Private Long-Term Care Insurance Celebrating 25 Years in Actuarial Recruitment

AMERICAN ACADEMY OF ACTUARIES ■ MAY | JUN ■ 2015

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| www.dwsimpson.com | (800) 837-8338 | [email protected] THESE JOBS AND MANY MORE CAN BE FOUND AT EzraPenland.com ■ MAY | JUN ■ 2015 Features Contents COVER ILLUSTRATION: JIM SALVATI

Past, Present, Future Private Long-Term Care Insurance 18 The industry is in a state of contraction … but LTCI can still be a vital part of private coverage options. By Paul E. Forte

The Connection Between Military & Business Strategies 28 A Brief History of Business Strategy How the precepts of military strategy have been applied—and misapplied—to business contexts. By Carlos Fuentes and Tom Maki

Look to the North for a Better Medicaid and the ACA Approach to Financing Social The sweeping health care reform 36 Security 40 means some big changes for home and Canada may have a blueprint for how community-based services—and who’s we can fund this important social eligible to receive them. insurance program. By Robert M. Damler and Marlene T. Howard By Ken Steiner

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INSIDE TRACK ��6 Musings on Time Published by Eric P. Harding

PRESIDENT’S MESSAGE ��8 Academy’s Aging Initiative Tackles Big Problems of the Day Mary D. Miller PRESIDENT Mary D. Miller

ACADEMY INSIGHTS ��10 EXECUTIVE DIRECTOR Past Is Prologue: Self-regulation and Its Mary Downs

Immeasurable Value for the Future DIRECTOR OF COMMUNICATIONS Mary D. Miller, Tom Terry, and Tom Wildsmith David J. Nolan UP TO CODE �� 14 EDITOR Why an Actuary Must/Should Read ASOP No. 1 Eric P. Harding Allan W. Ryan PUBLICATIONS & MARKETING PRODUCTION MANAGER Laurie Young

SPECIAL SECTION ��44 ADVERTISING 2015 Software Mohanna Sales Representatives Showcase (972) 596-8777

DEPARTMENT EDITORS WORKSHOP ��46 Thomas L. Bakos ACA and More— Sam Gutterman Health Care Reform Robert J. Rietz in 2015 Lenny Shteyman Cathy Murphy-Barron Tom Toce PUBLICATION DESIGN & PRODUCTION BonoTom Studio Inc. www.bonotom.com

TRADECRAFT �� 50 COMMUNICATIONS REVIEW COMMITTEE Actuarial Managed John Moore, Chairperson Services: Business Case Shawna Ackerman and Leading Practices Mary Bahna-Nolan Eli Greenblum Dave Czernicki, William Hines Kush Kotecha, Kenneth Kent and Dave Consentino Mary D. Miller Catherine Murphy-Barron BOOKLINKS �� 56 Arthur Panighetti Models at Work Thomas Terry Thomas Wildsmith By Jawwad Farid Review by David Ingram INTERNET ADDRESS www.contingencies.org CRYPTIC PUZZLE �� 60 Contingencies (ISSN 1048-9851) is published bimonthly by the American Der German Lesson Academy of Actuaries, 1850 M Street, NW, Suite 300, Washington, DC Created by Jerry Levy 20036-5805. For subscription information and customer service, con- Edited by Tom Toce tact the Contingencies subscription department at the address above or (202) 223-8196. Advertising offices: Mohanna Sales Represen- PUZZLES �� tatives, (972) 596-8777, [email protected]. Periodicals postage 62 paid at Washington, DC, and at additional mailing offices. Goodbye. See You Later! Copyright 2015. All rights reserved. This magazine may not be reproduced in whole or in part without written permission of the Lenny Shteyman publisher. Opinions expressed in signed articles are those of the authors and do not necessarily reflect official policy of the American Academy END PAPER ��64 of Actuaries. Cabin Fever Postmaster: Please send change-of-address notices for Contingencies Bob Rietz to Contingencies, PO Box 16976, North Hollywood, CA 91615-6976.

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Musings on Time

I JUST HAD A BIRTHDAY. I mention this not to solicit belated well-wishes (thank you all the same), but rather to explain my current contemplative mood. I find myself meditating on time—how it passes, how we perceive it (or don’t), and the uniquely relative nature of that slippery commodity.

That last point comes up frequently. My 4¾-year-old son al- to fix the problem, and our neighbors to the north may have ready has a well-defined lens through which he examines time. some ideas about how to do so. Ten minutes to clean his room, or else he loses his Legos for a Our aging population requires a clear-eyed examination of day? “That’s too quick!” Ten minutes until we leave for the zoo? how we’re going to care for those in need. In “Medicaid and the “But that’s so looong!” ACA” (Page 40), Robert Damler and Marlene Howard consider I had something of an epiphany when he asked when his a Medicaid provision in the Affordable Care Act that could mean birthday was, and why it was “still so far away.” When we’re 4 big changes for home and community-based care services, and years old, 1 year is 25 percent of life as we have perceived it—so who’s eligible to receive them. The feature illustrates how one the time until our next birthday seems interminable. Add a zero state chose to move forward under the new provision, offering to that achieved age and the percentage of life lived is much useful findings that other states can consider as they address smaller … which helps explain why time seems to speed up as their unique needs. we grow older. And finally, in his second feature on business strategy, “The Time is certainly a central theme in our cover story. In “Past, Connection Between Military & Business Strategies” (Page 28), Present, Future” (Page 18), Paul Forte investigates the private Carlos Fuentes and Tom Maki examines how the precepts of long-term care insurance marketplace—from its inception in military strategy have been applied—and misapplied—to business the 1960s, to its heyday in the mid-‘90s, to the tightening of the contexts. In their zeal to satisfy a nascent demand, business con- market today … and what of tomorrow? Forte argues that pri- sultants reached for tried-and-true military precepts from history vate LTCI remains a vital part of many coverage options and and adapted them to the contemporary workplace, with mixed suggests methods for making them sustainable for issuers and results. But that doesn’t mean military strategy has no analogue in policyholders alike. the business space, Fuentes argues—just that the strategic thinker And as time moves inexorably forward, and as more Baby needs to consider specific challenges when doing so. Boomers enter retirement, thoughtful approaches to financing This issue we say farewell to one of our puzzlers. Lenny our social insurance programs become ever more critical. In his Shteyman has delighted us with his puzzles for more than two feature, “Look to the North for a Better Approach to Financ- years. I thank him for services—and for his help in finding his ing Social Security” (Page 36), Ken Steiner lays out the problem replacements, who begin next issue. ahead—if we don’t address the looming funding shortfall, Social And thank you for reading Contingencies. I hope you find it Security faces insolvency. But, Steiner, notes, we still have time time well spent.

Editor’s note: Due to an editing error, the Up to Code article in the March/April issue of Contingencies erroneously suggested that a directory listing of an actuarial association is sufficient to indicate compliance with continuing education requirements for signing statements of actuarial opinion, and that the ABCD can recommend public reprimand to the Joint Disciplinary Council. Neither is the case. A corrected version online clarifies these points. We regret the error.

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Size 8.125” w X 10.875 H- .125” bleed - set up as 4 color ﬁ le: ARM-15-06425-P1-L&H_Contingencies_Mag-3-31 Publication date: May/June 2015 President’s Message MARY D. MILLER

Academy’s Aging Initiative Tackles Big Problems of the Day

“You are not defined by your past. You are prepared by your past.” —Unknown

WE COULD EASILY IMAGINE the unknown author of this simple truth to be an actuary. From a psy- chological perspective, the past is a memory that is retrieved in the present, and the future is a cognition made from one’s current vantage point in time. While we personally experience things from the position of “now,” the future and the risks it holds are very real—the fact of which we, as actuaries, are keenly aware and prepared to address.

In addition to our individual practice, much of our work ■■ Raising awareness of lifetime income options. Our ongoing through the Academy centers on informing others who are Lifetime Income initiative provides support for this part of responsible for developing public policy about patterns of the the aging initiative aimed at increasing retirement security past and the risks they suggest for the future. The costs of not for Americans. accounting for those risks can be high. No one wants to outlive ■■ Recognizing the effect of changing demographics on key pub- his or her income or be the subject of a security breach that lic programs like Social Security and Medicare and taking compromises sensitive personal data. Actuaries of every practice necessary steps to ensure they are sustainable. RiskAgility FM area can provide plentiful, detailed examples of such risks, and ■■ Exploring solutions to provide for affordable long-term care the Academy is routinely called upon by policymakers to do so. financing, and addressing caregiver needs and concerns Your business. Your models. Your way. The passage of time affects everyone. The signs of aging sur- through public and/or private programs. round us, ranging from physical changes in a bridge you cross ■■ Assessing the ability of Medicare and other public and private to get to work, to intangible changes in the value of personal or programs to meet the health needs of older Americans and company financial assets, to changes in one’s own body. We all those with disabilities. see the effects of aging, but the risks that emerge in aging sys- ■■ Towers Watson RiskAgility FM is a new financial modeling software product that helps you manage risk and tems can be more obscure. Some risks are clear-cut and obvious, Evaluating and addressing the risk of retirement-income sys- safeguard solvency in a powerful new way. Your way. such as a loss in asset value, but others are much less so - the tems not providing expected income into old age, especially in light of increasing longevity. The Academy’s Retirement for slow decay of an unmaintained bridge, or imperceptibly pro- RiskAgility FM enables life insurers to run financial models that accurately reflect their companies’ products and to run them in the AGES initiative will support this effort through the release gressive loss of bone or muscle in an aging body. ways that are easily adapted to their business processes. Aging is a universal and accessible phenomenon, and therefore of a second round of grades of private and public retirement a good springboard for discussing risks with others. It is hard to systems, and public policy proposals. Models built with Towers Watson MoSes financial modeling software can be imported into RiskAgility FM, and our U.S. Library imagine a single theme that more effectively allows us to engage ■■ Framing these issues together is an effective way to raise aware- offers a number of applications for RiskAgility FM to give you a quick start in modeling common product types. broadly in public policy discussions about how to address risks ness of the Academy’s work in these critical areas, especially The open modeling environment supports accurate calculations for your products today and in the future, as product designs, in the public interest. The Academy’s aging initiative provides a as policymakers’ attention is turned toward aging issues dur- company practices and regulatory requirements evolve. single umbrella under which to inform the public, policymakers, ing the ongoing, decennial White House Conference on Aging. and other stakeholders of the Academy’s compendium of work on Our world, present and future, is full of risk. It is important RiskAgility FM is built with the latest software technology for enhanced performance and ease of use. The software will be significant societal challenges. Those challenges include: that we share our knowledge so policymakers can develop so- available in Desktop, Team and Enterprise editions. ■■ Recognizing the risks posed by the deterioration of an aging lutions to mitigate risk from a position of being fully informed. Let us show you how RiskAgility FM can dramatically improve your company’s financial modeling so you can run your business physical infrastructure, including preventable property and Through our aging initiative, the Academy is committed to better. Email [email protected], or visit towerswatson.com/riskagilityfm for more information. casualty losses. that task.

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8 CONTINGENCIES MAY | JUN.15 RiskAgility FM Your business. Your models. Your way.

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RiskAgility FM enables life insurers to run financial models that accurately reflect their companies’ products and to run them in ways that are easily adapted to their business processes. Models built with Towers Watson MoSes financial modeling software can be imported into RiskAgility FM, and our U.S. Library offers a number of applications for RiskAgility FM to give you a quick start in modeling common product types. The open modeling environment supports accurate calculations for your products today and in the future, as product designs, company practices and regulatory requirements evolve. RiskAgility FM is built with the latest software technology for enhanced performance and ease of use. The software will be available in Desktop, Team and Enterprise editions. Let us show you how RiskAgility FM can dramatically improve your company’s financial modeling so you can run your business better. Email [email protected], or visit towerswatson.com/riskagilityfm for more information.

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Benefits Risk and Financial Services Talent and Rewards Exchange Solutions towerswatson.com MARY D. MILLER, Academy President; TOM TERRY, Immediate Past President; Academy InSights and TOM WILDSMITH, President-Elect option c: 50th anniversary lock-up with current logo

Past Is Prologue: Self-regulation and Its Immeasurable Value for the Future

CELEBRATING YEARS

THE AMERICAN ACADEMY OF ACTUARIES was established in 1965 in response to a very specific need. The U.S. profession lacked a process for dealing with professional misconduct by members of the various then-existing actuarial organizations. Quoting from Henry Rood, the first president of the Academy, Early History of the Academy

“The first step really came about in organizations worked separately to ad- Information on the early history of 1954 when a complaint of unprofes- dress these professionalism concerns the Academy is taken from American sional conduct was lodged by one and create a public recognition of the Academy of Actuaries: Historical member of the Society [of Actuar- actuarial “profession” in the United Notes for the Period Prior to October ies] against another. Lawyers who States, a common goal emerged to create 25, 1965, compiled in 1986 by Walter page 1 © point five design were consulted indicated that our a new organization to undertake defin- L. Rugland, Sr. This publication is constitution was weak and that overt ing professionalism and achieving the available on the Academy’s website. action by the board might subject sought-after professional status. It provides a detailed account of the accuser and all board members Representatives of the major U.S.- the events leading up to the forma- to legal claims for damages.”1 based actuarial organizations and the tion of the Academy, and includes Over the course of a decade of dedi- Canadian Association of Actuaries came extensive quotations from original cated effort, the small group of leaders of together in 1963 “informally and not by source documents dating from that the various actuarial educational and fra- official action of the governing boards of ternal societies began to recognize that the organizations. … Out of this meeting time. Mr. Rugland opens a window while excellence in quantitative skills came the real beginning of a new orga- on the process, allowing the reader was necessary, it was not sufficient for ac- nization of actuaries designed to unite to see into the deliberations of the tuaries to be recognized as a “profession” the actuarial profession in the United actuarial leaders of the past as they laid with the credibility and status afforded States” (emphasis added). At the meet- the foundations of a professionalism professions in the United States. High ing, the participants agreed to develop infrastructure that continues to serve standards of competence, qualifications, “plans for creating a national associa- the U.S. actuarial profession today. and conduct, as well as an enforcement tion of actuaries, membership in which mechanism, began to emerge as a com- would constitute qualification for … ac- mon concern and a common goal for creditation” (emphasis added).2 for the new organization to take over the developing U.S. actuarial profession The participants in that 1963 meeting the functions of the existing actuari- scattered in allegiances to various educa- adopted a statement that the proposed al organizations, except for the three tional and fraternal societies. association would address: points mentioned…”3 John H. Miller was one of the pro- ■■ establishment and maintenance of Thus was born the American Acad- fession’s leaders whose efforts led to the adequate professional standards emy of Actuaries. The three principles Academy’s founding (he later served as of actuarial practice to insure the that the Academy was established to the Academy’s third president). He protection of the public’s interest; address have consistently remained summarized the early leadership’s the core of the American Academy of ■■ establishment and enforcement of a professionalism concerns as a basis of Actuaries’ mission for 50 years. Formal- code of professional conduct; and establishing the Academy. At that time, izing the pursuit of these principles in it became clear among the diverse actu- ■■ conduction of a public relations the Academy provided a framework to arial organizations that “any attempt … program. identify and unify, across all practice to process alone in the pursuit of govern- “It might be pointed out that no- areas, the professional standards and ment accreditation would be ill advised where was there any idea of merging disciplinary infrastructure necessary for and probably fruitless.” As the various old organizations into a new one, or authentic and credible self-regulation

