Managing Operational Risk in Financial Reporting

One of the many fields in which actuaries operate is financial reporting. Valuation actuaries experience numerous challenges when it comes to raising reserves and reporting on why financial results are different to business plan. As such actuaries have to be very confident with the reserves raised to ensure analysis of profit is reasonably accurate.

This article provides a short summary of some strategies which valuation actuaries can use to ensure an efficient control framework is in place to manage operational risk and as such improve management reporting. The examples included in this article are:

• Collaborative relationship with Operations team
• Maintaining up to date checklists
• Investing in Infrastructure

Operational risk can present itself in many ways when deriving policy liabilities. Some possibilities include:

• Poor data quality where information on certain key rating variables are missing and as such are having a material impact on the reserves. An example is cause of claim indicator (Accident/Sickness) missing for open disability income policies.
• Failure to update assumptions in line with recommendations from and as intended by Appointed Actuary.
• Delays in administration of new products in the valuation system and as such “approximating” the reserve which may not be in line with underlying mortality and morbidity rates.

There are several strategies which actuaries can use to resolve issues such as these and pave the way for faster and accurate reporting of financials. These include:

1 – Collaborative Relationship with the Operations Team

Operations team go through many challenges of their own in their roles. As such we cannot expect them to resolve all data issues in one go. It then becomes important to resolve the most material data issue and then building the solution in Business As Usual (BAU) culture. The discussions are best limited to one or maximum two data quality issues at any one time. Sufficient time should be set aside and the two teams should work together regularly to ensure the collaboration is leading to higher confidence in the accuracy of financials.

2 – Maintain up-to-date Checklists

Actuaries should regularly maintain detailed checklists which state all the tasks which are needed when raising reserves. This is the initiative which is regularly skipped over. However through adopting this process, a number of errors can be avoided (by even experienced professionals) if work is reviewed against an up-to-date checklist.

The checklist should ideally contain all the steps such as formatting of data, update of economic and non-economic assumptions, and checking reserves for a single policy against all the assumptions.

3 – Investing in Infrastructure

It is important to invest in infrastructure which helps with improving efficiency, reviews, and movement of reserves since the last financial reporting period. This initiative can be cost effective if improvements are made to existing processes on an ongoing basis.

A valuation infrastructure would include sourcing policy and claims data; modeling reserves; conducting analysis of profit; and management reporting. Potential improvements could involve any one of following:

• A data cleaning model which makes reasonable assumptions for missing data. Changes in characteristics of data since previous reporting period can help justify movement in reserves.
• Policy checks which demonstrate reserves have been calculated correctly against best estimate assumptions
• Developing reporting templates which allow for analysis of change against previous reporting period.

Models should allow for analysis at a granular level. This helps with troubleshooting problems or answering detailed questions from management.

Actuaries can try to integrate one or two strategies in day to day tasks and team culture. Sound management of operational risk would lead to higher confidence in the financials; more time being spent on analysis; and easier communication of results with the wider business.

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