Section 8 External Forces and Change
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Objectives
- Describe the changing nature of external forces.
- Explain how changes in external forces can lead to risk.
Change vs the Monitor the Results stage of the Control Cycle
- Whether an external force is cultural or governmental, economic or demographic, one characteristic of the force is constant—change. A change in external forces may invalidate old solutions or eliminate old problems, give rise to new problems and new solutions. Change should be looked upon as opportunity. With change comes the responsibility to monitor your results.
- Forces within people’s control also affect the daily considerations of actuaries. Read about the impact of obesity, diet, exercise, and diabetes on the health care costs to learn about how behaviors impact the economic considerations an actuary must have.
- m2s1-01_ChangingPatterns.pdf has a few actuaries' thoughts on recent legislative or regulatory changes that affect their areas of practice and how the change affects their work.
- Read about lessons learned from the subprime mortgage crisis. As you read, think about what changes financial institutions ought to make going forward and how actuaries may be able assist in this effort.
- As part of the Monitor the Results stage of the Control Cycle, actuaries must constantly monitor changes to external forces and be ready to respond. They must be prepared to recognize new problems. They must anticipate changes to existing solutions as well as be able to design and test new solutions to new or modified problems. If we expect change, then we are better able to manage its effects. For example, if an actuary developing an annuity product for a life insurance company understands mortality trends, the actuary is likely to include an assumption regarding mortality improvement as part of the pricing model. This will offset the effects that improved longevity will have on the insurer’s profits and, perhaps, even its solvency in the future.
- The role of the actuary faces continual change and we must look forward to anticipate new roles and responsibilities. Read here for one example of emerging need for actuarial insight (afn-2007-iss23-essaye.pdf). According to the reading, the following are reasons that actuaries are well-suited to analyze and manage business risks:
- Actuaries have quantitative skills beyond those of the typical business school graduate.
- Actuaries have had to pass a series of difficult exams.
- All major business risks require quantitative analysis in order to determine their effect on profitability.
- Actuaries have the ability to aggregate the information to produce a complete understanding of firm-wide risks.
- Potential roles for actuaries in enterprise risk management are
- Analysis and modeling of historical modeling of market prices
- Analysis of operational risk events
- Stochastic models that can estimate future risks
- Solutions to problems may have the unintended consequence of changing the external forces associated with the original problem. This is especially true with solutions that take advantage of tax laws or regulations. Consider U.S. tax laws that govern flexible spending accounts for health care expenses. One type of flexible spending account permits employees to elect to have a portion of their salaries set aside in a medical reimbursement account. The employees’ contributions to the account are not taxed, lowering the employee’s total expenses. The solution was designed to:
- Transfer more risk to the employee.
- Minimize the employee’s after tax expenses.
- Reduce the employer’s total health care expense.
- Permit the employee to spend the minimum (avoid paying for benefits that they would never use).
When this benefit first became popular, one method of administration permitted employees to declare fund contributions after incurring the expense and before the claim was paid. Using this method, employees avoided any risk that their contributions to the plan would exceed their medical claims in a year. The IRS quickly issued regulations, changed an external force, that required employees to declare their contributions before the beginning of each year, not separately for each pay period.
- Over time, societal attitudes about product safety have changed. Not long ago, individuals assumed personal responsibility when using a product, but they now demand that products be designed and manufactured to minimize injury. These demands often make our lives easier and safer. Consider the stickers now affixed to power lawn mowers warning users to keep hands and feet away from the blades. While taking responsibility for avoiding your own dismemberment might have once been considered a simple matter of common sense, lawn mower manufacturers are now considered liable for injuries if they fail to warn consumers. This change in cultural attitudes about product safety—and the resulting lawsuits—has created significant additional risk for manufacturers. It has also created new opportunities for actuaries to design insurance products. These new insurance products must anticipate the possibility of new sources of product liability resulting from creative new legal arguments for finding manufacturers at fault.
- The health practice area is constantly under pressure to develop new products to meet changing economic and government realities. Existing designs have failed to keep up with cost, quality or access. For example, increasing emphasis on the use of prescription drugs to treat a variety of medical conditions led the U.S. government to adopt new prescription drug benefits for retirees over the age of 65, effective in 2006. This in turn created a need for changes in employer-sponsored plans for retirees. Employers must decide if they should
- Continue providing prescription drug benefits for retirees eligible for Medicare?
- Modify current plans so that they are integrated with the Medicare benefit and encourage retirees to enroll in the Medicare benefit?
- Persuade eligible retirees to not enroll in the Medicare benefit, thus allowing the employer to receive a direct subsidy from the federal government toward the cost of the employer’s plan?
- You can remain up-to-date by reading business and industry publications, forward-thinking magazines and news reports. Attend to changes and developments in science and technology. Monitor legislative and regulatory activity. Continue your education in areas that provide information on changing forces.
- Identifying changes in external forces is an integral part of the actuary’s job. They can affect any stage in the Control Cycle but the effects are noticed most often when Monitoring the Results.