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and made clear that actuaries are part of a “profession.” This infrastructure was formally established through the Acad- Given today’s scrutiny of emy’s bylaws. It has evolved over time to keep pace with the growing needs of the profession—whether by the profession. This evolution includes media reports of actuarial the establishment of the Actuarial Stan- work on public pension plans, dards Board (ASB), the Actuarial Board for Counseling and Discipline (ABCD), or on insurance issues, or the Committee on Qualifications, and from regulators seeking the Joint Committee that drafted the assurances that the Academy Code of Professional Conduct that was finally adopted by the boards of each of is addressing actuarial the U.S.-based actuarial organizations qualifications—the profession and continues to monitor and preserve a needs the Academy’s focus single Code for the profession. This professionalism structure is on preserving the reputation necessary for actuaries to be, and to be and high standards of the recognized as, a learned profession (with actuarial profession. attributes similar to other recognized professions, including a code of conduct, threshold qualification, and technical practice standards). Everyone knows that actuaries who achieve associateship and fellowship through rigorous testing are extremely gifted with quantitative skills. But a learned profession demands more. Acting ethically and understanding the nu- ances presented by challenging situations are not quantitative skills. But they are the established half a century ago, to estab- members of the profession as viewed essential elements necessary to uphold lish norms of professional conduct and by the other U.S.-based actuarial orga- the reputation of the actuarial profession provide a means to require adherence to nizations on the one hand, and the need and produce the public trust that justifies them, has been thoroughly examined and and goal to safeguard the public on the and allows us to regulate ourselves. This strongly upheld. other hand. Today more than ever, that Academy framework, long independent of Every U.S. actuary should celebrate balance, free of potentially conflict- special interests, allows the excellence of that outcome. The will and ability of ing self-interested goals, is needed and each individual actuary’s work to accrue to the actuarial profession to address the visible in the work of the Academy. A the profession as a whole and the credibil- ethical behavior of its members, simply well-designed regime of self-regulation ity of the profession as a whole to accrue because they are actuaries committed maximizes the benefits of collective wis- to the individual actuary. to a Code of Professional Conduct, has dom to the public, the profession, and its The validity of the profession’s self- been affirmed as a good and valid pro- individual members, and assures a fu- regulatory discipline process has recently cess. Given today’s scrutiny of the ture where actuaries understand what been tested. In a lawsuit filed against the profession—whether by media reports of it means to act as a profession and fulfill Academy in Cook County, Illinois—the actuarial work on public pension plans, the responsibilities they undertake to the state of the Academy’s incorporation or on insurance issues, or from regulators public, their clients, their employers and nearly 50 years ago—the profession’s seeking assurances that the Academy is to the actuarial profession. discipline process was fundamentally addressing actuarial qualifications—the challenged. The court found no merit in profession needs the Academy’s focus on Endnotes that challenge. The Illinois court’s dis- preserving the reputation and high stan- 1Walter L. Rugland, Sr., American Academy of Actuaries: Historical Notes for the Period Prior to missal of the claim against the discipline dards of the actuarial profession. October 25, 1965, American Academy of Actuaries, process housed at the Academy con- In establishing the Academy 50 years Washington, D.C. June, 1986, p. 1. firms the strength of that process. This ago, the founders sought a balance be- 2Rugland, p. 7. 3Rugland, p. 7. means that the structure envisioned and tween the interests of the individual ISTOCKPHOTO

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Why an Actuary Must/Should Read ASOP No. 1

IN THE NOVEMBER/DECEMBER 2014 edition of Contingencies, the ASOPs to the deviation provisions of an article by fellow ABCD member Kathy Riley appeared in this de- ASOP No. 41, Actuarial Communications, in accordance with the ASB’s project to partment. That article, in the context of a situation involving a multi- standardize the ‘deviation’ provisions in employer pension plan, discussed the importance of the terms “must/ all ASOPs.” Unlike the previous versions should” and “may,” as used in actuarial standards of practice (ASOPs), of the Introduction, this new document the implications with respect to deviation from the guidance of an was labeled as an ASOP, making clear the guidance it contains is binding. ASOP, and the need for appropriate disclosure language. Precept 3 of the Code of Professional The actuary in this hypothetical ex- No. 1, “intended to offer actuaries guid- Conduct requires that “An Actuary shall ample was dealing with differences in ance on the operations of the Actuarial ensure that Actuarial Services performed wording between the current and new Standards Board (ASB), the content and by or under the direction of the Actuary versions of ASOP No. 4, Measuring Pen- format of standards, and the ASB’s intent satisfy applicable standards of practice.” sion Obligations, and looked to ASOP with respect to certain terms that appear The number of ASOPs promulgated by No. 1, Introductory Standard of Practice, frequently in the text of the standards the ASB and binding for U.S. actuarial for the definition and use of the terms themselves.” The Background Section of practice is 49 as of the time of publica- “must/should” and “may.” ASOP No. 1 further states that “the Intro- tion, with numerous exposure drafts in My purpose here is to broaden the duction was updated in October 2008 to various stages of development, so that discussion of ASOP No. 1 and to raise make clear that the ASB, in promulgating number will continue to grow. Actuar- consciousness of the importance of this ASOPs, seeks to define an appropriate ies need to be aware of the standards standard. level of practice (rather than simply applicable to a particular work product Some historical perspective will be codifying current practices), to remove or actuarial service; doing so becomes useful. ASOP No. 1 is relatively new, pub- references to ‘prescribed statements of more difficult as actuarial practice be- lished in March 2013 and effective June 1, actuarial opinion’ in light of revisions comes more complex and the number 2013. It replaces the document Introduc- made to the Qualification Standards for of standards grows. One useful tool for tion to the Actuarial Standards of Practice, Actuaries Issuing Statements of Actuarial staying abreast of the latest standards first issued in 2004, which was, as stat- Opinion in the United States, and to con- is the Applicability Guidelines, which ed in the Background Section of ASOP form the provisions on deviations from provide assistance to actuaries in determining applicable ASOPs for a particular assignment. These guidelines, revised in October 2014, are in Excel format and can be downloaded from the Academy’s website. While not “binding guidance,” they are very useful in suggesting what

Editor’s note: Due to an editing error, the Up to Code article in the March/ April issue of Contingencies erroneously suggested that a directory listing of an actuarial association is sufficient to indicate compliance with continuing education requirements for signing statements of actuarial opinion, and that the ABCD can recommend public reprimand to the Joint Disciplinary Council. Neither is the case. A corrected version online clarifies these points. We regret the error. JOE SUTTLIFF

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TW-Contingencies-8-125x10-875-RCS-NA-2013-34269.indd 1 9/26/2013 5:26:39 PM Up to Code CONTINUED

Section 3 of ASOP No. 1 discusses briefly the ASB’s exposure process to seek input, and describes the intended scope of ASOPs. The need to exercise professional judgment is emphasized.

ASOPs might apply to specific tasks, bro- the actuary can still comply with that step and decision in an actuarial assign- ken down by practice area. In addition, ASOP by providing an appropriate ment. Generally, ASOPs are not narrowly they remind the actuary that there are statement in the actuarial communica- prescriptive and neither dictate a single three standards that apply to virtually all tion with respect to the nature, rationale, approach nor mandate a particular out- assignments: ASOP No. 23, Data Quality; and effect of such deviation.” (Sections come. Rather, ASOPs provide the actuary ASOP No. 41, Actuarial Communications; 4.2 and 4.3 above refer respectively to with an analytical framework for exercis- and finally ASOP No. 1, the subject of this the situations where assumptions are ing professional judgment, and identify article. required by law, and where material as- factors that the actuary typically should Section 1 (Overview) of ASOP No. 1 sumptions or methods are set by another, consider when rendering a particular provides a description of the process and for which the actuary thus disclaims type of actuarial service.” of establishing and revising ASOPs and responsibility; both such situations also The standardization of format of emphasizes that through the Code of require disclosure.) All standards of ASOPs is discussed throughout ASOP Professional Conduct, actuaries who are practice now require that the actuary No. 1. Section 3 notes that each ASOP members of any of the five organizations include the disclosure required by ASOP has a specified effective date, but actuar- that have adopted the Code are bound to No. 41, Section 4.4 in the case of devia- ies may look to them at their discretion follow the standards promulgated by the tion, as well as the disclosures required for advisory guidance prior to the effec- ASB. by ASOP No. 41, Sections 4.2 and 4.3, as tive date, and while in exposure draft Section 2 (Definitions, Discussions, applicable. format. and related Guidance) is important in Other terms defined/discussed in Section 4 (Compliance with ASOPs) that first it discusses aspects of the now- Section 2 of ASOP No. 1 include: “Actu- emphasizes that ASOPs are binding upon consistent framework of all ASOPs, arial Services,” “Actuarial Soundness,” actuaries, and that “Actuaries should noting that all ASOPs have a list of defi- “Known,” “Deviation,” “Materiality,” take a good faith approach in complying nitions, which are intended to apply only “Practical or Practicable,” “Principal,” with ASOPs, exercising good judgment in the context of the particular ASOP. “Professional Judgment,” “Reasonable,” and professional integrity.” This section However, the definitions in ASOP No. 1 “Reliance,” and “Significant/Signifi- notes that actuaries are responsible for are meant to apply to all ASOPs (unless cance.” These definitions—or, more determining which ASOPs apply to their the same term is specifically defined for accurately, discussions in many cases work, and discusses again deviation and use in the particular ASOP). The terms where a precise definition is elusive the related disclosures. “must/should” and “may” are defined (good examples being “Materiality, The following quote from ASOP No. and discussed (ASOP No. 1 refers to them Practical or Practicable” and “Reason- 1 (Section 4.4) is a good way to close, and as “terms of construction”). Section 2.1 able”)—are helpful in determining how remind the reader that the ABCD is here states that “failure to follow a course of standards apply to the actuary’s work. to help. action denoted by either the term ‘must’ Section 3 of ASOP No. 1 (Purpose “When an actuary believes that mul- or ‘should’ constitutes a deviation from and Format of Actuarial Standards of tiple ASOPs have conflicting provisions the guidance of the ASOP. In either Practice) notes that “ASOPs identify when applied to a specific situation and event, the actuary is directed to ASOP what should be considered, done, docu- none provide explicit guidance concern- No. 41, Actuarial Communications.” mented, and disclosed when rendering ing which governs, the actuary should Section 4.4 (Deviation from the Guid- actuarial services.” This section also dis- apply professional judgment and may ance of an ASOP) of ASOP No. 41 states cusses briefly the ASB’s exposure process wish to contact the ABCD for confiden- that “if, in the actuary’s professional to seek input, and describes the intend- tial guidance on appropriate practice.” judgment, the actuary has deviated ma- ed scope of ASOPs. The need to exercise ALLAN W. RYAN, MAAA, FSA, is a terially from the guidance set forth in an professional judgment is emphasized. It member of the Actuarial Board for applicable ASOP, other than as covered is noted that “the ASOPs are principles- Counseling and Discipline. under sections 4.2 or 4.3 of this standard, based and do not attempt to dictate every

16 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG

18 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG by Paul E. Forte

Private Long-Term Care Insurance

PRIVATE LONG-TERM CARE INSURANCE (LTCI) IS NOW IN ITS FOURTH DECADE— the last, in the view of some, in which it will be sold widely across America. Before we observe the obsequies, it may be well to take stock of where we actually are, because sales of stand-alone LTCI products—not to mention linked or combination products, chronic illness coverage, and short-term care insurance—do take place each day, suggesting that private LTCI is filling a need. At the same time, private LTCI’s chief rival and alternative—social LTC insurance— has failed to win much support beyond the public policy advocates and nonprofit groups that push it forward. There are many reasons for this, including the recognition that using Roman coin featuring Janus, general revenues to finance long-term care benefits for the broad public in the vein of the Roman god of thresholds, Social Security and Medicare would be costly. Yet the need for long-term care is growing. who was associated with This article attempts to frame the broad arc of historical private LTCI market de- beginnings, new ventures, and velopment, in an effort to assess its strengths and weaknesses. It argues that private transitions—as LTCI is hardly finished, that it remains the best choice for uninsured millions looking well as endings. Romans thought to protect their retirement against the risk of needing long-term care services sometime Janus presided over finance and before the end of their lives. risk-oriented ventures, so However, changes need to take place in order to make private LTCI more satisfac- his depiction on coins is not tory and cost-efficient. Such changes include a better understanding among consumers unusual. about the real need for and cost of long-term care services in relation to premiums, more flexibility on the part of state regulators, and determination of insurers to manage volatility. Insurers particularly must adjust their stance, becoming more Janus-like—capable at once of looking both backward and forward, mindful of designs that have undermined and continue to erode earnings, yet also remaining committed to their core disciplines, of which the assumption of risk over long periods of time is fundamental. ILLUSTRATION BY JIM SALVATIOW ILLUSTRATION Past, Present, Future CONTINUED

Figure 1: Private Long-Term Care Insurance History at a Glance 1990 1995 2000 2005 Pepper CalPERS LTCI • LTC Security Act creates Federal Long Deficit Reduction Commission (1993 RPF) Term Care Insurance Program (FLTCIP) Act expands Mid-1960s Late 1980s on LTC • NAIC rate stabilization regulation1 partnership with CNA introduces Partnership with state 1996 state Medicaid 2003 first LTCI in wake Medicaid offered in HIPAA CNA and Conseco of Medicare four states exit market

