A task force of the National Association of Insurance Commissioners is asking the board of directors of the Casualty Actuarial Society to reverse a decision to rescind a “statement of principles” of the profession.

The CAS action would seem to have limited impact, confined to a single group of industry professionals, but regulators and consumer groups see broader implications that could force states to rewrite regulations or insurance laws.

Last year, the CAS board voted to rescind three documents that set forth some of the foundational ideas underlying three key actuarial activities—ratemaking, reserving and valuing insurers—without seeking input from members. Representatives of the NAIC’s Casualty Actuarial and Statistical Task Force and the Consumer Federation of America have raised questions about the behind-the-scenes withdrawal of all three documents—”Statement of Principles regarding Property and Casualty Insurance Ratemaking (May 1988), Statement of Principles regarding Property and Casualty Valuations (September 1989) and Statement of Principles regarding Property and Casualty Unpaid Claims Estimates (November 2014). But it’s the rescission of the ratemaking document that has gotten the most attention.

CFA’s Director of Insurance J. Robert Hunter, himself a CAS member, charges that the surreptitious board action opens a back door for actuaries using tools like price optimization to label the final rates determined by such methods as “actuarially sound.”

“The rescindment of the ratemaking SOP provides the impression that the principles are no longer viewed as valid by the actuarial profession.”

CASTF letter to CAS Board

While regulatory actuaries aren’t quite on the same page as the CFA, on Tuesday, the CASTF unanimously voted to send a letter to the CAS board urging reversal of the rescindment. “We submit that the Statement of Principles regarding Property and Casualty Insurance Ratemaking is too important of a document and too widely cited and relied upon to be rescinded at this time,” the task force members wrote in the draft, stressing that the value they found in the withdrawn ratemaking SOP relates to its simplicity, focus and accessibility to the regulatory community.

Separately, on March 1, the CAS opened a formal two-week comment period to invite more feedback from CAS members and other stakeholders, setting a comment deadline of March 15.

What do the principles say?

In addition to defining terms like incurred losses, commissions, underwriting profit and other costs involved in setting cost-based rates (Section I), the rescinded ratemaking document discussed “considerations” related to identifying exposure units and relevant data, as well as concepts like homogeneous groupings for ratemaking accuracy, credibility, loss development and trend factors (Section III). But the core of the ratemaking Statement of Principles (SOP), from which the document takes its title, is Section II—a section clearly titled “Principles.”

  • Principle 1 said that a rate estimates “expected future costs.”
  • Principle 2 said that ratemaking provides for “all costs” associated with the transfer of risk.
  • Principle 3 said that while ratemaking provides for the costs of an “individual risk transfer,” it is appropriate for actuaries to consider aggregate experience of similar risks if an individual risk is not a credible basis for cost estimation.

Listed in Section II were four principles, the first three of which are encompassed by Principle 4:

“A rate is reasonable and not excessive, inadequate, or unfairly discriminatory if it is an actuarially sound estimate of the expect value of all future costs associated with individual risk transfer.”

Why were they rescinded?

When the CAS communicated its decision to rescind the SOPs via a media statement on its website and in a weekly emailed newsletter to members a few days before Christmas, the statement explained that there are other duplicative documents that address similar tenets and the redundancies prompted the CAS board’s action. In particular, the CAS noted that there is overlap between information in the SOPs and a later set of guidelines developed by a group known as the Actuarial Standards Board, whose express purpose is to develop standards of appropriate actuarial practices. These Actuarial Standards of Practice “serve to assure the public that actuaries are professionally accountable,” the ASB website explains.

The ASB’s ASOPs “describe the procedures an actuary should follow when performing actuarial services and identify what the actuary should disclose when communicating the results of those services.” Importantly, the ASOPs also provide a basis for disciplining actuaries when they don’t adhere to the standards.

In its December statement, the CAS noted that more than 50 ASOPs have been adopted in the past 30 years. Given duplication of information in some SOPs and ASOPs, “the CAS Board determined that the Statements were no longer necessary and that rescinding them will eliminate any confusion that may have existed between actuarial principles and actuarial standards.”

