Section 5 Governmental Influences
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Objectives
- Describe governmental influences.
- Describe the application of governmental influences across and within traditional areas of actuarial practice.
- Explain the effects of governmental influences on the Define the Problem and Design the Solution stages of the Control Cycle.
Definition and examples
- Government programs, legislation and regulations are continually under review and revision, e.g., egulations on insurance rates and profit margins and laws in response to accounting scandals and under-funded pension plans are constantly evolving.
- Governmental factors drive employers’ actions. For example, U.S. employers satisfy the compulsory workers’ compensation law by obtaining private insurance, by self-insuring or by using a state workers’ compensation fund.
- Governmental influences also drive the emergence of new areas of focus for business. For example, regulations related to capital adequacy requirements for banks, insurance companies and the energy sector are likely drivers of new developments in Enterprise Risk Management (ERM).
- Governments can provide security benefit programs such as public pensions, disability pensions, health insurance, sickness benefits, unemployment benefits and benefits for workers injured on the job, involving actuaries..
- The term “governmental influences” is broad. It encompasses all levels of government, including national, state or provincial, local and even international. It includes actions taken by legislative, executive and judicial functions, such as legislation, regulation and court decisions.
- Governmental influences affect actuaries in all areas of practice in diverse ways:
- Actuaries educate clients and employers about the effect of regulation on the design of products or plans.
- Actuaries work on both government-funded and private programs.
- Some laws, regulations or contracts require a task to be performed by an actuary because a qualified actuary’s credentials show competence for the task.
- Governmental influences sometimes limit the range of possible actuarial solutions.
- Governmental influences extend to accounting requirements. The actuary must be aware of the differences between accounting results and results used for the purpose of determining cash requirements.
- Rules and regulations influence core actuarial functions, such as the valuation of assets and liabilities of a financial program.
- Self-regulated organizations, including professional organizations such as the Society of Actuaries, represent a form of regulation.
- Governmental influences link to the other external forces, e.g, the cultural/social values category of external forces:
- Cultures influence how governments are structured.
- Government provides for citizens’ needs. When a need affects all or a majority of people, the government will virtually always have a role in helping to create solutions.
- Acceptance of and resistance to government intervention is a reflection of cultural/social values. e.g. seat belt laws, which affect insurance rates.•The availability and extent of government coverage (social insurance, for example) is in response to cultural/social values.
- Historical aspects of a country, including government, are a part of culture.
- Government policy reflects the values of society. For example, regulations that apply to health care are based on what the society values.
- Public officials (such as regulators) should reflect the values of their constituencies.
- The degree of regulation is a social decision.
- Anti-discrimination laws affect product development and plan design.
- Government regulation giving tax-preferred status to annuity products, for example, affects the market for life insurance.
- Read m2s5-01_ExpertSocVal.pdf for interaction between social values and governmental influences.
- Changes in family structure, demographics, employment patterns, and other socio-economic drivers significantly affect political systems and government support systems. Read the article (link out of date http://www.ippsr.msu.edu/publications/ARDemographic.pdf) to see how demographics play a significant role in public policy and economics.
- In Understanding Actuarial Management (2010), read Sections 5.3 and 5.4, pages 111–113. These sections present a high-level overview of the regulatory context, government policy, taxation, political and judicial decisions, social assistance and insurance.
- Judicial rulings can affect actuarial work by:
- Decisions on the amount of damages payable
- Interpreting how new legislation will work
- Interpreting the wording of an insurance policy
- The reading recommends paying attention to, or monitoring, pending legislation and government policy as well as the platforms of political parties that are not currently in power.
- Governments affect citizens and actuaries in a variety of ways. For example, legislation passed by the government might require changes to products designed by actuaries. Judges’ rulings can change the interpretation of an existing law. Actuaries need to monitor existing and pending laws to make sure that products are lawful and also meet the requirements of customers.
Regulation
- Concerning laws and rules that govern financial services industries.
- Applies to all actuaries, regardless of area of practice. E.g., fFinancial institutions are often regulated by government. Laws and rules govern the insurance industry and products. Federal, provincial and regional legislation regulate pension plans and the banks and trust companies that hold these funds.
- In Understanding Actuarial Management (2010), read Chapter 7, pages 177–196. This chapter provides an overview of the regulatory environment.