1980 1985 1990 1995 2000 2005 2006 2007

1980 1985-1990 Early 1990s Mid-1990s 1996 U.S. Census “Second Group LTCI Small Principal exits 2002 Humana, Aetna “Graying of America” generation” marketing to group LTCI market • Apex of LTCI AEGON/ LTCI policies Fortune 500 marketing market sales: Transamerican* companies and 901,000 new lives; *re-entry 2010 universities 104 insurers: $1.2 billion in sales • FLTCIP initial enrollment2

I. Private LTCI Market Overview, 1960s–present risk from irreducible uncertainty. Private LTCI made its first appearance in 1964, just about the The high point of the U.S. private LTCI market, according time Medicare was launched. There was little enthusiasm for to America’s Health Insurance Plans, was 2002, just after the early products, which were medically oriented, limited to nurs- longest expansion period in stock market history (see Figure 1). ing home use, and without protection against inflation. Not until The turn of the millennium saw more than 100 insurers issue the late 1980s did “second generation” LTCI policies appear— more than 900,000 new policies, generating $1.2 billion in new policies that introduced important consumer-friendly features sales, with distribution taking place across individual, group, such as home health benefits, a benefit eligibility trigger orient- association, and affinity channels.1,2 ed to functional disability (measured by cognitive deficits and Major underwriters of individual LTCI included Aetna, loss of ability to perform activities of daily living (ADLs), which American Express, Bankers Life, Travelers, John Hancock, include eating, bathing, dressing, toileting, transferring (walk- Mutual of Omaha, Prudential, Transamerica, and Equitable. ing), and continence), care coordination, lifetime benefits, and Employer-group underwriters included Aetna, John Hancock, inflation adjustment options. Consequently, the LTCI market is MetLife, TIAA-CREF, and Prudential. These insurers designed still young when compared with life or supplemental health in- and implemented the very largest corporate plans, such as those surance; it’s also young when compared with its closest cousin, for Procter & Gamble, Dow Chemical, IBM, GE, and the Bell long-term disability, which was already mature by 1970. companies. Colleges and universities including Harvard and the The relative newness of private LTCI bears repeating. Private City University of New York offered plans to faculty and admin- LTCI is complicated, requiring the kind of sophistication associ- istration, and AARP sponsored one of the largest plans for its ated with successful defined benefit pension underwriting. At immense membership, as did the Screen Actors Guild, a smaller issue: how to price long-dated liabilities so as to generate pre- but influential association. UNUM sold hundreds of plans to dictable cash flows, taking into account the inherent volatility law firms and select small employer groups. In 1995 CalPERS of a line of business whose numerous pricing inputs (e.g., lapse launched its self-insured LTCI plan for California employees rates, morbidity rates, interest rates, expenses) may unexpect- and retirees, and in 2000, Congress passed the Long Term Care edly shift, making it hard for actuaries to separate measurable Security Act (PL 106-265), creating the Federal Long Term Care

20 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG 2006 2013 Pension 16 remaining insurers Protection Act 2007-2011 selling stand-alone LTCI; Financial crisis, low 172,000 new lives; 2012-2014 interest rates, inflation $484 million in sales Growth in adjustment woes LTCI Hybrids

2008 2009 2010 2011 2012 2013 2014

Major carrier exits due to poor UW results, investor qualms

2010 2013 August 2014 Penn UNUM Allianz, Community Prudential CLASS Act NAIC Model Treaty (Retail) Equitable, Living Assistance UNUM repealed; Act rate John Hancok Services and (group) Federal stability (group), Supports Act Commission provision MetLife (CLASS Act) on LTC enacted under ACA NOTES: 1LTCI insurers formerly used a loss ratio minimum of 60%-65%. After the NAIC 2000 Model Act and Regulation, states insisted on more conservative pricing, including rate stabilization provisions, raising costs. 2The FLTCIP was established by an act of Congress, the “Long Term Care Security Act of 2000” (PL 106-625) and is the only private LTCI program not regulated by the states, being governed instead by regulations issued by the U.S. Office of Personnel Management (OPM), which are promulgated through the Federal Register. The FLTCIP remains the largest LTCI program in the country, with more than 272,000 persons covered and generating more than $430 million in annualized premium in FY2014.

Insurance Program (FLTCIP). The FLTCIP became the largest such durations. But equities and other market-based securities LTCI program in the country, stimulating premium growth and can introduce volatility. Cash, of course, is not an option, except setting new benchmarks for service. in the smallest amounts, as it is subject to inflation. Individual policies were sold on a commission basis, first by As insurance experience began to emerge in the late 1990s, career agents, general agents, and other producers, and later actuaries found that a number of their assumptions were op- by banks and wirehouses. Early group plans, marketed to the timistic. This realization led to some early moves at re-rating. Fortune 100 companies, were usually designed and competed Regulators were caught unprepared, many being unfamiliar by actuarial firms like Towers Perrin, Hewitt, and William Mer- with how the new product worked. According to Jim Glick- cer on a fee basis. As the largest employer groups got scooped, man, co-founder and CEO of LifeCare Assurance Company, insurers began to move downmarket to the many thousands of regulators themselves brought on the crisis in LTCI pricing they smaller employers without LTCI plans, thus preparing the way wished to avoid, first by adopting minimum loss ratios, which for brokerage, which based its services on commissions. required insurers to spend a minimum level of premium rev- Pricing was a challenge from the start. Because no privately enue on claims, spurring them to set rates as low as possible to insured data were available on which to base actuarial assump- avoid the possibility that the percentage of LTCI revenues paid tions about lapse, mortality, morbidity, and other risk factors, out in claims might be too low, then by reversing themselves actuaries doing initial pricing had to rely on the National Nurs- by adopting a model4 that penalized insurers that raised rates, ing Home Survey of the mid-1980s, which furnished general which caused them to set initial rates as high as possible to avoid population data as opposed to insured population utilization the risk of having to increase rates.5 data,3 or to extrapolate data from related business lines like For Glickman, this second wave of regulations precipitated health and disability. numerous decisions, including changes to underwriting, higher There was also the matter of interest rates. LTCI liability business pricing, and carrier exits.6 cash flows (usually projected to last more than five decades) are Certainly things began to look very different in the 2000s, long-dated, while asset cash flows (usually based on fixed in- a mood that culminated in the financial crisis on Wall Street come) are not. This is because they are typically unavailable for in 2007-2008. Low interest rates made it hard for insurers to

MAY | JUN.15 CONTINGENCIES 21 Past, Present, Future CONTINUED

hit fixed investment targets, as bond yields reached near-record guaranteed renewability doesn’t guarantee that premiums will lows, while rising claims and premium waiver for those on claim remain level in the future. State insurance departments can limit reduced cash flows. Not surprisingly, stand-alone sales slumped, the premium increases that insurers seek or block them altogeth- although some insurers posted fairly strong numbers in the mid- er, but they also must help insurers remain solvent or themselves 2000s, while the FLTCIP posted some excellent results in 2011 face the consequences of carrier failure. Such consequences will for its second Open Season. almost certainly include increased demand for taxpayer-financed Fast-forward to the present. As of the end of 2013, about coverage, which is already at unsustainable levels. 7.4 million persons held private LTCI of some sort, roughly 80 Such is the LTCI market today. Coverage is trending toward percent through individual policies and 20 percent via group the more finite, and it is costlier. Actuaries are now more con- coverage. These policies generated about $12 billion in earned fident that pricing for their products is being corrected, and premium. Sales dwindled to just over $400 million annualized, marketing executives are more circumspect, positioning LTCI and the downward trend appears to have continued into late not as a total financial solution, but as a limited tool, a valuable 2014, at least in the individual/retail market.7 adjunct to other financial resources. Whether such a value prop- According to Broker World, only 16 insurers are currently osition will prove satisfactory to consumers or render private offering stand-alone LTCI policies, with more than 25 such in- LTCI untenable is anyone’s guess. surers having exited since 2008.8 Sales volumes have been unofficially capped and marketing support has been cut back. Claims, on the other hand, have continued to rise. In 2012, $6.6 billion in LTC insurance claims was Those insurers not wishing to paid to over 264,000 claimants.9 Two insurers each now pay out in excess of $1 billion exit the market have begun annually. to reposition themselves. The The disposition among insurers is sober. Independent rating agencies and stock analysts remain skeptical, if not sour. The unmistakable trend is one of de- plaintiff bar has discovered LTCI, with the number of lawsuits filed against insurers up sharply in recent years.10 risking, with insurers now offering Those insurers not wishing to exit the market have begun to reposition themselves. The unmistakable trend is one of de-risk- thinner benefits at fatter prices. ing, with insurers now offering thinner benefits at fatter prices. Take, for example, underwriting. While insurers still aim to accept persons whose health is typical for their age, they are II. Actuarial Challenges requiring more hard evidence of good health. Age ranges are Lapses were the first important actuarial assumption that had more restricted, attending physician’s statements are being re- to be rethought. Early LTCI actuaries assumed lapse rates many quired on all fully underwritten applications, more testing is times greater than those of today’s assumptions. As Dawn Helwig stipulated in the form of laboratory work, pharmacy screens are noted in a feature in the November/December 2014 issue of Con- being utilized, and more pre-existing conditions are being found tingencies, premium rates based on initial lapse rates of 8 percent uninsurable, with co-morbid scenarios resulting in limited cov- and ultimate lapse rates of 5 percent were not uncommon in the erage or declines. early 1990s. These assumptions were based on experience with Recently, several major insurers have changed from unisex to other health insurance products. These rates were subsequently gender-specific rates, citing evidence that females do live longer revised downward significantly, so that most LTCI actuaries are and use more long-term care than males. using ultimate lapse rates of well under 1 percent. The change The same de-risking logic is being applied to plan design. in assumptions about how so few will terminate voluntarily re- Unlimited (lifetime) policy benefits are being pulled. Shorter sulted in dramatic restatements of the reserves needed to pay maximum plan durations of five to seven years are becoming the claims and necessitated large rate increases. norm, with three- and even two-year plans receiving emphasis. Lapse assumptions were followed by concern about interest Limited pay options, indemnity riders, return of premium, and rates. As noted above, LTCI liabilities are long-dated, often in restoration of benefits have been suspended and in some cases excess of 30 years, but assets are not, leaving insurers with lim- preferred health discounts discontinued. Cash benefits continue ited options for investing. Most invest in bonds and other fixed to be offered by some insurers, but only as a rider. Guaranteed instruments. However, the inability to earn good rates of return renewability, which means that coverage cannot be canceled if in the past decade has meant lower discount rates, especially premiums are paid as scheduled, is a valuable consumer pro- during and after the recent financial crisis, and again higher pre- tection because the carrier cannot change provisions or cancel miums. The difficulty in getting a good return on assets under coverage provided premiums continue to be paid. However, management has affected all LTCI pricing.

22 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG The interest rate challenge is perhaps best seen in relation to automatic compound inflation adjustment. Stand-alone LTCI— Since the early 1990s, an inflation adjustment factor of 5 percent Actuarial Issues compounded had become the gold standard. Agents and brokers, who also wanted to protect their clients, made it de rigueur. But ■■ Assumptions: morbidity, mortality, lapse, a daily maximum benefit and a lifetime benefit pool increasing recovery, continuance, interest rates, inflation increases by 5 percent compounded per year presupposes a healthy interest rate environment. State insurance departments disallow rate ■■ Unlimited/lifetime policies increases based on interest rate assumptions, and soon insurers ■■ Inability to get rate increases approved by state found themselves in the rough water, caught between the Scylla of regulators ballooning liability and the Charybdis of asset-liability mismatch. ■■ Capital strain This problem was further exacerbated when the Federal Reserve ■■ Profitability began implementing massive bond-buying programs to hold down interest rates as economic stimulus. Mortality has been an issue, with older persons living even claims utilization, where reserves may fluctuate widely within longer on claim than expected. The 1994 Group Annuity Mor- a normal period. With the benefit of stochastic modeling, which tality Table remains the basis for all mortality projections with employs Monte Carlo simulation methods, the authors exam- impact for selection based on gender and underwriting class. ine a host of features and provisions to ascertain outliers from But the bigger concern is morbidity, comprising incidence, risks that merely appear to be so. What needs to take place, they utilization, recovery, and continuance. This subject has long conclude, is an examination of all the features and provisions that remained something of a black box. The data needed to assess pose parameter risks and magnify uncertainty. Such a reckoning the biological endpoint of natural human life are not yet avail- would help to ensure that each risk assumed aligns with an insur- able, although some longevity experts have argued that there er’s marketing strategy and capacity for or tolerance of risk—and will eventually be a reduction in morbidity with death arriving conversely, to identify and avoid risks that may only make sense relatively soon after a reasonably healthy and active life.11 Still, in light of social or other non-business objectives. Failure to dif- most LTCI actuaries continue to assume that the elimination ferentiate among risks that are reasonably predictable from those of disease will result in many more persons living to advanced that are not has resulted in confrontations with state insurance age in a state of debility, and/or remaining in a state of debility departments as insurers seek approval for premium increases for a longer period of time. In this assumption they are look- that may not correspond with the actual risks assumed. ing at insured experience rather than general population data. Finally, there is the matter of reinsurance. Reinsurance is an Disability at older ages has actually been improving among the important tool in other risk lines. Yet it is almost absent in LTCI. non-insured, while disability among insured persons, particu- There are many reasons for this, including changing assump- larly those with dementia, seems to be lengthening.12 tions about the amount and length of claims, rate increases that Whatever the reality that will one day be borne out by re- do not get approved, unwillingness of reinsurers to assume risk search, actuaries must give more thought to what Rachel without information that insurers find hard to obtain, and ac- Brewster and Sam Gutterman have termed “a properly deter- tion by the Federal Reserve to depress interest rates. But it is mined provision for risk and uncertainty” with respect to both unsurprising that reinsurance has not played a major role in the premiums and reserves.13 development of private LTCI. Insurers initially thought the risk Citing the classic North American actuarial distinction be- was manageable, and early reinsurance contracts tended to be tween process risk, which is subject to random fluctuations that written as coinsurance, which lowered total risk assumed but nevertheless fall within certain probability distributions that also reduced premiums. Today, however, the use of reinsurance can be measured, and parameter risk, which involves random is likely to increase as carriers look to manage volatility in their occurrences that resist prediction because they follow no known books and reduce capital strain. If the experience of Genworth probability pattern or model, Brewster and Gutterman argue and other insurers is to carry weight, reinsurance would seem a for approaches that “decompose” and quantify risks. In another necessary tool that should be employed on a wide basis. recent paper, Roger Loomis, Christopher Churchill, and others similarly underscore the importance of achieving an accurate III. Operational Challenges understanding of the “boundaries of normal variation,” i.e., how As noted, LTCI poses administrative challenges, as might be much variance is entailed for each operational or financial met- expected of a permanent product in flux. Take, for example, ric—and estimating the probability of random events occurring inflation adjustment, especially with respect to future or guar- in certain intervals.14 anteed purchase option (FPO or GPO) offers. These adjustments Not surprisingly, the latter requires the assignment of a con- must be orchestrated regularly (generally every one to three fidence factor and comes particularly into play with lapse and years, depending on the plan design) and can pose problems

