The Abolition of Gender Discrimination

On the 1^st of March 2011 the European Court of Justice made a ruling that commencing on December 21^st 2012 insurance companies will no longer be able to use gender as a risk factor in setting premiums. The ruling applies to all life, health, general and pension products. This decision to inhibit gender discrimination will undoubtedly have vast implications for actuarial work going forward. Prior to this ruling gender discrimination has been explicitly permitted under EU equal treatment rules, 'if sex is a determining risk factor... substantiated by relevant and accurate actuarial and statistical data'. Below I will examine some of the changes that this ruling may entail.

Long before the invention of computers and sophisticated statistical software it has been well accepted that on average women live longer than men. Even in early with profit policies that lacked the proper data to generate highly granulated groups it was standard practice to offer different terms of contract to males and females. The deterioration of this standard practice will inevitably have huge pricing implications.

For life insurance, as men and women will be grouped together, we can expect that women’s premiums will rise while males will fall. Keeping all other factors equal this will be because women will find themselves in a less select group as male mortality elevates the average mortality of the group with the opposite being true for males. Similarly for car insurance (which has received much media attention) women will be grouped with their less select male counterparts. This should raise female premiums and lower male premiums despite decades of statistical data have proven that men are more likely to claim in this industry. However, the ruling will benefit females when purchasing annuities or pensions as it will not be considered that females live longer than the average group age when mixed with males.

As the most common factor in underwriting will be prohibited we can expect that many alternative risk factors will evolve on the introduction of this new ruling. In particular it is expected that underwriting will become much more aggressive and insurance companies will attempt to determine gender in different forms (type of car, profession, previous illnesses, etc.) If this is the case it would appear that the new ruling is a dead weight lost to society as insurers continue to discriminate on sex but in less direct measures and through more expensive underwriting. It must be said that perhaps more aggressive underwriting could uncover more influential risk factors than sex that would increase claim likelihood. For example maybe a person’s salary has more influence on their mortality than gender does. This new law could revolutionise underwriting which arguably up to now has relied on outdated methods of risk classification.

There will also be huge changes in how insurance products are marketed as corresponding males and females must be charged the same premiums. For life insurance and general insurance, companies will want a higher female customer base to subsidise males with the opposite being true for pension and annuities. One measure of doing this is targeted advertising campaigns to the desired audience of the same gender. Companies may also engage in strategic customer retention methods that would attempt to retain customers of a certain sex whilst discouraging customers of an unfavourable sex. In addition companies may start to offer ‘special group rates’ to groups such as trade unions or social clubs in which they can achieve a customer base of an often similar gender. For example a life insurance company may offer a special group rate to a trade union in a profession traditionally populated by females to attain a woman customer base.

It will be interesting to see if a company is allowed to ask about gender on the policy form even though it is not allowed to use this information in its pricing process. If not a company may be unaware of the subgroups represented in its customer base and the ‘selection against the office’ problem inherent in this new ruling will be amplified. It is also interesting to note that life tables which traditionally discriminate between males and females may have to be updated to merge the two genders as in Europe there is no longer a use for such information.

As always I am interested in any and debate that this article may provoke. 

The use of Sovereign Annuities in Defined Benefit Schemes

On 8^th November 2010 The Society of Actuaries in Ireland issued a statement on the sovereign annuity concept which is aimed to alleviate many of the difficulties currently faced by defined benefit schemes in Ireland. The concept is intended as a short term tactical measure and not a substitute for long term reform. I have evaluated the proposal in this context below.

Firstly it is worth noting that 80% of Irish defined benefit schemes are underfunded and the intention of this proposal is to reduce some of the financial stress imposed on these schemes. This proposal argues that the interest rate used to comply with the minimum funding standard should be the interest rate on Irish Government Bonds. For the purpose of the minimum funding standard, the liability in respect of pensions in payment is determined by reference to the cost of buying annuities in the insurance market. This is because annuities are considered a matching asset to pension liabilities as they provide a regular series of fixed or variable income payments in a similar manner to pension benefits. Currently the discount rate used to value future pensions is the interest rate on German Government Bonds because of their availability, suitable duration and most importantly their excellent security rates. The funding deficits currently being experienced by most defined benefit schemes have been exacerbated by the current low yield on German sovereign bonds. At the time the proposal was issued the yield on German 10 Year Government Bonds was 2.5 % which was significantly lower than Irelands 8.062%. We can anticipate that the large spread between German and Irish Bonds will remain for the next couple of years.