- The Basel Committee’s Core Principles of Banking Supervision addresses requirements and preconditions of “effective supervision of banks in a jurisdiction.” The Basel Committee also documents the Capital Accord, which “sets out a uniform approach to capital requirement for banks.”
- Read Chapter 14 through Section 14.4.1 in Understanding Actuarial Practice (2012). This reading discusses the nature of regulations and their effect on life insurance companies and products.
- The two most important goals of insurance company regulation are: (Select all that apply.)
- Guarding against the bankruptcy of insurance companies.
- Ensuring insurers conduct their business ethically and fairly.
Taxation
- Concerning the system to raise revenues for governments.
- Tax laws have a direct effect on the profitability of private corporations and an indirect effect on the design of insurance and pension products.
- Tax laws in both the United States and Canada are updated frequently to reflect change, sometimes as the result of perceived abuses of the tax laws in those countries.
- The following reading outlines the basic principles and practices of the taxation of income of individuals and corporations. Note that the latest update was in 2000 and that many changes have taken place since even then. Read chapters I through III to page 20 of “Principles of Taxation” (m2s5-05_SN5-23-00.pdf).
- Key points regarding taxation include:
- The primary purpose of taxation is to raise revenue for governments. Secondary purposes are to:
- Use taxes to manage the economy (for example, during a recession or economic slowdown, tax rates are cut to encourage consumption expenditures by individuals and to encourage business investment by corporations).
- Contribute to the social good by redistributing income from the more affluent to the less affluent (such as a progressive income tax system).
- Income tax laws have become extremely complex and over-burdened with a vast array of deferrals, deductions, exemptions and credits.
- In Canada, with the exception of the province of Quebec, individuals and corporations alike usually file a single combined federal/provincial tax return.
- The U.S. Tax Reform Act and Canadian Tax Reform were enacted to improve fairness.
- Taxable income is generally defined as gross income less the sum of deductions (in the United States) or credits (in Canada) such as business expenses, support of dependents, contributions to charities or to savings plans, medical expenses, certain education costs, moving expenses (related to change in place of employment), U.S. state and local property and income taxes, etc. Deductions may be subject to limitations and restrictions.
- Accounting practices for financial statements differ from accounting for taxation purposes.
- Income and dividend taxation varies by income production unit (for example, individual, partnerships, small corporations, trusts, investment conduits and corporations).
Contract law
- Laws enforcing an agreement between two or more parties.
- Lawyerly definition: Contracts are promises that the law will enforce. The law provides remedies if a promise is breached and recognizes the performance of a promise as a duty. Contracts arise when a duty does or may come into existence, because of a promise made by one of the parties. To be legally binding as a contract, a promise must be exchanged for adequate consideration. Adequate consideration is a benefit or detriment that a party receives which reasonably and fairly induces them to make the promise/contract. For example, promises that are purely gifts are not considered enforceable because the personal satisfaction the grantor of the promise may receive from the act of giving is normally not considered adequate consideration. Certain promises that are not considered contracts may, in limited circumstances, be enforced if one party has relied to his detriment on the assurances of the other party.
- In short, to be valid, a contract requires a promise; a duty now or in the future; and adequate consideration. It does not require governmental approval or a written document.
- For actuaries, among the most important contractual arrangements is the insurance policy, which is a contract that has been offered by the company and agreed to by the policyholder. Insurance provisions are governed by the contract language. If there are ambiguities that lead to a conflict or a lawsuit, it is possible that any ambiguities will be judged in favor of the policyholder since the holder had no role in drafting the insurance policy. In many companies, actuaries are part of the team that is asked to review the contract before it is filed with the regulatory body.
- Other contracts important to actuaries include agents’ commission arrangements, licensing contracts for commercial financial projection software and others. We are not lawyers and won’t be asked to provide legal advice, but we have an obligation to understand pertinent contractual provisions and help our companies express themselves clearly and accurately in areas where we have specific knowledge.
Trust law
- Laws regarding property owned by one person (the trustee) for the benefit of another (the beneficiary).
- A trust is responsible for paying benefits of a retirement plan; that is, it is a funding agency for a plan. A trust may be defined as property managed by one person, known as the trustee, for the benefit of another, known as the beneficiary. The trustee is typically a corporate trustee (e.g. a bank or trust company) responsible for investing and paying benefits or making funds available to the plan sponsor. The agreement between trustee and plan sponsor is subject to trust law. This differs from plans arranged through an insurance contract in that an insurance contract does not need to (but can) be held in trust.