MAY | JUN.15 CONTINGENCIES 23 Past, Present, Future CONTINUED

Stand-alone LTCI Policy Administration Challenges ■■ Inflation adjustment ■■ Benefit eligibility via ADLs and cognitive deficits ■■ Informal benefits ■■ State Medicaid partnerships ■■ Discount provider networks ■■ Benefit reductions in lieu of rate increases ■■ Blended rates that reflect prior value of policy and new risk assumed in pricing ■■ Closed blocks

such as the common misperception among enrollees that these offers are the same as rate increases, which makes extra work for call centers. There is also the expense associated with preparing and mailing complex per- sonalized option packages at regular intervals. Pegging the rate of inflation adjustment to an inflation index such as the CPIU makes sense both as an offset against rising interest rates—because interest rates and inflation generally move in tandem—and administratively, because premium and inflation adjustments would be linked. Determining benefit eligibility remains problematic because of subjective elements despite a carefully administered process. There is no question that functional and cognitive triggers are better indications of conditions that necessitate long-term care support than earlier medically oriented requirements, such as prior hospitalization, because many requiring long- term care services do not require skilled medical intervention. Activities of daily living are recognized by health professionals as having a high degree of inter-rater reliability. They may be depended on by insurers wishing to establish dependency on an objective basis, but this does not prevent attempts made by insureds and family members to manipulate situations not in their favor, which can in turn elicit further controls by insurers. The jury remains out on how best such triggers can be administered satisfactorily without risk of abuse. Increasingly specialized data drawn from experience, based not on triggers alone but on multiple information sources, including medical reports, health provider notes, and cognitive evaluations, should fill any gaps. Another controversial item is informal benefits—those covering services by nonprofessionals, including friends and neighbors. While hard evidence of significant fraud is lacking, concerns exist around the difficulty of verify- ing actual hours worked vs. those reported by caregivers.15 More controls need to be in place to ensure that criteria are met for what is likely to become the most popular feature of private LTCI. We need not dwell on state partnerships, which allow a policyholder, upon exhaustion of policy benefits, to keep an amount of his or her assets equal to what those received in private LTCI policy benefits and still qualify for Medicaid relief. These partnerships continue to struggle due to variations in state Medicaid policy rules. The difficulty in making them work is likely to be increased by the recent provision that states will not be keeping records on the insurance policies held by their residents. This means that insureds will be entirely dependent on insurers to furnish com- pliant documentation of insurance and that insurers may incur additional

24 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG record-keeping costs associated with verification.16 Matters largely due to disagreements over what role private insurance could be made easier for insurers by federal action in the U.S. should play in LTC finance going forward. Treasury. All that would be needed is a ruling that HIPAA-quali- The commission itself was shadowed by the Community fied policies are eligible for partnership treatment in every state, Living Assistance Services and Supports (CLASS) Act, which regardless of inflation protection and other features, and part- was repealed in early 2013. CLASS was not as well-designed as nership could become a nationwide reality. it might have been, given its strictly voluntary nature, absence Rate increases can also pose administrative problems, even of underwriting, and lifetime benefits. But defenders of CLASS without such requirements as the December 2014 changes to viewed its repeal not as a failure of policy so much as a political the NAIC Long-Term Care Insurance Model Regulation would defeat.19 With respect to the two biggest objections to private involve.17 Unlike health and other kinds of term insurance, LTCI—access and affordability—CLASS won points, substitut- LTCI is designed to build reserves over time so as to meet ob- ing for the “cherry picking” of conventional underwriting a ligations years down the road. An insurer offering guaranteed more egalitarian five-year vesting period without underwrit- renewable policies must be prepared to continue those poli- ing criteria, with a modest benefit yielding a low premium. The cies unless they are transferred to another insurer. If a transfer objective of the former was to prevent new enrollees from being takes place, a system conversion is likely. Adequate time must able to go on claim immediately after their effective date, while be allowed to make required changes and perform testing. So the latter was put in place to avoid excess claims costs. insurers wishing to change administrators or systems must Had CLASS stood, such measures would certainly have had address the prior value built up in the policy over time and their appeal. There has already been discussion within the pri- the new risk assumed in pricing. Another wrinkle is presented vate industry about whether a vesting period could be added when an insurer seeking to raise rates offers benefit reduction to conventional medical evidence underwriting as a way to options, so that insureds can avoid the increase. Such options, cover more persons. And, as noted above, the size of policies now referred to as “landing spots,” can be especially hard to is shrinking. implement where there are blended rates and other anomalies Advocates suggest that a social insurance program could that do not arise with term funding. take the form of a front-end “first dollar” or back-end “cata- Closed blocks are a relatively new development that poses its strophic” plan with reimbursement payments, or preferably own challenges. Major insurers such as Aetna, MetLife, UNUM, cash payments for simplicity, with an emphasis on home and Prudential, and John Hancock (Group) have significant num- community-based care. This tracks what is now happening with bers of policies that they continue to administer, but that could Medicaid, where home and community-based care has become change in the future. The cost of specialized system and call the new standard in many states.20 Insurers would undoubtedly center upgrades goes up each year, while the ability to attract prefer that their coverage be front-ended, with the potentially and retain expert staff remains a challenge. It is hard to imagine, long tail covered by government programs and without cash given the digitization of virtually all service in a wired world, payments due to the likelihood of abuse. Whether insurers that publicly traded insurers with closed blocks will make the would agree to participate in a structure that would leave them needed investments. Qualified third-party administrators that with the long-tail end of claims is unclear. A more realistic invest in self-service tools and other automation will flourish. design might be a co-insurance approach, with each dollar of claims divided between public- and private-sector financing. IV. Social Insurance Failure of the private LTCI market to grow has not been lost on V. Future Private Market Directions social insurance advocates. Some have described it as “implod- In recent years insurers have introduced riders to other insur- ing,” an inaccurate appraisal. In truth, the private LTCI market ance policies providing for LTCI coverage that avoid some of the has not collapsed, but private market troubles have created an pricing uncertainties associated with stand-alone LTCI. These opening for social insurance, which is a regular feature of the hybrid or “combo” policies—which usually consist of an LTCI social security systems of Austria, Belgium, Germany, Israel, Ja- rider linked to a base annuity, disability, or life insurance policy pan, the Netherlands, and other countries.18 that retains its own features—are receiving a good deal of atten- As early as 1990, the bipartisan Pepper Commission issued a tion. These are outside the scope of this article, so I will offer report recommending social insurance for home care and three only a few comments. months of nursing home care. Over the intervening period nu- There is no question that alternatives to conventional stand- merous proposals have been made by scholars at the Brookings alone LTCI are needed. Not every buyer is comfortable with the Institution, Georgetown Financing Center, and other think tanks terms of stand-alone LTCI, and many have additional financial citing the exclusion of those with pre-existing health conditions needs not addressed by stand-alone LTCI. To help meet those from coverage and a high if not unaffordable premium. In 2013, needs, hybrids offer additional value in lieu of cash, so that the the Commission on Long Term Care looked at long-term care policyholder can expect a benefit if the need for LTC benefits issues but stopped short of recommending finance solutions, never happens. There are other advantages, such as the ability

MAY | JUN.15 CONTINGENCIES 25 Past, Present, Future CONTINUED

LTC finance will be driven by still another factor: rising health care costs. A disproportionate percentage of total health care costs is incurred at end of life.

to be accepted for coverage without underwriting (in the case of they are facing is part of the business itself, with results that an annuity/LTC hybrid), or with lower underwriting standards may be spread, or the result of random variables that lie too far (in the case of a life/LTC hybrid). outside the circle of known risks and therefore merit special However, hybrids as designed today—with the daily benefit consideration from regulators. achieved via a rider to the base policy—are simply not able to Self-funding strategies based on new, more flexible rules for generate as much coverage per dollar of premium as stand-alone taxation and withdrawals from IRAs, 401(k)s, and other popular LTCI, and few carry such provisions as care coordination services investment vehicles, will also certainly be welcome. Whether or international benefits, the desirability of which could increase viewed as a means of self-insurance or as a mechanism for pay- as baby boomers consider lower-cost retirement venues abroad. ing LTCI premiums, these accounts could fill in some of the Moreover, they usually require a substantial payment up front, gap in protection caused by LTC risk. However, most Americans giving the insurer a large amount of capital with which to work. are under-saved as well as under-insured, and to ask savings ac- It is no accident that hybrids are being marketed aggressively at counts to do more than generate retirement income—namely, to this time, given the repositioning of the industry, as they help the finance the biggest impediment to a secure retirement short of insurer to hedge unwanted LTCI risk. Some who buy hybrids may job loss or a catastrophic medical event—seems a stretch. discover that the benefits offered under hybrid policies do not As a result, state governments will continue to face signifi- match the levels of care and special provisions stand-alone poli- cant pressure. Medicaid financing is unsustainable, and the cyholders enjoy. And the price tag would be prohibitive for many. better part of Medicaid spending is based on federal revenue. My own preference, as set forth in “Fresh Thinking on That many states are prepared to make changes is evidenced Long-Term Care,” in the January/February 2014 issue of Con- by the decision of several to sell the liability of current Med- tingencies, is for the creation of a new private LTC insurance icaid beneficiaries to private-equity firms that cap the risk via exchange (the American Long Term Care Insurance Program, managed care. This shift may help to balance budgets, but it ALTCIP) that would be sponsored and regulated by the federal has proved problematic in Tennessee, Illinois, New York, and government under federal law but underwritten and adminis- elsewhere, where new scoring that raises the disability thresh- tered by private insurance companies. old required to qualify for certain types of care has resulted in This exchange would feature a powerful website and deci- some applicants being denied or cut off from care.21 It is hard to sion tools with automated application processing to expedite a reconcile such facts with the conclusions of a recent study by large enrollment. However, it would go beyond the consumer’s the Center for Retirement Research at Boston College, where it initial buying decision to ensure ongoing satisfaction by align- is argued that the use of “corrected care status transition prob- ing premiums with emerging experience via a separate account abilities” of those 65 and older going into nursing homes reduces mechanism. A portion of profits would be awarded to insurers the value of private insurance, and that “given the availability of and program administrators on the basis of performance metrics Medicaid,” most single individuals should not buy insurance.22 evaluated and audited by federal regulators. Select features—na- Finally, there is the federal government itself, which may tional brand promotion, ease of administration, and reinsurance not see the economic growth it needs to reverse a longstand- to reduce volatility and therefore capital strain—would help ing trend toward greater and greater sovereign national debt. make the exchange attractive to insurers. We can expect to hear more on this as we head into the 2016 Unlike the scene today—which is dominated by insurers using election. Indeed, 2016 may be a watershed year: Aging baby professional distributors who are largely oriented to high-net- boomers, increasingly worried about retirement security, could worth individuals—the ALTCIP would aim for the broad middle create pressure for action such that cobbling together even a market, reducing sales and administrative costs via an electronic flawed arrangement for financing LTC soon will trump a “per- approach and bringing basic coverage to millions of baby boom- fect” solution years out. ers ahead of the LTC service demand curve without placing an LTC finance will be driven by still another factor: rising additional burden on taxpayers or increasing government debt. health care costs. A disproportionate percentage of total health The quest for products that offer real value and search for care costs is incurred at end of life. Steve Holland and others effective ways of convincing individuals of their LTC needs will have shown in a recent study that private LTCI “measurably continue. Insurers must adequately price the risks involved in reduces” such expenses because it pays for hands-on assis- LTCI. At the same time, they must decide whether the volatility tance with personal care, resulting in improved medication

26 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG compliance, nutrition, socialization, and falls prevention, all of PAUL E. FORTE is chief executive officer of Long Term Care which reduce hospital admissions and readmissions—sources Partners LLC. The opinions and positions voiced in this paper 23 of huge medical expense. are those of the author and do not represent the opinions of In sum, the forces favoring the persistency and further de- Long Term Care Partners; its parent company, John Hancock Life velopment of stand-alone LTCI are numerous and strong. But Insurance Company (U.S.A.) and subsidiaries; or the U.S. Office of these may not be enough. Personnel Management (OPM). The author alone is responsible Private LTCI can play a major role in financing the nation’s for any errors or misjudgments this paper may contain. growing LTC needs, or it can play handmaiden to a social insurance scheme that may come to pass in the next decade. Which of Note: This paper had its origins in a presentation given at the So- these roles it assumes will hinge, I submit, on whether the private ciety of Actuaries Health meeting in San Francisco on June 25, sector has the resolve to push past the short-term orientation 2014. The author would like to thank Tia Goss Sawhney for the with which it has been preoccupied, to embrace a market future invitation to present; Marc Cohen, Marie Roche, and Sam Gutter- that is only now starting to arrive—or whether it will decide, in man for close readings of the full draft; and Jon Seder for excellent the final analysis, that such a future is not worth the risk. graphics, research, and editorial support.