The implications of valuing the minimum funding standard on a higher interest rate will of course lower the liabilities of trustees to their pension contributors as the higher rate discounts the future outgo streams in a more powerful manner. This would mean in the short term that the schemes would not in fact be underfunded. In addition this implies that pension schemes would need to invest in an asset that earns an interest rate equal (or greater) than that used in the discounting basis. In many cases this will mean direct investment in sovereign bonds themselves and would generate a significant new source of exchequer funding as it would encourage trustees to invest in Irish sovereign bonds as a matching asset for minimum funding standard and pensioner liabilities. It could then be argued that it is in this proposal is in the national interest and in the private pension holders interest as when Irish sovereign bond yields revert to norms, the capital value of the asset will rise. In addition because of the difference in spread ‘buying Irish’ instead of German bonds would mean that the annuities for retiring members can be bought more cheaply and this would free up funds for active and deferred members of the scheme. This would mitigate the effect of the “priority rule” under which pensioners have first call on the assets in the event of scheme wind-up. Another advantage is that it would align the interests of private pension holders who are under a prefunded scheme and state pension holders who operate under a ‘Pay as You Go’ System. Their interests are now aligned as they are now both depending on the state to look after them in their old age, the state pensioners under the PAYG system and the private pensioners through receiving the coupon form the government bonds.

Considering all of the above it is my humble view that the disadvantages of such a scheme significantly outweigh the advantages. The major flaw I see with the society’s proposal is that the argument assumes there is market distortion and that the market has overpriced the risks associated with Irish Government Bonds. I feel that the market acts on perfect information and it is extremely naïve to make such a radical assumption. Although a switch from German to Irish Sovereign Bonds does not involve currency risk, the main driver of the difference in spread is the counter party risk of default. The spread indicates that the market is demanding a premium for such a risk and it is unfair to assume that Irish pension holders would assess the risk differently. Any assumptions regarding the market should not stray too far from the notion of no arbitrage in my view and this scheme suggests a long term window of arbitrage as the default risk is consistently overpriced. In a practical sense it would of course be necessary for the National Treasury Management Agency to issue coupon only bonds of appropriate duration to match the liability to pension holders under this annuity scheme. However in my opinion there are other practical issues to be considered. One of the key arguments made in favour of this scheme is that it would align public state pensions with private pensions. In my view the private pension holders are at far greater risk of default. Consider if the ‘Pay As You Go’ state pension was to default or break down completely as its members are extremely well organised into unions and groups their power to lobby and strike is vast. I would anticipate riots on the streets, shut down of state services and essentially the fall of a nation unless the government made a U turn on its decision. As a result members of the state pension scheme have far greater bargaining power than individual private contributors who tend not to be as organised and receive such media attention. This is why I feel their interests are far from aligned as each group is facing different risks. Actuaries advising trustees of course are required to operate in accordance with society’s best interest and it may be deemed that the scheme would create a significant new source of exchequer funding. However it should not be to the detriment of the client which in the case is the private pension holders in the scheme. It is my view that these schemes increase the risk to an unacceptable level to pensioners concerned and for further reasons outlined above should not be introduced.

The Relevance of the Actuarial Profession

In September 2010 Dr Wendy Chapman was deemed ‘fit to practice’ after facing disciplinary investigations by a General Medical Council in the UK. Leinster fans will remember Chapman as the doctor at the centre of rugby union's "bloodgate” scandal. The incident occurred in the Harlequins vs Leinster Heiniken Cup Quarter Final in which ‘quins winger Tom Williams asked Chapman to cut his lip as a cover-up after he bit into a fake-blood capsule which enabled Harlequins to use a blood sub. His apparent injury meant a specialist goal kicker could come on to the pitch in the dying minutes of the game. The ruse backfired: the substitute missed the late goal kick, Harlequins lost 6-5, and an inquiry led to heavy fines and bans for the disgraced player and the club's director of rugby.

The decision to allow Dr Chapman to continue to practice after evident gross misconduct undoubtedly brings shame to the medical profession in the UK. In addition it suggests that society should take a fresh look at the relevance of professions in the modern era. Do professions act in the public’s interests? Do professions have regulatory powers over its members? Are professions still beneficial to society as a whole?

I will attempt to answer these questions in an Actuarial Context.

A profession may be defined as a group of individuals who are granted monopoly powers in the provision of certain labour services. So medical doctors have monopoly

powers in (amongst other things) prescribing drugs, accountants in identifying

(auditing) a firm’s profit (for taxation and other purposes), etc. The tasks only

actuaries can do – the statutory roles of actuaries – vary by legal territory (e.g.,

Ireland, UK, US, etc). Such statutory roles for actuaries relate mainly to the

certification of the adequacy of assets to cover liabilities for a life insurer, general

insurer, pension scheme or friendly society. Of course, actuaries are also valued advisers in other, related, spheres.

It is often customary to break a profession down into three prongs:

• The Cognitive Element – expert, specialised knowledge from long training course,

with sound judgment applying this expertise.

• The Normative Element – high ethical standards, serving the public good.

• The Organisational Element – organised in recognised grouping (e.g., Society of

Actuaries, Institute and Faculty of Actuaries) with disciplinary powers over members to enforce the ethical and competency standards demanded.