- If a pension plan is held in a multiemployer trust, it may be more difficult to make necessary changes to plan provisions since there are more parties to consider. There are also times when a life insurance contract is owned by a trust for tax and other reasons.
- In a retirement plan, fiduciaries manage the retirement plan and its assets that are held in a trust fund. Laws define fiduciary responsibilities. Although there are exceptions, the trustee’s general responsibilities include loyalty, care, diversification of plan assets, impartiality, adherence to statutory constraints, advancement of property productivity and acting in accordance with the trust agreement. Trust law has evolved over the years and now is based on the prudent investor rule that focuses on the investment portfolio rather than on individual investments.
Accounting standards
- Statutory accounting practices and generally accepted accounting principles for financial reporting.
- Read Governmental Influences: Accounting (m2s5-07_Accounting.pdf) to learn more.
Government influences vs the Control Cycle
- Read m2s5-08_AskLifeActuary.pdf about influences on life insurance industry.
- Read m2s5-09_AskRetireBenActuary.pdf about influences on retirement industry.
- For example, these governmental actions may affect health actuaries:
- Limit the tax deductibility of health insurance premiums paid by employers.
- Expand the benefits under the Medicare system.
- Increase taxes on the profits of health insurance companies.
- Limit the use of some types of individual medical information in underwriting health insurance policies.
- Require all employers to provide health insurance to full-time employees.
- In finance, Investment and ERM, there are varying reasons for, and degrees of, regulation. Note that the degree of regulation is a social decision, which means that regulation has social underpinnings. Regulations are imposed to achieve these objectives:
- Safety of principal.
- Stability of value.
- Sufficient liquidity.
- Appropriate diversification.
- Reasonable relationship between assets and liabilities.
- The tax structure is one of the most critical areas that actuaries working in finance, investment and ERM must consider when determining portfolio holdings. For instance, capital gains are generally taxed less than ordinary interest income in the United States. Similarly, investments in municipal bonds may enjoy the benefits of reduced taxation. Actuaries must reflect these and other tax-related considerations when producing a portfolio that performs optimally on an after-tax basis. Read Governmental Influences and Finance, Investment and ERM (m2s5-10_F_I_ERM.pdf) to learn about how regulation, taxation and other topics important to actuaries practicing in finance, investment and ERM and how they affect potential solutions.
- According to the reading:
- In the United States, the Sarbanes-Oxley Act of 2002 is designed to reduce fraud and is a result of the collapse of Enron.
- Under ERISA in the United States, investment managers are under specific mandate to diversify plan assets to avoid large losses.
- Increases in the money supply lower short-term interest rates, ultimately encouraging investment and consumption demand.
- The advent of Keynesian economics brought about the recognition that the income tax is an exceptionally powerful tool to be used in the management of the economy.
- Fiduciary liability exists for those who manage financial affairs of others because the society believes those who do so have special responsibilities.
- An extended period of interest-rate increases can hinder the bond market performance, especially if these changes to short-term rates ripple through to longer-term rates.
- Other key points of the reading:
- Actuaries must be familiar with regulations that restrict the types of and amounts of permitted investments.
- It is important to remain current on fiscal and monetary policies because they may create advantages and/or disadvantages for insurance products and pension plans.
- Actuaries should be thoroughly familiar with governmental regulatory bodies that are responsible for overseeing the industries in which we practice.
- In the United States, the Sarbanes-Oxley Act of 2002 is causing actuaries to exercise more care and due diligence in performing many of our daily work activities.
- Tax policy has a substantial effect on insurance and pension products. Actuaries must be completely up-to-date in this area.
- In the health practice area. The government has the following effects
- The effect on the economy drives the types of health products available.
- The government affects businesses as well as individuals and, in turn, affects the health practice area.
- Government tax policy on business may encourage or discourage employers from providing health benefits to their employees and dependents. Indeed, in a few jurisdictions (Hawaii, for example), employers may be required to provide health benefits to their employees.
- Tax policy may also encourage individuals to purchase health benefits.
- The availability of social insurance programs through the government affects the type of insurance individuals will purchase through private companies.
- The government philosophy on providing social benefits to its citizens also affects the types of benefits offered in health insurance products. Medicare and workers’ compensation provide certain health benefits to citizens. The level of these benefits sometimes encourages individuals to supplement their disability and health benefits to provide complete coverage.