Endnotes 1See America’s Health Insurance Plans, “Long-Term 9American Association of Long Term Care Insurance, Government Accountability Office, Report to the Care Insurance in 2002,” June 2004, p.22. AHIP “Long-Term Care Insurance Facts - Statistics” (http:// Ranking Member, Committee on Finance, U.S. Senate, reported that the LTCI market had in fact grown an www.aaltci.org/long-term-care-insurance/ May 12, 2009, p.1-6. average of 18% each year between 1987 and 2002, learning-center/fast-facts.php). 16See “State Long-Term Care Partnership Program: while, by the end of 2002, there were more than 5,600 10See Rafalko, Akbar, and Gugig, “LTCi Litigation Reporting Requirements for Insurers,” final rule by the employer group plans in effect. Update/Prevention,” an unpublished presentation Health and Human Services Department on Dec. 18, 2Karen Fisherkeller, LIMRA Annual Review 2013, “U.S. delivered at the 2015 ILTCI Conference, Colorado 2008. Group Long-Term Care Insurance” and “U.S. Springs, Colo., March 24, 2015 (http://www.iltciconf. 17Such changes would include making pre-rate Individual Long-Term Care Insurance.” org/index_htm_files/31-LitigationFinal.pdf). stabilization provisions consistent with current 3The purpose of the 1985 National Nursing Home 11See Eric Stallard’s recent article in Long Term Care provisions applicable to rate stabilizing policies, Survey (NHHS) was “to establish a complete ‘baseline’ News, Society of Actuaries, August 2014, pp. 23-27. establishing complex administrative systems to set of utilization data that can be used in actuarial Stallard cites the famous postulate of James F. Fries, produce durational loss ratios that would vary from models and as a basis of comparison with other MD, now more than 30 years old, concerning a state to state, and using the primary interest rate in experience.” The survey notes that its objective was not “compression of morbidity” paradigm, or reduction in place of the maximum valuation interest rate for loss to develop “utilization data that are directly lifetime morbidity. Fries affirmed a natural point at ratio calculations. See “Long Term Care Insurance appropriate for pricing or reserving of long term care which human homeostasis is not achievable even if Model Regulation,” National Association of Insurance (LTC) insurance products,” but rather reflects chronic diseases are effectively eliminated, thus Commissioners, September 2014, Sections 20 and 20.1, “tabulation of admission rates and length of stay reducing the length of morbidity itself (“Aging, Natural p.641-32–641-45. distributions that are useful for those who are Death and the Compression of Morbidity,” New 18See Mark Merlis and Paul N. Van de Water, “Long interested in LTC insurance.” See “Report of the England Journal of Medicine, Vol 303, No. 3, July 17, Term Care Financing Models from Abroad,” National Long-Term-Care Experience Committee, 1985 National 1980, p. 130-135.) See also Fries “The Theory and Academy of Social Insurance, No. 9, November 2005. Nursing Home Survey Utilization Data,” Transactions Practice of Active Aging,” Current Gerontology and 19 of Society of Actuaries, 1988-90 Reports. Geriatrics Research, Volume 2012, article ID 420637. See Joe Caldwell and Howard Bedlin, “Beyond the CLASS Act: The Future of Long Term Care Financing 4 12 Rate stabilization was ushered in by the NAIC Model I am indebted to Sam Gutterman for this insight. Reform,” The Gerontological Society of America, Act and Regulation of 2000. This was supposed to 13“The Volatility in Long Term Care Insurance,” Society Public Policy and Aging Report, 2014, p. 50-55. prevent large rate increases by requiring pricing of Actuaries, Long Term Care Insurance Section, 2014. 20 actuaries to certify, in the initial actuarial filing of an According to the Center for Medicare and Medicaid 14 LTCI product, that the premium schedule was See Roger Loomis et al., “Understanding the Volatility Services (CMS), the final rule of Section 1915(i) State sufficient to cover anticipated costs under “moderately of Experience and Pricing Assumptions in Long Term Plan HCBS, under which states may use federal adverse” circumstances and that the schedule is Care Insurance,” Society of Actuaries, May 2014, p. 20. Medicaid funds to pay for home and community- reasonably expected to be sustainable over the life of The authors note that with respect to a moderately based services (HCBS) “reflects CMS’ intent to ensure the form. However “moderately adverse” was never sized block of business, “process risk can cause that individuals receiving services and supports really defined. In recent years, efforts have been made significant variance in certain financial and through Medicaid’s HCBS programs have full access to reduce subjectivity by introducing a percentage of operational metrics over short periods of time, but that to the benefits of community living and are able to margin that must be maintained as part of the guideline. over longer periods, that variance is largely diversified receive services in the most integrated setting.” See The authors of a recent SOA paper, cited below, take away. If the level of process risk is not correctly CMS Fact Sheet, “Home and Community Based this problem up in the context of parameter risk. understood, there can be unreasonable expectations Services,” CMS Media Relations, January 10, 2014. for smooth short-term results. Over the long term, 5 21See Nina Bernstein, “Pitfalls Seen in a Turn to Allison Bell, “NAHU 2012: The LTCI Fear Factor,” process risk has a tendency to even itself out. … LifeHealthPro, June 27, 2012. Privately Run Long-Term Care,” New York Times, Process risk is the strict responsibility of the insurer March 6, 2014. 6Margie Barrie, “Understanding LTCi Rate Increases,” and constitutes the risk the insurer must absorb; 22 LifeHealthPro, May 2, 2014. Another view is that of Ali parameter risk represents potential outlying risks, and Leora Friedberg, Wenliang Hou, Wei Sun, and Zaker-Shahrak of the California Department of should arguably be set by insurers and regulators Anthony Webb, “Long-Term Care: How Big a Risk?” Insurance: Actuaries knowingly adopted unrealistic together.” Center for Retirement Research at Boston College, November 2014, Number 14-18. assumptions, trusting that guaranteed renewability 15A 2009 Government Accountability Office (GAO) 23 would, in any case, allow them to raise rates. investigation of increased national Medicare spending Steve Holland, MD, Sharrilyn Evered, PhD, and Bruce 7Karen Fisherkeller, LIMRA Annual Review 2013, 2014, concluded that “Upcoding—overstating the severity of Center, PhD, “Long-Term Care Benefits May Reduce “U.S. Group Long-Term Care Insurance” and “U.S. a beneficiary’s condition—by home health agencies End-of-Life Medical Care Costs,” Population Health Individual Long-Term Care Insurance.” (HHA) and other fraudulent and abusive practices Management; 17; 332-339. 8Thau, Helwig, and Schmitz, “2014 Long Term Care contributed to Medicare home health agency spending Insurance Survey,” Broker World, July 2014, p.2. and utilization.” See “Improvements Needed to Address Improper Payments in Home Health,” U.S.

MAY | JUN.15 CONTINGENCIES 27 The Connection Between MILITARY & BUSINESS Strategies A Brief History of Business Strategy

By Carlos Fuentes and Tom Maki SHUTTERSTOCK / ISTOCK

28 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG Strategy without tactics is the slowest route to victory. Tactics without strategy is the noise before defeat. —The Art of War, Sun Tzu

At heart, strategy is about improving one’s chances of winning. World War II provided additional impetus to the development Thus, it is not surprising that those who find themselves com- of quantitative strategic tools when entire armies of scientists peting with others have adapted (and mal-adapted) military focused on solving the problem of optimizing the allocation of strategic concepts. This phenomenon has been particularly scarce resources, thus creating techniques such as operations pronounced in the business world as scholars, consultants, and research (OR). Examples of practical problems that were solved managers embrace the basic strategic ideas of military thinking using OR abound; one of the earliest was improvements in the in developing their own sets of tools. Royal Air Force’s radar defense systems. Success in this project Business managers started to adopt concepts of military strategy when mass markets began to form in the late part of the [Editor’s note: This is the second in a series on strategy 19th century and large manufacturing concerns became aware of in contemporary business culture. For the first in the series, the advantages of coordinating different functions—production, please go to http://www.contingenciesonline.com/

SHUTTERSTOCK / ISTOCK financing, marketing—giving rise to vertically integrated firms. contingenciesonline/20141112#pg32.]

MAY | JUN.15 CONTINGENCIES 29 The Connection Between Military and Businees Strategies CONTINUED

generated the idea of enhancing “operational” systems through Strategic thinking demands training and effort on the user’s “research” in related areas. part. This remains an entry barrier for many who are nonethe- And indeed, other areas benefited from the application of less interested in strategy and its fashionable lingo. Accordingly, OR-like studies to destroy U-boats (the interested reader might in some circles, the emphasis switched from sophisticated enjoy the Wall Street Journal’s book review “How Scientists thinking to easy-to-use, one-size-fits-all recipes. Sank the U-Boat,” devoted to Stephen Budiansky’s book Black- ett’s War. See http://www.wsj.com/articles/SB10001424127887 The Experience Curve 323696404578297832534018040, accessed Jan. 24, 2015). The Early in its existence, the Boston Consulting Group followed scientific importance of OR was immediately recognized, as at- the dictum of his founder, Bruce Henderson, of “selling pow- tested by the proliferation of the academic research it generated erful oversimplifications.” A famous example is the Experience and the Nobel Prize winners it produced. The fact that OR be- Curve. This concept, borrowed from work done by the Air Force came a fundamental tool in basically all industries is a testament on Learning Curves, portrayed the relationship between output of its success in real-world applications. and costs: as output doubles, cost per unit declines by 20 percent The focus on solving practical problems became the driv- (see Figure 1). ing force behind the creation of other strategic tools such as the Central to the Experience Curve concept were explanations Learning Curve (see, for example, Statistical Methods for Learn- behind the claimed 20 percent cost decline that was usually at- ing Curves and Cost Analysis by Matthew Goldberg and Anduin tributed to economies of scale, technological innovation, and Touw), which was the result of research carried out by the U.S. organizational learning. Each of these “causes” became, in turn, Air Force. Unfortunately, but understandably, government fund- a subject of inquiry. ing was not as plentiful in peacetime, and the rapid advancement Although useful in certain contexts, it is easy to appreciate in applied research seen during the war slowed down. the limitations of “powerful” generalizations when they are tak- That is not to say that the practical importance of strategic en as natural laws. But whether grounded in an understanding thinking diminished. For example, post-war competition for of industrial engineering or on hearsay, concepts such as the funding among the Army, the Air Force, the Navy, and the Ma- Experience Curve are influential to the point of becoming part rine Corps raised the question of whether a unified organization of the general management culture—have you heard about the would be more effective than four separate and independent 80/20 rule? units. Arguments for and against integration permeated into the business world, such as the Navy’s emphasis on Distinctive Com- Ansoff’s Innovation Matrix petencies, which stressed the advantages of maintaining separate There have been plenty of instances in which scholars propose units because, as the argument goes, success in a given area re- static frameworks to guide managers’ thinking. An early ex- quires specific skills (seeThe Concept of Corporate Strategy by ample is Igor Ansoff’s Innovation Matrix for making decisions Kenneth Andrews). about corporate growth (see Corporate Strategy by Ansoff ) (see Figure 2). According to Ansoff, the optimal strategy (market penetration, He thinks too market development, product development, diversification) is linked to the firm’s core competencies. Specifically, firms should much; such men are not undertake unnecessary risks by investing in new products dangerous. or services that don’t match the firm’s distinctive competencies. Critics comment that Ansoff’s Matrix is not a strategic tool —Julius Caesar, Shakespeare for reasons such as the following: ■■ It assumes that the main objective is growth, which often is Scholars, Consultants, and Managers Enter the only one of several competing goals; Strategy Field ■■ It ignores the company’s internal factors, particularly operations and resources; Scholars and consultants, inspired by the success of military ■■ It ignores the environment in which companies compete, spe- strategy, developed tools that business managers received with cifically regulation, competition, and market structure; enthusiasm. In some instances, large companies formed stra- ■■ It assumes that decisions can be made with relative confi- tegic units chartered with the development of techniques to dence or at worst that risk can be assessed; and tackle practical problems. GM’s Profitability Optimization Mod- ■■ It assumes that data analysis can be translated into strategic el, created to improve capital allocation via ROI estimates at the planning. business unit level, is one such example. Many of these criticisms apply to similar frameworks.

30 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG FIGURE 1 FIGURE 3 Experience Curve Growth-Share Matrix UNIT COST 1.20 Market Share (Cash Generation) Large Small 1.00

0.80 Market High Stars Question Mark Growth 0.60 (Cash Usage) Slow Cash Cows Dogs 0.40

0.20

0.00 0 5,000 10,000 15,000 20,000 FIGURE 4 OUTPUT SWOT Analysis Framework Helpful to Achieve Harmful to Achieve Objectives Objectives FIGURE 2 Internal Origin Ansoff’s Matrix Strengths Weaknesses (Company) Existing Products New Products External Origin Existing Markets Market Penetration Product Development (Industry, Regulatory Opportunities Threats New Markets Market Development Diversification Environment, etc.)

FIGURE 5 Porter’s Five Forces (Industry Competition)

The Growth Share Matrix ■■ Cash Cows—Business units with large market share in a Another powerful oversimplification was BCG’s Growth Share slow-growing industry. The advice is to use the cash they Matrix, a portfolio planning model that classified business units generate to invest in other industries. into four categories that were functions of market growth (a ■■ Dogs—Business units with small market share in a slow-grow- proxy of market attractiveness) and market share (a proxy of ing industry. Candidate should be liquidated (see Figure 3). a company’s strength). The purpose of this model was to help managers allocate resources among competing units, which the SWOT Analysis model classified as: Fortunately, some easy-to-use frameworks such as Strengths, ■■ Stars—Business units with large market share in a fast-grow- Weaknesses, Opportunities and Threats (SWOT) Analysis ing industry. Good candidates for investments. proved valuable. SWOT was probably inspired by the mili- ■■ Question Marks—Business units with small market share tary concept of Net Assessment although its academic origins in a fast-growing industry. They require investments, but the are disputed. Some give credit to Albert Humphrey, others to outcome is uncertain. George Albert Smith and C. Roland Christensen. The purpose

MAY | JUN.15 CONTINGENCIES 31 Tag CONTINUED The Connection Between Military and Businees Strategies CONTINUED

FIGURE 6 The Value Net

of SWOT Analysis is to understand the business’ strengths and 1. Bargaining power of suppliers—availability of substitutes, weaknesses within the industry where it operates, because in- supplier competition, switching costs; and dustry determines to a great extent opportunities and threats. 2. Bargaining power of customers—buyers’ elasticity of demand, Strengths and weaknesses include patents, work force expertise, switching costs, availability of information (costs, quality, etc.). management ability, location, reputation, etc. Opportunities and Porter’s Five Forces, a staple of business education, are usu- threats include suppliers, competitors, regulation, etc. The fa- ally depicted as shown in Figure 5. mous SWOT framework is a two-by-two matrix (see Figure 4). Although this approach is sound for identifying risks and op- To further illustrate the influence of military thinking portunities, anybody who has used it knows how difficult it is to on business strategy, note that the SWOT framework was extract from it anything other than broad conclusions—e.g., “we “strengthened” by linking it to distinctive competencies (a con- should build strategic resources”— especially in rapidly evolving cept originally developed by the Navy). The analogies don’t end industries. For this reason, more general frameworks have been there: What would a firm have to do if it lacked those critical developed, such as the Value Net. competencies? Some advocated taking risks to acquire them and considered this approach—willingness to take risks—to be The Value Net a competency in itself. Adam Brandenburger and Barry Nalebuff noticed that corpora- Critics point out that SWOT results can be general and dif- tions usually compete with other “players” (firms, in this context) ficult to translate into effective plans of actions. For this reason, to achieve growth goals and to capture market share (see Think- SWOT is better used as one of several tools in strategic analysis. ing Strategically by Adam Brandenburger and Barry Nalebuff ). Unlike Porter, Brandenburger and Nalebuff incorporate in their Porter’s Five Forces model the idea that competition is not necessarily a zero-sum Perhaps the most famous framework is Porter’s Five Forces (see game (a term borrowed from Game Theory) because growth can Competitive Strategy by Michael Porter). Derived from concepts be achieved by selling more than rivals (zero-sum game) or by of industrial organization economics, this model is used to ana- growing the market (non-zero-sum game), or by doing both. How lyze the five competitive forces that shape the industry in which players understand and perform their roles (i.e., their level of co- a firm competes, and, consequently, determine industry profit- operation and their level of competition) determines the outcome ability. Three forces are related to horizontal competition: of the “game,” that is, the outcome of interactions. The authors 1. The threat of substitute products or services—e.g., ability to sub- point out that in certain circumstances some rules can be changed stitute products or services, ease of substitution, switching costs; to make the game more favorable, and they explain how this can 2. The threat of new entrants—entry barriers (e.g., patents), cus- be achieved. There are four types of player in the Value Net: tomer loyalty, regulation, capital requirements; and 1. Customers 3. Rivalry among established competitors—price and product 2. Suppliers features transparency, market penetration, advertising. 3. Competitors Two forces are related to vertical competition: 4. “Complementors”

