Risk adjustment, medical inflation and management pressure

The CFO's request is earnings management, not actuarial judgement. The risk adjustment is meant to reflect the uncertainty in the fulfilment cash flows. Moving from the 75th to the 55th percentile may be legitimate if the entity's risk appetite and disclosure support it, but doing it to hit a covenant, without evidence, is not. The claim that 'most companies use the 55th' is irrelevant unless supported by the entity's own methodology and disclosure.

The sales request is more serious: omitting a known 12% medical inflation trend misstates the expected cost of the contract. If the account is won on a false assumption, the insurer will lose money and the actuary will have signed a misleading price. Competence and integrity require the best estimate to include known trends.

The junior analyst's point must not be ignored. A loss ratio that excludes late-reported claims is incomplete; the cut-off should be consistent with the reserving and reporting basis, and any known backlog should be estimated.

Response: document the requests and the reasons for refusing them; provide the CFO with the technical basis for the risk adjustment and the impact of a change; provide sales with a correct price and, if necessary, alternative options such as a higher excess or a lower commission. Escalate to the audit committee if pressure continues. The appointed actuary's statutory role and the profession's code of conduct require objectivity, transparency and a willingness to resign rather than sign a misleading statement.

The risk adjustment is the compensation the entity requires for bearing the uncertainty about the amount and timing of cash flows. There is no prescribed percentile; the entity selects a technique and confidence level consistent with its risk appetite and discloses it. A 75th percentile is not inherently right, but a move to 55% must be justified by a change in risk appetite, a change in the liability's variability, or evidence that the previous level was not calibrated. It must not be chosen to achieve a profit target.

Technically, estimate the distribution of the liability for incurred claims, including reserve risk, late reporting and large claims. Show the risk adjustment at several percentiles and explain the selection. The CSM is the unearned profit; changing the risk adjustment changes the CSM and the profit emergence, but it does not change the expected cash flows. The audit committee should see the effect on the liability, the CSM and the solvency ratio.

For the health contract, set the best-estimate medical inflation from credible data: provider tariffs, claims frequency, utilisation, benefit changes and the specific provider network. A 12% trend may be the portfolio estimate; if the contract's mix is different, adjust it, but do not delete it. Include it in the renewal price and show sensitivity. If the account is price-sensitive, reduce margin, change the benefit design or increase the excess; do not reduce the assumed trend. The junior analyst's cut-off issue should be quantified and included in the loss ratio.

Memo to the audit committee:

1. Risk adjustment. The CFO has requested a reduction from the 75th to the 55th percentile to increase CSM release ahead of a covenant test. I have not agreed. The current level is consistent with our disclosed methodology and risk appetite. I will provide the committee with the distribution of the liability and the impact of alternative percentiles, but I recommend no change unless there is an evidence-based reason. A change made to hit a covenant would be inconsistent with the accounting objective and with the profession's standards.
2. Group health renewal. Sales has asked that a known 12% medical inflation trend be omitted to retain the account. I have refused. The renewal price will include the best estimate of trend. If the account is loss-making at that price, management may decide to accept a lower margin, but the assumption must not be falsified. The account is 8% of GWP, so the decision is material.
3. Data. A junior analyst has identified that the loss ratio excludes claims reported after the quarter-end cut-off. I will quantify the backlog and reflect it in the reserving and pricing data. This is a data control issue, not a reason to delay the correction.
4. Solvency. The ratio is 1.55 against a 1.50 minimum and a 1.70 target. The gap should be addressed through capital, reinsurance or business actions, not through reserve or risk-adjustment changes.
5. Documentation and escalation. I will document the requests, my responses and the technical basis. If the pressure continues, I will ask the committee to minutedly support the actuarial position. I will also ensure the external auditor and, if necessary, the regulator are not misled.