate, timely and comprehensive communication of:
Key operating priorities.
Key strategic growth objectives.
Historical loss experience.
Historical and projected exposures (e.g. sales, payroll, transactions, man-hours, etc.)
Any shifting in risk-bearing philosophy.
Key loss prevention and control programs, both current and planned.
Any significant change in the key financial targets.
With this information, the actuary will be able to deliver services that will generally align with the company's objectives and hopefully minimize unplanned liabilities that would hurt the balance sheet or income statement.
Finally, much the same information as mentioned above is necessary to design a risk financing program that meets the needs of your company and its shareholders. The accurate forecast and evaluation of your losses and exposures is a key tool in your arsenal only to the extent that you develop the actuarial, accounting and chief financial officer relationships, making you better able to design and implement effective risk financing programs.
Would you like advice from an experienced colleague on a risk management, benefits management or actuarial problem? Four quarterly features in the Perspective section of Business Insurance can give you some answers.
Ask A Risk Manager, Ask A Benefits Manager, Ask A Benefit Actuary and Ask A Casualty Actuary answer written questions from readers on risk and benefits management issues and actuarial problems.
This month's column on risk management issues is written by Christopher E. Mandel, director of risk management at PepsiCo Restaurant Services Group in Louisville, Ky. Dennis J. Nirtaut, managing director of compensation and benefits for Andersen Worldwide S.C. in Chicago, answers questions on employee benefit plans. William J. Miner, an actuary with Watson Wyatt Worldwide in Chicago, answers actuarial questions on benefits issues. And, Richard E. Sherman, president of Richard E. Sherman & Associates Inc. in Ashland, Ore., answers actuarial questions in the casualty field.
Address your questions to ASK, Business Insurance, 740 N. Rush St., Chicago, Ill. 60611. Please give us your name, title and employer; however, Business Insurance will consider unsigned letters.