32 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG FIGURE 7 Modeling the Dynamics of the Obese Population

Genetic Predisposition

Exercise

Real Food Prices Awareness

Genetic Predisposition Depletion

Obesity Rate OR(t) B R

Depletion Lifestyle

Complementors, a concept introduced by Brandenburger managers improve their understanding of the environment in and Nalebuff, are players whose products or services add value which their companies operate and to practice decision making. when bought together. The Value Net makes it clear that ignor- For a general description of this tool, including the Causal Dia- ing them—which happens frequently—can be a costly mistake. gram shown in Figure 7, see System Dynamics in the September/ For example, in the computer industry, microprocessor man- October 2011 issue of Contingencies. ufacturers and software developers are complementors: The One of the building blocks of System Dynamics is Causal more powerful the microprocessor, the more sophisticated the Diagrams, which depict cause-and-effect relationships between software, and vice versa (see Figure 6). relevant variables. If you can draw correctly the causal diagram, With an understanding of how the four types of players in- you understand how the system operates—and you can model it. teract, and realizing that they do not necessarily have to battle For example, key aspects of the evolution of the obese popula- zero-sum games, Brandenburger and Nalebuff identify elements tion can be represented as follows (see “Modeling Obesity” in the that should be part of any sound strategy. November/December 2012 issue of Contingencies) (see Figure 7). With the mathematical model, policymakers can test sce- System Dynamics narios and answer questions such as the following: The purpose of System Dynamics is to model the evolution of ■■ What would the effect of taxes on unhealthy food be—a re- complex systems that respond to feedback loops and are subject duction or an increase in the obese population? (The answers to cause-and-effect delays. Such systems, usually represented in might be surprising.) physics by sets of differential equations, depict many real-world ■■ Will the obese population reach a point of equilibrium if no situations. System Dynamics has been applied to the study of actions are taken to curb obesity? the Cold War arms race, simulation of scenarios of OPEC oil ■■ If actions are taken to reduce obesity, how much time will it production, forecasting the demand for life insurance, undertake for these initiatives to yield results, and how significant standing company morale, predicting the evolution of the obese will they be? population, etc. System Dynamics has also been used to cre- ■■ What is the expected increase in health care costs to society? ate Management Flight Simulators, analytical tools that help ■■ What are the effects of increasing obesity on quality of life?

MAY | JUN.15 CONTINGENCIES 33 Tag CONTINUED The Connection Between Military and Businees Strategies CONTINUED

Game Theory Game Theory studies the interactions of self-interested agents. However beautiful Even at a basic level—that is, without the aid of sophisticated the strategy, you should mathematics—it can be very useful to tackle real-life problems. Consider the following framework, called The Prisoners’ Di- occasionally look at lemma: Two men are suspects in a crime. They are interrogated separately in an effort to extract the truth from them, and they the results. are told that their sentences will be as follows: —Winston Churchill ■■ If they both confess, then both will be convicted of a minor offense and sentenced to one year in jail. By the 1990s, many managers who looked for answers to ■■ If both defect, then both will be sentenced to jail for five years. practical problems became disenchanted, not only with Pop ■■ If one confesses and the other does not, the confessor will Strategy but also, by association, with strategy in general. For be released immediately but the other will be sentenced to example, in 2002 Kim Warren writes in the preface of his book 10 years in jail. Competitive Strategy Dynamics that “the Strategic Management The best course of action for both men (“the system”) is field is in a somewhat sorry state today, as compared with the to cooperate—the best course of action for each individual is confidence it exhibited in the 1970s and 1980s.” to confess, whether the crime was committed or not. To use a Game Theory term, confessing is the dominant strategy because Blue Ocean Strategy it always produces the best individual outcome. Do behaviors Pop Strategy has been very influential even in academic circles. change if the same game is played repeatedly? Yes, because the For example, Blue Ocean Strategy, an idea developed by Chan suspects understand that a gain today can result in future losses. Kim and Renee Mauborgne, maintains that instead of competing Consequently, in repeated games, we should expect some degree among each other in existing industries (“Red Oceans”), compa- of cooperation. nies should create uncontested market spaces (“Blue Oceans”) This simple framework has interesting applications in the to render competition irrelevant. The authors introduce tech- business world, such as with supply chain management, where niques to facilitate attaining this goal, such as the Strategy the decisions of self-interested players lead to suboptimal out- Canvas, a two-dimensional graphical representation of the com- comes, known in this context as double marginalization. The ponents that make products or services better. Management, realization that profits could be improved if one decision-maker according to the authors, should decide which components were in charge explains the popularity of vertical integration to must be eliminated, reduced, raised, or created. reduce the number of self-interested players. This is why in its The recipe style of the ideas proposed by Kim and origins Ford Motor Company not only produced automobiles Mauborgne in their book, Blue Ocean Strategy: How to Create but also controlled raw material (steel mills, iron mines, glass Uncontested Market Space and Make the Competition Irrele- factories, etc.) and the production of auto parts such as tires. vant, are summarized in the Wall Street Journal online review, Why is it that vertical integration, so popular with large What is Blue Ocean Strategy (http://guides.wsj.com/manage- industrial companies during most of the 20th century, is in de- ment/strategy/what-is-blue-ocean-strategy/; accessed Jan. 24, cline? The answer is that technology has changed the rules of the 2015), which introduces the book as “a leadership guide fea- game—but the new rules can be analyzed with Game Theory. turing step-by-step how-tos.” In it, Kim and Mauborgne give examples of companies that they believe have created “Blue Pop Strategy Oceans” such as Cirque du Soleil, which reinvented itself by The lure of easy-to-understand strategic frameworks was re- introducing opera and ballet while eliminating animals from sponsible for the creation of a profitable industry, Pop Strategy, its shows. While it is difficult to disagree with the premise that which promotes the use of strategic terminology but offers little it is better to operate in uncontested markets than in highly more than generalizations and frequently flawed advice. (The competitive environments, critics point out that the prescrip- authors of this article adapted the term Pop Economics, coined tion is so general that it offers little guidance, for example, to the by Nobel Prize Laureate Paul Krugman). The problem with pop health insurance executives who face regulatory uncertainty frameworks is twofold: First, they generally advocate a formu- and fierce competition in public exchanges. For criticism about laic approach to strategy, usually the result of observations in the ideas presented in Blue Ocean Strategy see “Ocean Strategy, unrepresentative data samples; second, they are ill-equipped Red or Blue Belongs to the Dead Sea,” published by the TRU to tackle problems in dynamic environments—that is, in most Group (http://trugroup.com/whitepapers/TRU-Blue-Ocean- real-world situations. Strategy.pdf; accessed Jan. 24, 2015). It is important to point

34 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG out, however, that Blue Ocean is influential among many manag- of the historical context in which strategy evolved is useful, par- ers and scholars, as attested by the creation of the Blue Ocean ticularly a good grasp of the thoughts of those with practical Strategy Institute at INSEAD (see http://centres.insead.edu/ expertise and clear minds. Paraphrasing some of the principles blue-ocean-strategy/; accessed Jan. 24 2015). Headquartered in of military strategy discussed in “A Lesson From the Greeks” France, INSEAD is a premier European business school. (Contingencies, November/December 2014), it is a good idea to keep in mind that: From Good to Great ■■ Competition is unpredictable; it involves skill and chance; Few Pop Strategy books can match the influence of From Good ■■ Competition is dynamic; it demands constant reassessments, to Great as inferred by the 4 million copies sold. Author Jim adaptation, and management of resources; Collins analyzed 11 companies that transformed themselves ■■ Strategy involves general principles and frameworks, not reci- from, well, good to great, where the criteria to achieve great- pes for success; ness is sustained periods outperforming competitors as well as ■■ Strategic thinking involves the ability to craft plans that are the stock market. likely to improve outcomes; The purpose of From Good to Great was to identify the cor- ■■ Strategic analysis requires foresight; that is, it involves the porate traits of success, which Collins summarized as focusing ability constantly to assess risks and opportunities; narrowly on business objectives and areas of competence, and ■■ Any tools or abilities, analytical or otherwise (e.g., intuition), in the development of assets/capabilities that support them. that improve one’s judgment also increase the chance of suc- Collins, like many pop strategists, has been criticized for his cess and therefore are strategic instruments. backward-looking approach, the small sample size of his study, sample bias, etc. But perhaps the most damaging piece of evi- If you don’t have the dence is, ironically, the performance of the 11 “great” companies since the book was published. As a group they have amply un- time to do it right, derperformed the stock market, and two of them became “dogs”: Fannie Mae and Circuit City. Interestingly, Collins admits that what makes you think his praised 11 deteriorated to mediocrity but, he points out, he that you’ll have the never asserted that this elite group would perform well in the future. time to do it over? Despite these gaps—the failures of Fannie Mae (rescued by the government) and Circuit City (went out of business), the luke- —Seth Godin warm performance of the other nine “great” companies, flaws in the analysis, the author’s own admission that the “great” compa- The track record of military strategy is strong. The track nies deteriorated to mediocrity—the book is still considered by record of business strategy is mixed. Is it so because business many almost a business bible. For reviews, see “A Well-Crafted problems are more difficult to tackle than military problems? Critique of Business ‘Success’ Books and My Ambivalence About No. Is it for lack of corporate resources? No. Maybe the answer Good to Great” by Bob Sutton (http://bobsutton.typepad.com/ lies in our tendency to apply simplified frameworks instead of my_weblog/2009/04/a-wellcrafted-critique-of-business-suc- facing complexity head-on. History shows that doing so requires cess-books-and-my-ambivalence-about-good-to-great-.html; a serious commitment to learning, hard work, the ability to pon- accessed Jan. 24 2015) and “Good to Great to Gone” in the on- der, a dose of foresight, flexibility to adapt, and the capacity to line edition of The Economist (http://www.economist.com/ tolerate risk. node/13980976; accessed Jan. 24, 2015). Similar criticism ap- CARLOS FUENTES, MAAA, FSA, FCA, MBA, MS, is director plies to other famous Pop Strategy books such as Tom Peters’ of the actuarial and underwriting departments of the and Robert Waterman Jr.’s In Search of Excellence. commercial products at Security Health Plan of Wisconsin. His professional interests include strategy, particularly system Is Strategy Useful? dynamics and game theory. He can be reached at carlos_ Even a cursory review of strategic tools can be overwhelming [email protected]. because it typically presents a multitude of summarized ideas TOM MAKI, MS finance, is the director of strategic financial that cannot be appreciated in a quick read. The sense of un- planning and analysis at Security Health Plan of Wisconsin. easiness is amplified by the fact that the merits of some theories Tom has many years of experience in strategic planning, are disputed, suggesting—correctly—that even practitioners and forecasting, and budgeting. He can be reached at trmaki7@ scholars disagree on basic points. This is why an understanding gmail.com.

MAY | JUN.15 CONTINGENCIES 35 LOOK TO THE NORTH For a Better Approach to Financing Social Security

OCIAL SECURITY HAS A SIGNIFICANT FINANCING PROBLEM. Under best-estimate assumptions, System assets (on a combined trust fund basis) are projected to be exhausted in 2033. If no action is taken by Congress before then, System benefits payable in 2034 will effectively be reduced by almost 23 percent S across the board. If Congress adopts actions similar to those taken in the 1983 Amendments, the financing problem may be temporarily solved, but such actions would be unlikely to produce long-term sustainable solvency.

Actuarial valuations prepared by Social Security actuaries The figure also shows projected combined trust fund exhaus- have shown that the System has been out of actuarial balance for tion in 2033 and the approximate levels of benefits expected to a long time, and the long-range actuarial deficits have been gen- be supported by System tax revenues in the years following the erally increasing from year to year. The American Academy of expected trust fund exhaustion. Actuaries has, for many years, called on Congress to take action The figure clearly shows that under these “best estimate” to address Social Security’s financial problem sooner rather than assumptions, System revenues are projected to be insufficient later. Unfortunately, because of the accumulation of relatively to provide for future scheduled System benefits despite accu- large trust funds and no expressed commitment to accumulate mulation of combined trust fund balances of $2.764 trillion as larger trust funds, Congress has ignored the increasing actuarial of the end of 2013. deficits and calls for reform. Fortunately for us there exists a reasonable precedent for Figure 1: OASDI Income, Cost, and Expenditures as Percentages solving Social Security’s financial problem using an actuarial of Taxable Payroll [Under Intermediate Assumptions] approach. The actions taken for the Canada Pension Plan serve 25% as an excellent blueprint for the changes currently needed for Cost: Scheduled Cost: Scheduled but not fully Social Security. and payable payable benefits Based on the Intermediate Assumptions described in the 20% benefits 2014 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors and Federal Disability Insurance Trust Funds (2014 OASDI Trustees Report), the cost rate (the ratio 15% of program cost to taxable payroll) for the combined programs (referred to in this article as “Social Security” or “System”) is expected to increase from 13.95 percent of taxable payroll for Income 10% Expenditures: 2014 to 17.03 percent for 2034. By comparison, the income rate Payable benefits as percent of Payable benefits = (the ratio of program income to taxable payroll) for 2034 is scheduled benefits: income after trust projected to be only 13.18 percent of taxable payroll, a shortfall 5% 2013-32: 100% fund depletion in of 3.85 percentage points of taxable payroll. The cost rate is 2033: 77% 2033 projected to increase after 2034 to 18.19 percent for 2088. The 2088: 72% cost rate projected for 2088 is expected to be 4.90 percent of 0% taxable payroll higher than the projected income rate for that 2000 2010 2020 2030 2040 2050 2060 2070 2080 2090 year. The trustees report provides a nice picture of this projec- Calendar year tion (see Figure 1). ISTOCK

36 CONTINGENCIES MAY | JUN.15 Steiner Ken By LOOK TO THE NORTH For a Better Approach to Financing Social Security

This feature discusses Social Security’s current financing problem, different measurements of the size of the problem, how the problem came about, how Canada solved a similar financing problem with the Canada Pension Plan (CPP), and why an approach similar to the one adopted for the CPP would be worth considering for Social Security.