Indeed, there is an ASOP that addresses terms like “exposure base” and “credibility” and “trends” that are also discussed in the ratemaking SOP, and another ASOP addresses “homogeneity.” Still another even discusses “actuarial judgment.”

CFA’s Director Hunter isn’t totally buying into the explanation. He points out that the ASOPs do not contain the principles themselves. In addition, there is no discussion of linking final rates to cost-based indications in the ASOPs, he said.

Hunter specifically notes language that the ASB used in communicating the 2017 release of one of its ratemaking ASOPs to casualty actuaries, describing why that last piece is missing. The 2017 statement said that ASB was aware “that significant differences of opinion within the profession regarding certain aspects of ratemaking, including pricing, price optimization methodologies and rate filing requirements, that would need to be reconciled before a comprehensive standard of practice on ratemaking could be developed.” Recognizing this, the ASB chose to focus solely on “the development or review of future cost estimates for prospective property/casualty risk transfer and risk retention,” leaving the development of an ASOP addressing final rate filings for a later date, one that could address “various issues within rate regulatory discussions today (for example, price optimization, unfair discrimination and the Principles contained in the current CAS Statement of Principles).”

Is Price Optimization Acceptable?

Debates surrounding the concept of price optimization were a hot topic about five years ago. Price optimization essentially considers consumer shopping activity—the maximum amount that a consumer might be willing to pay and the likelihood that a consumer will switch carriers for a better price—rather than calculating rates based on projected costs, such as claims, overhead and profit. Hunter was one of the more vocal opponents of the practice because he believes the practice discriminates poor people and people of color, who tend to shop around less frequently than wealthier consumers, due to potentially fewer market options.

“The hole in actuarial standards is a thumb in the eye of CASTF, which specifically opposed CAS’s prior attempt to change the language in the ratemaking principles to allow price optimization.”

Robert Hunter, CFA

Providing a summary of the activities of the actuarial bodies on the rescission and adoption of various SOPs and ASOPs, and a mini-history of the price optimization debate to CASTF and to Carrier Management, Hunter wrote, “The hole in actuarial standards” left by the rescission of the ratemaking SOP “is a thumb in the eye of CASTF, which specifically opposed CAS’s prior attempt to change the language in the ratemaking principles to allow price optimization.”

An actuary could make a rate filing today, fully complying with current ASOPs and, in the end, pick a rate “out of thin air” or rates adjusted by a price optimization or other algorithms, “untethered from any cost-based indication.” Nothing would prevent that actuary from declaring to a state regulator that he or she met actuarial standards.

And the problem is growing more serious because “disclosure of the uses of new algorithms in rate filings is often obscure or even completely missing,” he contends.

Members of CASTF, in the letter they are sending to the CAS board, offer a different take. “We recognize that there are opportunities to modernize the SOP for recent developments in ratemaking such as price optimization, artificial intelligence and predictive models. These developments can be addressed with amendments to the SOP rather than a wholesale rescindment of the document,” the letter states.

Earlier in the letter, the regulatory actuaries write: “The rescindment of the ratemaking SOP provides the impression that the principles are no longer viewed as valid by the actuarial profession. We find this especially troubling in an environment in which characteristics used by insurers in pricing are being challenged, quite publicly, for their perceived lack of a relationship to risk.”

Bias and AI, Predictive Models

After voting to send a letter to the CAS urging the reinstatement of rescinded principles on ratemaking this week, members of the CASTF also discussed work that is being done by the NAIC to help states complete technical reviews of predictive models now being used in carrier rate filings when states don’t have the resources to deal with those.

NAIC predictive model reviews comment on the model documentation and may flag statistical errors or questionable support but stop short of imposing regulatory authority or recommending acceptance or rejection of the reviewed models by state regulators, according to information shared during a CASTF meeting Tuesday.

A public Webex link to Tuesday’s CASTF proceedings is available on the NAIC website.

Separately, insurance commissioners have recently expressed the view that technology and artificial intelligence be used to remove human bias from pricing models.