Firstly looking at the Cognitive element it is generally well accepted that actuarial work is of a highly skilled nature and there is a market need for this expert knowledge. Actuary as a profession ensures that its members are of a suitable high technical standard before undertaking a task. There is a long series of technical examinations that must be passed before an applicant can commence practicing as an actuary. This not only has educational benefits for society but ensures a high level of quality control in the abilities of individuals becoming an actuary. This is especially important in the actuarial profession as members of the public are unaware as to whether a job is being completed to an appropriate level due to the specialized nature of the knowledge involved. Moreover the contracts involved are often very financially significant to those involved and through its monitoring and examinations the actuarial profession continuously protects consumers through ensuring that its members have adequate ability for the job. Evidence that actuaries are of adequate ability for the tasks they undertake can be seen in how the profession has successfully discharged its responsibilities to society since being granted professional status by Queen Victoria in 1868. Since 1868 the amount of actuarial institutions that have failed pales in insignificance with respect to its counterparts in other long term financial institutions such as banks.

It is my opinion that actuaries in particular have rarely neglected the normative element of a profession and over the years have always acted with a wider duty of care. The normative side of being a professional actuary is set out in guidance by the professional bodies in the form of Professional Conduct Standards (PCS) and a set of Guidance Notes which an actuary must comply with at all times. Right from the outset those who sought a Royal Charter from Queen Victoria were seeking ‘fit and proper gentleman’ as members and in the guidance we can see that this idea is till evident in 2011 as integrity and fairness are key concepts which an actuary must abide by. It is also quite clear that actuaries, as a profession, serve the public good. Over the past 143 years actuaries have instilled confidence in long terms savings which has been of huge benefit to society. Before the profession was set up, financial institutions had a very short lifespan which did not encourage individuals to save for retirement. Members of the public at that time were dependent on workhouses to avoid poverty in retirement or on death of the working family member but since the establishment of professions to run institutions confidence in long term saving has sky rocketed and individuals are now able to plan and protect themselves against future contingencies. In addition it must be noted that this has facilitated the efficient allocation of capital in society to those who need it now (e.g. start up companies) and those who need it in the distant future (Life Insurance/Pension Policy Holders) This was especially relevant in the nineteenth century during the end of the industrial revolution when many industries were capital hungry and actuaries at the time efficiently allocated the funds so that industries have developed at an advanced rate. Even today Life and Pension Offices are one of the largest institutional contributors to the worlds markets.

It must be said that as a profession the society of actuaries is particularly well organized. Compulsorily the members must meet to advance actuarial science through their continuous professional development. Notably the organization of actuaries into a profession might also help in other joint ventures that cannot be efficiently done in isolation. As a group actuaries have contributed to research, data collection and dissemination (CMI), so risk is more accurately priced leading to new products and lower prices. Actuaries have done this and customers benefit from extended and more accessible market. In addition actuaries self educate which takes the burden of society of having to pay for the education and ensuring that it is of sufficient standard. Up until 2004 actuaries have traditionally self regulated with the society having regulatory powers over its members. Thus the society punished any members acting outside of the professional code of standards. Due to the high level nature of activities society benefited greatly from having a regulatory body that fully understood the nature of the work being carried out.

That said the profession is by no means perfect and if the ‘bloodgate’ scandal exposed flaws in the medical profession then it must certainly be said that the closure of Equitable Life Assurance, the longest serving life assurer, exposed serious short comings in the actuarial profession. Prior to the year 2000 life assurance and provident funds largely maintained the confidence of the public for more than 150 years largely due to the role of an actuary. However in the year 2000, Equitable Life closed its door to new business and, unsuccessfully tried to sell itself. The failure of Equitable Life was largely due to Guaranteed Annuity Rates sold by some with profit pension policies up to the 1980s. When interest rates changed unfavourably Equitable Life was unable to meet its obligations and without the proceeds of a sale to restore the capital strength of the with-profits fund it was clear that the board would have to stop selling new business. This prompted the UK Government to investigate what when wrong at Equitable Life (the Penrose Report published in 2004) and, more widely, what is wrong in the UK Actuarial Profession (the Morris Report (Interim Report 2004, Final Report 2005). The Morris report introduced greater academic and non-actuarial input into syllabus development, improved quality control for exams and exam marking and introduced continuous professional development as a compulsive requirement for the profession. More importantly it reduced the professions ability to self-regulate. Now in the UK, the technical Guidance Notes are set by the Board for Actuarial Standards (BAS), a body that is independent from the Institute and Faculty of Actuaries, and reports ultimately to the Financial Reporting Council. The Institute and Faculty of Actuaries remain responsible for ethical standards, and thus retains responsibility for the relevant Guidance Notes and The Actuaries Code. Both the failure of Equitable Life and the findings of the Morris of report do suggest that the profession was indeed failing its duty of care to society however the report does indicate the need for the profession and the changes suggested are relatively minor considering the extent of the investigation. The will of the profession to act in the public interest can be seen by the support given to the report and the effective manner in which the society has complied with changes. All things considered I firmly believe that actuary as profession is still successfully discharging its responsibilities as a profession to society. That said the profession must never take its status for granted and must continue to seek improvements in both the society itself and in actuarial science in general.

The purpose of this article is to inspire thought and debate so please do not hesitate to leave a comment, criticism or question in relation to any relevant material.