Different Measurements of Problem Size There exists some confusion about the magnitude of the reve- long-range period that are increasing and reach 4.90 per- nue increases/benefit reductions necessary to solve the System’s cent of payroll for 2088. These large deficits indicate that financial imbalance. Pages 65 and 66 of the 2014 trustees report annual cost continues to exceed non-interest income after discuss several alternatives: 2088, so continued adequate financing would require larger changes than those needed to maintain solvency for the 75- Assuming the intermediate assumptions accurately capture year period. Over the period extending through the infinite future demographic and economic trends, solvency for horizon, the actuarial deficit is 4.1 percent of payroll under the program over the next 75 years could be restored us- the intermediate assumptions. ing a variety of approaches. For example, revenues could The last paragraph above is a somewhat vague reference for be increased in a manner equivalent to an immediate and the need for System reform to meet the requirements of “sustain- permanent increase in the combined Social Security payable solvency.” This concept was developed by Social Security roll tax rate from 12.40 percent to 15.23 percent (a relative actuaries and is one that is also recommended by the American increase of 22.8 percent), cost could be reduced in a man- Academy of Actuaries in its issue brief, Actuarial Perspective on ner equivalent to an immediate and permanent reduction the 2014 Social Security Trustees Report (October 2014): in scheduled benefits of 17.4 percent, or some combination of approaches could be used. The American Academy of Actuaries’ Social Security Com- However, eliminating the actuarial deficit for the next mittee believes that any modifications to the Social Security 75-year valuation period requires raising payroll taxes or system should include sustainable solvency as a primary goal. lowering benefits by more than is required just to achieve Sustainable solvency means the program is not expected solvency, because the actuarial deficit includes the cost to run out of money any time in the 75-year projection pe- of attaining a target trust fund ratio equal to 100 percent riod, and trust fund ratios are expected to finish the 75-year of annual program cost by the end of the period. The ac- projection period on a stable or upward trend. Sustainable tuarial deficit could be eliminated for the 75-year period solvency is a stronger standard than actuarial balance in two by increasing revenues in a manner equivalent to an im- ways. First, actuarial balance is based on averages over time, mediate and permanent increase in the combined payroll without regard to year-by-year figures that could indicate tax from 12.40 percent to 15.39 percent (a relative increase inability to pay benefits from trust fund assets at some point of 24.1 percent), reducing cost in a manner equivalent to along the way. Second, actuarial balance can exist even when an immediate reduction in scheduled benefits of 18.2 per- trust fund ratios toward the end of the period are trending cent, or some combination of approaches could be used. sharply downward. Sustainable solvency, in contrast, requires Under the intermediate assumptions, the OASDI strict year-by-year solvency AND trust fund ratios that are program has large annual deficits toward the end of the level or trending upward toward the end of the period.” ISTOCK

MAY | JUN.15 CONTINGENCIES 37 Look to the North CONTINUED

While the Academy statement above clearly favors System that the enacted changes would solve the 75-year actuarial modifications that produce sustainable solvency over modifi- deficit in existence at the time. Prior to the 1983 amendments, cations achieving just a 75-year actuarial balance, it does not the System had been financed on a nearly pay-as-you-go ba- quantify the immediate increase in tax rates or reductions in sis. After the 1983 amendments, Social Security actuaries and benefits necessary to achieve sustainable solvency. Presumably, other experts struggled with what to call the implied funding sustainable solvency can be achieved through a combination of anticipated under the new law. Some individuals argued that actions that will reduce the actuarial deficit by something close the large fund accumulation was not intended. Ultimately, So- to the infinite horizon actuarial deficit of 4.1 percent. cial Security actuaries decided that the financing implied by the So, while we may not have agreement on the magnitude of rev- 1983 amendments was no longer pay-as-you-go, but instead was enue increases or benefit reductions required to restore long-term partial advance funding. The 1983 amendments contained no solvency to the System, there does seem to be some agreement that provisions to ensure that such partial advance funding would action should be taken soon to avoid the significant benefit reduc- continue in the future; in fact, many experts at the time weren’t tions that will occur when System trust fund assets are exhausted. sure that accumulation of such a large fund was a good idea. Therefore, Congress had little commitment to preserve the spe- How Did We Get Here? cific level of advance funding anticipated under the law. The 1983 amendments to the System were designed to solve In the years following the 1983 amendments, the annual the 75-year actuarial deficit in existence at that time (deter- trustees reports did indeed show declining actuarial balances, mined under the Intermediate II-B due primarily to reflection of previous- assumptions). In addition to adopting ly unrecognized revenue shortfalls and several benefit reductions, Congress in- The 1983 amendments changes in assumptions and methods. By creased the System’s tax rate in several did not consider the 1989, the System was no longer considered steps to reach its ultimate level of 12.4 significant revenue to be in close actuarial balance; the actu- percent (combined employer and em- arial deficit divided by the average cost ployee rate) in 1990 and later years. The shortfalls that were rate over the 75-year period exceeded 5 System’s income rate was expected to be expected to occur in the percent. greater than the System’s cost rate un- Historically, the trustees generally til about the year 2020, and huge trust years following the viewed falling out of close actuarial bal- funds were projected to accumulate dur- end of the 75-year ance as a call for changes in the System to ing the first half of the 75-year projection projection period. bring it back into actuarial balance. How- period to be sufficient (when combined ever, in 1989, the trustees decided that with expected System revenues) to meet since System assets were increasing and the shortfalls expected to occur in the second half. were expected to increase for quite a number of years, there was But the 1983 amendments did not consider the significant no need to make changes necessary to bring the System back revenue shortfalls that were expected to occur in the years into actuarial balance. Page 86 of the 1989 trustees report stated: following the end of the 75-year projection period. Unlike the Because the program is projected to be solvent for several approach recommended to solve today’s financing problem, decades in the future, the Trustees do not recommend that there was no consideration prior to 1983 of the concept of long- any immediate action be taken to change either the financing term sustainable solvency. or benefit provisions for the OASDI program. However, study The Social Security actuaries in 1983, however, were fully and analysis concerning the implication of the expected large aware that the OASDI cost rate would likely increase rapidly buildup of the trust funds and possible ways of addressing the from 2005 to 2030 because the number of System beneficiaries deficits projected for the distant future should begin soon. was projected to increase much more rapidly during that period than would the number of covered workers. This outcome was Thus began a period—now extending to 26 years and counting— the result of relatively high fertility rates from the end of World where no action was taken to solve the long-range actuarial deficit. War II to the mid-1960s, followed by relatively smaller numbers Even though trust fund assets totaled about $2.8 trillion at the of persons born during the subsequent periods of low fertili- end of 2013, the 1983 amendments anticipated that the funds would ty. While the 1983 amendments reduced the 75-year actuarial be much larger by then. Arguably, once the System fell out of close deficit to essentially zero, they did very little to address this ex- actuarial balance, tax rates should have been increased, benefits pected increase in System cost rate projected from 2005 to 2030. decreased (or some combination should have occurred) during the While the actuarial experts may have been fully aware in past 26 years so that the System’s actuarial balance was maintained. 1983 of the expectation of a declining actuarial balance in future years and may also have been aware of the buildup of large The Great White North Is In the Black trust fund balances as part of the 1983 “solution,” arguably the Canada offers a different perspective on the challenges of financ- members of Congress who voted for the law were only aware ing a national retirement plan. A close study of how that country ISTOCK

38 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG has navigated the past several decades will suggest steps the U.S. could take now to help mitigate its own financing problems. Appendix A of the 26th Actuarial Report on the Canada Pen- sion Plan (CPP) provides an excellent background of the actions leading up to and taken as part of the 1997 Amendments to CPP. Applying the CPP Approach to Social Security In summary, the 1997 amendments involved increasing contri- In conclusion, the author believes that the actions taken in the bution rates over the short term, reducing the growth of benefits 1997 amendments to the CPP represent a good starting blueprint over the long term, and investing net cash flows in private mar- for solving Social Security’s long-term financing problems. Spe- kets. The amendments also included significant changes to the cifically, adoption of a combination of increased taxes intended Plan’s financing provisions, including the introduction of steady- to remain level after an initial phase-in period, reasonable ben- state funding intended to build a reserve of assets and stabilize efit reductions, and self-sustaining provisions based on the the ratio of assets to expenditures over time and full funding of results of actuarial valuations to safeguard accumulation of de- any increases in benefits or new benefits. sired levels of System funding would improve intergenerational According to Appendix A, “The combination of steady-state equity, provide a better price tag for the System and increase the funding and full funding supports the objective of the 1997 re- public’s confidence in the program. It is too bad that we haven’t form package to improve the financial long-term sustainability taken such action sooner, but it is not too late to do so now. of the Plan so that the CPP will be affordable and sustainable This year’s trustees report contains the following conclusion for future generations.” with respect to the long-term problem: In brief, to determine the steady-state rate, the CPP actuar- The Trustees recommend that lawmakers address the ies project benefits and revenues for 75 years and solve for the projected trust fund shortfalls in a timely way in order to lowest contribution rate to stabilize the asset-to-expenditure phase in necessary changes gradually and give workers and ratio over time. Specifically, this lowest or steady-state rate is the beneficiaries time to adjust to them. Implementing changes combined employer and employee contribution rate for which soon would allow more generations to share in the needed the projected ratio of Plan assets to expenditures 10 years after revenue increases or reductions in scheduled benefits. the end of the current three-year review period equals the same Social Security will play a critical role in the lives of 59 mil- ratio projected for 60 years after the review period. lion beneficiaries and 165 million covered workers and The CPP’s steady-state rate plus any additional rate needed their families in 2014. With informed discussion, creative for full funding of benefit enhancements as described above thinking, and timely legislative action, Social Security can gives the minimum contribution rate for the Plan. For each ac- continue to protect future generations. tuarial valuation of the CPP, the minimum contribution rate is recalculated to reflect actual experience since the previous The leadership of the actuarial profession has often en- valuation, as well as changes in assumptions and methodology. dorsed the concept of serving the public need. Tom Terry, then Consistent with the concept of sustainable solvency discussed president of the American Academy of Actuaries, said in the above, the CPP asset-to-expenditure ratio is expected to reach a November/December issue of Contingencies: stable level and remain at that level for at least the next 75 years. The Academy builds trust both by caring about doing the right If the minimum contribution rate is higher than the legislated thing and then by doing it to the best of our collective ability. rate, and the federal and provincial governments do not take We care deeply about the consequential public policy issues action, the insufficient rates provisions in Section 113.1 of the for the American people, such as ensuring Social Security’s Canada Pension Plan statute will apply to automatically increase benefits and the promise of public pension plans. Earning this the contribution rate and/or freeze benefits. trust means continually holding ourselves to the highest stan- The CPP actuaries call this steady-state rate a partial fund- dards of scrutiny when serving the public interest. ing approach that is a hybrid of pay-as-you-go financing and full funding. An important part of the 1997 amendments was the The author encourages the profession and its members to advo- increased responsibility given to the actuarial valuation reports cate an actuarial approach for Social Security similar to the one under the law. The CPP legislation now includes self-sustaining employed for CPP as the “creative thinking” that the trustees provisions (automatic adjustments) to safeguard desired levels (and our lawmakers) so desperately need in fulfillment of the of Plan funding in the event that the minimum contribution rate profession’s duty to the public. exceeds the legislated contribution rate and no recommenda- KEN STEINER is a retired pension actuary. He is a former tion is made by the federal and provincial ministers of finance vice president for pension issues and chairperson of the Social to either increase the legislated rate or maintain it. Insurance Committee for the American Academy of Actuaries. He Thus, the financing approach adopted for the CPP envisioned endeavors to support the Academy’s mission to serve the public a “Self-Sustaining Sustainable Solvency”—designed not only and the actuarial profession in his retirement by helping individuals to achieve sustainable solvency at the time of adoption of the develop reasonable spending budgets in retirement via his blog at ISTOCK changes, but also to maintain it automatically in the future. http://howmuchcaniaffordtospendinretirement.webs.com/.

MAY | JUN.15 CONTINGENCIES 39 Medicaid The sweeping health care reform means some big changes for home and the ACA and community- based services— and who’s eligible to receive them.