“AI will bring better targeted, more relevant and better priced products to market, along with easier ways to uncover and eliminate discriminatory practices,” Connecticut Insurance Commissioner Andrew Mais wrote in an exclusive article for Carrier Management.

Jonathan Godfread, North Dakota’s commissioner, told an audience at the InsurTech NY Spring Conference 2021 this week, “The biggest benefit that I see coming is the ability to truly remove some of that inherent human bias,” during a session titled “Regulatory Trends for AI and Algorithm Bias.”

Both regulators are members of the NAIC’s Innovation and Technology Task Force (which Godfread chairs) and the NAIC’s Big Data and Artificial Intelligence Working Group.

Last year, the NAIC adopted its own set of principles—”Guiding Principles on Artificial Intelligence“—outlining the need for fairness, accountability and transparency in technical models.

Addressing the issue of overlap between the SOPs and ASOPs, the CASTF letter suggests that the SOPs were more useful for regulators and non-actuaries. “[P]arties that are not closely affiliated with the CAS are challenged to search, read through and comprehend multiple ASOPs, which are often issue-specific. Much of the utility of the Ratemaking SOP was in its simplicity and focus; it applied to all aspects of actuarial ratemaking—a true principles statement—and provided value even if duplicative of certain parts of different ASOPs.”

The letter goes on to offer the example of someone testifying before a legislative committee or explaining a concept to a consumer, suggesting that “referring to multiple ASOPs risks the audience’s attention and comprehension as opposed to a singular SOP document that is credible, concise and understandable to a layperson.”

Identifying himself as a layperson during a public meeting of the task force Tuesday, a law professor said that the word “transparency” was missing from the back-and-forth between the CAS board and CASTF members. “The principles it seems can play a significant role [here]. Overall regulators, insurers and government entities are all being asked for much more transparency. The growing sophistication of risk models makes transparency even more difficult, and this seems to be a minor step back in terms of transparency” because the principles allowed “people who are not actuaries to have a better understanding of what the rules are.”

A carrier actuary offered a quick correction. “These aren’t rules. These are guidelines in the absence of rules,” he said, referring to the withdrawn principles.

They are not even “guidance,” according to the statement issued by the CAS announcing the rescission in December.

“While the Statements of Principles were intended to articulate common actuarial tenets and serve as foundations for the development of the Actuarial Standards of Practice, the Statements included several instances of standards-type concepts and language that could be perceived as practice guidance, which was never their intent,” the statement said. “In rescinding the Statements, the board also noted that the tenets of the Statements were not intended to be enforceable in actuarial discipline cases in the way that actuarial standards are referenced in the Code of Professional Conduct.”

The withdrawn SOP also notes the flexibility that actuaries have in ratemaking beyond the stated “principles.” “Since it is desirable to encourage experimentation and innovation in ratemaking, the actuary need not be completely bound by…precedents,” the SOP said, requiring, however, that material assumptions are disclosed. Elsewhere the rescinded SOP refers to considerations such as marketing goals and competition to the extent they affect estimate future costs of risk transfer.

What happens next?

During the CASTF meeting Tuesday, CAS President Jessica Leong welcomed the feedback letter from the regulatory task force. “I do want to say we take the concerns you’re expressing very seriously. We take the professionalism of our members very seriously as well,” she said. “Given a lot of the feedback that we have received to date, we are opening a more formal comment period that will last until March 15,” she said, noting that the board will consider all feedback provided during the comment period.

But it’s possible that the CAS board will decide not to reinstate the principles.

A representative of the CAS speaking at a February virtual CASTF meeting said that every U.S. state has “not excessive, not inadequate and not unfairly discriminatory” language in their regulatory statutes, but only three have direct reference to the statement of principles in laws or regulations.

Hunter recommended that if the rescinded principles are not reinstated, then the NAIC should create a bulletin for the states to delete references to “sound actuarial principles” in rate regulations and laws. During the February conference, task force actuaries also discussed the prospect of developing their own principles or adopting the rescinded principles themselves. Hunter suggested a Model Law to codify the principles in question. But none of the alternatives was discussed at Tuesday’s meeting.