- Review Section 29.4 in Understanding Actuarial Practice (2012).
- In the United States, states do not allow discrimination in insurance eligibility/coverage on the basis of race, gender, age or disability.
- Mandated benefits affect health actuaries; in the United States, states may require coverage for a type of procedure or service.
- In the United States, solvency is monitored by state insurance departments with NIAC guidance.
- Other key points from the reading are:
- In Canada, the federal and provincial governments share in the regulation of insurance. In the United States, federal and state regulation affects the health benefit marketplace at various levels.
- Tax policy on health providers and health products affects their design. Favorable tax treatment of some health products makes them more attractive.
- The government is a provider of health care (at some level) in most countries.
- Government, as a very large employer, has a role in affecting the health benefit market by the types of benefits it offers to its employees.
- For the retirement industry, knowledge of legislation and regulations affecting pension plans is critical to an actuary’s ability to serve as an adviser to plans and their sponsors. Any retirement program that the actuary designs has to satisfy regulatory requirements. Read Section 22.4 of Understanding Actuarial Practice (2012) for more insight to the impact of tax laws on employer sponsored pension programs.
- Key points from reading:
- Knowledge of legislation and regulations affecting pension plans is critical to an actuary’s ability to serve as an adviser to plans and their sponsors.
- Using their tax systems, many countries encourage employers to provide private pensions for their workers and to encourage individuals to save for retirement.
- In the United States, ERISA made fundamental changes in the U.S. retirement system in the areas of reporting and disclosure, participation and vesting, funding, fiduciary responsibility and administration and enforcement.
- Social security programs provide retirement income to the broadest group of any of the retirement income sources. Benefits are generally determined based on a blend of social adequacy and individual equity.
- In the area of casualty insurance, governmental influences on casualty insurance are quite similar to influences that government has on life and health insurance. The major area of difference is rate regulation. Rate regulation directly affects the products designed or priced by the actuary. Read Governmental Influences: Property and Casualty (m2s5-13_PCinsurance.pdf) to learn more.
- Casualty insurance is a term whose meaning can vary by user and context. For example, casualty insurance may be used to refer to all insurance that is not related to life insurance, health insurance, or property insurance, or the term may refer to specific insurances. In this module a broader meaning of the term, casualty insurance, is used that includes both property insurance and liability insurance. In some countries, such as Australia, the term ‘general insurance’ is used to denote insurance that includes both property insurance and liability insurance.
- One of the most important governmental influences involves tax policy.
- For health actuaries: The favorable tax treatment of some health insurance coverage helps actuaries decide the types of health products that will be attractive to customers and should be offered.
- For investment actuaries: All tax-related considerations (such as rates and rules for capital gains and ordinary income) must be reflected by actuaries when analyzing potential portfolios that perform optimally on an after-tax basis.
- For life actuaries: In the United States, actuaries must thoroughly understand the tax code and associated regulations regarding the relationship of premiums to benefits to ensure the policies they design enjoy available tax advantages.
- For retirement benefits actuaries: Actuaries must know how the tax system is used to encourage employers to provide private pensions for their workers and to encourage individuals to save for retirement.
- One of the difficulties for actuaries is that government action is subject to many non-financial factors. Government policies often change in response to shifts in cultural and social values. Government policies also change as economic and business environments change. Government can use its most powerful tools (such as tax policy) to influence social policy.
- Read Chapter 18 of Understanding Actuarial Practice (2012) to get an overview of how regulations affect the design, pricing, and reserving of life insurance and annuity products.
- Learn more about retirement benefits, and specifically about ERISA, the IRS, the Employee Benefits Security Administration and the Pension Benefit Guaranty Corporation, consider visiting the Web sites listed here:
- The Government Accountability Office (GAO) has a document a9d02745sp.pdf) with a lot of information about ERISA.
- Follow this link http://www.irs.gov/retirement/article/0,,id=103022,00.html (not active) to learn more about the IRS’s role with respect to ERISA.
- Learn more about EBSA. This page is at the official Department of Labor Web site and provides a brief summary of the historical background and the administrative responsibilities of the EBSA with respect to retirement plans.
- Learn about the history of the PBGC. This page is at the official PBGC Web site. It contains the mission statement of the PBGC and some statistical figures reflecting the agency’s work.