By Robert M. Damler and Marlene T. Howard

HE AFFORDABLE CARE ACT (ACA) has by the Medicaid program and are agreed upon by the state and had a significant effect on the way consumers, federal government agencies. While Section 1915(i) predated payers, and providers operate in the health care the enactment of the ACA, the ACA legislation provided some market. For Medicaid programs in particular, the modifications to Section 1915(i) that increased its visibility in the ACA implemented changes that affected eligibility, HCBS landscape. The modifications have prompted a number funding, and policy related to the Medicaid proof states to apply for the inclusion of HCBS in their respective gram. While 28 states are moving forward with state plans through the 1915(i) provision.2 the implementation of Medicaid eligibility expansion for indi- The 1915(i) state plan option is viewed as a flexible solution viduals between the ages of 18 and 64 and below 138 percent of to meeting the HCBS needs of individuals who do not qualify T 1 the federal poverty level (FPL), many other aspects of the 2010 for the more restrictive eligibility criteria under a 1915(c) waiv- legislation provide additional opportunities for eligibility and er program. Prior to deciding to implement a 1915(i) state plan benefit changes that would interest key stakeholders and war- option, there are several important implications that must be rant consideration in actuarial budget forecasts. considered. This article discusses several features and consid- One of the additional items relates to Section 1915(i) of the erations of the 1915(i) state plan option. We will also consider Social Security Act (SSA), which addresses the inclusion of a unique example of a state that overcame Medicaid eligibility home and community-based services (HCBS) in the state plan. challenges by implementing a program using the 1915(i) state

State plan services refer to the scope of benefits that are covered plan option. SHUTTERSTOCK

40 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG Overview of Home and Community-Based Services Figure 1: High-Level Comparison of 1915(c) “Home and community-based services” refers to a set of benefits Waivers and 1915(i) State Plan Option that are designed to assist individuals with alternatives to insti- 1915(i) State Plan tutional care. The individuals require assistance with activities Option (after ACA ` 1915(c) Waivers revisions) of daily living (ADLs) and may receive therapies to manage and Service array Home and community- Same requirements treat chronic conditions. The required intensity of services will based services outlined as 1915(c). Service vary depending on the degree of an individual’s disability. In under Section 1915(c)(4) offerings are not limited the Medicaid program, this service array has traditionally been (b) of the SSA. Examples: to the services provided Case management, through established provided under parameters set forth in Section 1915(c) of the homemaker, respite 1915(c) waivers, SSA, which requires that an individual satisfy state-established care. provided they are within institutional level of care criteria in order to become eligible for the parameters outlined in Section 1915(c)(4)(b) the HCBS waiver services. As a result, the majority of historical of the SSA. Medicaid experience for HCBS reflects the cost profile of a long- Income 300 percent of 150 percent of FPL.* term care or nursing home population (i.e., those who meet the eligibility Supplemental Security state-established institutional level of care criteria). Income Federal Benefit The 1915(i) state plan option offers an alternative method Rate. of providing HCBS through the Medicaid program. Recently, Medically State-established Needs-based many states have been exploring this option and are interested needy institutional level of criteria that are less eligibility care. stringent than 1915(c) in understanding the fiscal impact of 1915(i) implementation. requirements requirements**. When using historical experience to project expenditures for a Example: Assistance 1915(i) state plan option, actuaries and states need to consider with two activities of daily living. the varying risk profile of the targeted population, particularly for services that may already be provided under a 1915(c) waiver. Target Permitted. Permitted. populations The cost of services as part of a waiver may not be fully compa- (waiver of rable to the cost for a population targeted for the 1915(i) state comparability plan option, given the eligibility requirements that may vary requirements) between the 1915(c) waivers and the 1915(i) state plan option. Statewide Permitted to be waived. Not permitted to be application waived. The table in Figure 1 provides a comparison of the key policy issues between 1915(c) waivers and the 1915(i) state plan option. Enrollment Permitted. Not permitted. limits The sections that follow provide additional detail and describe the evolution of the 1915(i) state plan option, from its roots in the Demonstration Required. Not required. of cost Deficit Reduction Act to modification under the ACA. neutrality

*The income threshold for 1915(i) may vary, as explained later in this article. The Deficit Reduction Act and 1915(i) **Needs-based criteria will vary with the income threshold for 1915(i). Section 1915(i) of the SSA was established under Section 6086 of the Deficit Reduction Act of 2005 (DRA), which discussed ■■ States did not have to demonstrate cost neutrality compared “Expanded Access to Home and Community-Based Services for with institutional expenditures for the eligible population: the Elderly and Disabled.” Effective Jan. 1, 2007, this version of This is primarily because there would be no comparable Section 1915(i) afforded states the flexibility to add certain home institutional cost for individuals who do not have to meet in- and community-based services to the Medicaid state plan.3 Prior stitutional level of care criteria for 1915(i) eligibility. to the DRA, these services had to be included as part of a 1915(c) ■■ Income eligibility threshold at 150 percent of FPL: In addition waiver program and could only be offered to individuals who to meeting the needs-based criteria with a less restrictive defi- met institutional level of care criteria. nition than institutional level of care, an individual’s income In order for individuals to be eligible for benefits under the must be no higher than 150 percent of the federal poverty 1915(i) state plan option, the Medicaid program had to establish level to be eligible for the 1915(i) service package. needs-based criteria, which were required to be less stringent ■■ Comparability requirement had to be met: Any Medicaid-cov- than those defined for institutional level of care. The more re- ered individual who met the medical necessity criteria could laxed needs-based eligibility definition could result in escalating utilize the HCBS package offered under 1915(i) (comparabil- program costs. As a result, states were given the option to limit ity requirement). the number of people receiving the service package and estab- ■■ Statewide application requirement was waived: States were lish waiting lists, to recognize budget constraints that could be permitted to limit the geographic scope of the 1915(i) state present with implementing the 1915(i) state plan option. plan option. Under the ACA, states are no longer permitted Other significant aspects of the 1915(i) state plan option as to waive the statewide application requirement for services presented in the DRA include the following: provided through the 1915(i) state plan option.

MAY | JUN.15 CONTINGENCIES 41 Medicaid and the ACC CONTINUED

ACA and New Considerations burden required to amend the current waiver and demon- Section 2402 of the ACA focused on “Removing Barriers to strate cost neutrality in order to provide additional HCBS. HCBS” and applied some important revisions to Section 1915(i). It is important to note, however, that because 1915(i) eligi- The Centers for Medicare and Medicaid Services (CMS) sub- bility is determined by needs-based criteria and cannot be sequently issued a final rule on Jan. 16, 2014, that provided restricted to waiver enrollees, any individual who qualifies clarification and additional information related to the revised for this 1915(i) plan design can utilize these services without Section 1915(i). enrolling in an HCBS waiver. One of the most significant modifications to Section 1915(i) ■■ Design 1915(i) service packages that mirror one or more was the addition of Section 1915(i)(7), which allowed states to of the current 1915(c) benefit packages: This benefit design define target populations for the delivery of the HCBS benefit would allow a state to extend the scope of the HCBS to indi- package. This section waives the comparability requirement es- viduals who are eligible for the 1915(c) waiver but are unable tablished in the DRA version of Section 1915(i). The CMS final to enroll because of enrollment limits presented by the waiv- rule proposed that the parameters for the target populations er. An approved 1915(i) application of this type would allow be defined by “diagnosis, disability, Medicaid eligibility groups, states to offer the waiver service package to additional eligible and/or age.” individuals without having to amend the current waiver to The waiver of the comparability requirement allowed states increase enrollment slots, and would resolve any waiver wait- to do the following: list issues. This strategy can also lead to a smooth phase-out ■■ Define multiple target populations for 1915(i) and tailor mul- of the current 1915(c) waivers if the state elects not to renew tiple HCBS packages that could be individually allocated to the 1915(c) waiver at the end of the demonstration period. each population; and A final key component of the ACA as it relates to Section 1915(i) ■■ Vary the amount, duration, and scope of a single 1915(i) ser- was the allowance for states to introduce an optional medically vice between various target populations. needy eligibility group that could qualify for full Medicaid cov- If states choose to define target populations, CMS will pro- erage upon meeting the needs-based criteria for 1915(i) services. vide approval for an initial five-year period, and the 1915(i) Using the 1915(i) state plan option as a vehicle for comprehensive application will need to be renewed at the end of the period for Medicaid coverage can assist states in targeting certain groups subsequent five-year approval periods. States are required to that would not otherwise be eligible for Medicaid benefits. use needs-based criteria in defining the target population, and The following example highlights the method one state used are not permitted to require that an individual be assigned to a in applying this provision to ensure continued Medicaid cover- specific Medicaid eligibility group. For example, a state cannot age to one such specialized group. require enrollment in a 1915(c) waiver in order to be eligible for the services outlined in the 1915(i) state plan option. Indiana Medicaid: 1915(i) for Behavioral and While the ACA allowed the comparability requirement un- Primary Health Care Coordination der 1915(i) to be waived, it eliminated the enrollment limit and On June 1, 2014, the state of Indiana converted from Section waiting list provisions of the original 1915(i). Consequently, 209(b) status to Section 1634 status. (In summary, a state op- states need to be vigilant in their definitions of needs-based cri- erating under Section 209(b) status establishes state-specific teria and/or target populations, in order to manage the cost of eligibility criteria for Medicaid disability status rather than the 1915(i) program as a component of state Medicaid budgets. accepting the Supplemental Security Income (SSI) disability The ACA also expanded eligibility for the 1915(i) state plan determination. Under Section 1634 status, Medicaid eligibility option to individuals with incomes up to 300 percent of the determinations for disabled individuals would be based on SSI Supplemental Security Income Federal Benefit Rate. If states eligibility determinations.) choose to use this income eligibility definition for a 1915(i) ser- The Office of Medicaid Policy and Planning (OMPP) raised vice package, individuals must meet an institutional level of care the income eligibility limit to 100 percent of FPL for disabled as well as the needs-based criteria defined by the state. If states individuals. This change enabled many beneficiaries affected by maintain the income eligibility threshold of 150 percent of FPL the transition to maintain full Medicaid coverage. Individuals as established by the DRA, individuals do not have to meet an with incomes exceeding this threshold would generally be eli- institutional level of care. gible to purchase insurance through the exchange marketplace The waiver of the comparability requirement and the ex- and to receive premium subsidies. Unfortunately, a number of panded income eligibility definition result in the following individuals were at risk of losing Medicaid coverage who were options in the design of a 1915(i) service package for a popula- classified with serious mental illness, not meeting institutional tion that meets an institutional level of care: levels of care, and with income levels exceeding 100 percent of ■■ Offer home and community-based services that are not FPL. Prior to the Section 1634 transition, these individuals qual- currently covered under the 1915(c) waiver: In this sce- ified for a set of mental health services through the Medicaid nario, the 1915(i) state plan option reduces the administrative Rehabilitation Option. With the conversion to Section 1634 status

42 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG The goal of the 1915(i) service was to provide a pathway to full Medicaid coverage and the specific mental health services that would be required by the eligible individuals. in the state, it was uncertain whether third-party reimbursement ■■ Centers for Medicare and Medicaid Services (January 16, would be available to these individuals for the level of mental 2014). “Medicaid Program; State Plan Home and Community- health services needed to function safely in the community.4 Based Services, 5-Year Period for Waivers, Provider Payment To allow for continuation of Medicaid coverage for this Reassignment, and Home and Community-Based Setting population, therefore, OMPP applied for a behavioral and pri- Requirements for Community First Choice and Home and mary health care coordination (BPHC) service under the 1915(i) Community-Based Services (HCBS) Waivers; Final Rule.” state plan option, which is a care management benefit targeted Federal Register. See http://www.gpo.gov/fdsys/pkg/FR- to adults age 19 or older with a qualifying mental health condi- 2014-01-16/pdf/2014-00487.pdf. tion and income up to 300 percent of FPL. ■■ U.S. Government Accountability Office Report to Congressio- The goal of the 1915(i) service was to provide a pathway to nal Requesters (June 2012). “Medicaid: States’ Plans to Pursue full Medicaid coverage and the specific mental health services New and Revised Options for Home- and Community-Based that would be required by the eligible individuals. This result Services.” See http://www.gao.gov/assets/600/591560.pdf. was achieved through the optional eligibility group provisions ■■ Letter from Centers for Medicare and Medicaid Services to and the income disregards for medically needy individuals out- State Medicaid Directors (August 6, 2010). “Re: Improving lined in Section 1902 of the SSA.5 Due to the 1915(i) program Access to Home and Community-Based Services.” See http:// changes under the ACA, Indiana was able to maintain access to www.medicaid.gov/Federal-Policy-Guidance/downloads/ critical mental health services for more than 4,500 individuals. SMD10015.pdf. ■■ Letter from Center for Medicaid and State Operations to State Summary Medicaid Directors (April 4, 2008). “Guidance on Implemen- In the period between the January 2007 effective date of 1915(i) tation of Section 6086 of Deficit Reduction Act of 2005.” See as set forth by the DRA and the revisions introduced by the ACA http://www.medicaid.gov/Federal-Policy-Guidance/down- in 2010, only five states had incorporated HCBS into their state loads/SMD040408.pdf. plans. By August 2014, 12 states were participating in the 1915(i) ■■ O’Keeffe, J., Saucier, P., et al. (October 29, 2010). “Understand- state plan option and four more states were planning to partici- ing Medicaid Home and Community Services: A Primer, 2010 pate in federal fiscal year 2014. The growing popularity of the Edition.” See http://aspe.hhs.gov/daltcp/reports/2010/prim- 1915(i) state plan option can be attributed to its flexibility, which er10.htm. allows states to do the following: ROBERT M. DAMLER, MAAA, FSA, and Marlene T. Howard, ■■ Provide a vehicle for full Medicaid coverage to medical- MAAA, FSA, are consulting actuaries with the Indianapolis office ly needy individuals who would not otherwise qualify for of Milliman. Their expertise with the Medicaid industry primarily Medicaid; involves consulting to state agencies. ■■ Add HCBS and/or expand coverage of individuals who meet institutional levels of care without having to amend current Endnotes 1915(c) waivers; and 1 Kaiser Family Foundation (August 28, 2014). Status of State Action of the ■■ Meet the HCBS needs of Medicaid enrollees who have a Medicaid Expansion Decision. State Health Facts. Retrieved October 27, 2014, from http://kff.org/health-reform/state-indicator/ degree of physical and intellectual disability that does not state-activity-around-expanding-medicaid-under-the-affordable-care-act/. qualify them for institutional levels of care. 2 According to the Kaiser Family Foundation, 12 states were participating in A key consideration in the implementation of a 1915(i) ser- the 1915(i) state plan option and four more states were planning to participate in fiscal year 2014, as of August 2014. See http://kff.org/medicaid/state-indicator/ vice package is that the delivery of HCBS through the state plan section-1915i-home-and-community-based-services-state-plan-option/. may assist in managing eligible individuals’ chronic conditions, 3 In an April 4, 2008, letter from CMS to state Medicaid directors, the and may lead to savings by delaying or avoiding more costly care service offerings were limited to any or all of the following: “case management in a hospital or other institutional setting. As a result, both the services, homemaker/home health aide services, personal care services, adult day health services, habilitation services, and respite care. In addition, the program cost and potential offsets in other service categories following services may be provided for individuals with chronic mental should be presented in discussions of the financial implications illness: day treatment or other partial hospitalization services, psychosocial rehabilitation services, and clinic services (whether or not furnished of providing the 1915(i) state plan option. in a facility).” 4 Indiana Family and Social Services Administration. Behavioral and Primary Useful Resources Healthcare Coordination (BPHC) 1915(i) Home and Community Based Service (HCBS). Retrieved October 27, 2014, from http://www.in.gov/fssa/files/BPHC_ The following resources were instrumental in the writing of this Overview_Presentation_for_Providers.pdf. article, and are also very good references for additional informa- 5 More information related to the BPHC program is available on the Indiana tion related to the 1915(i) state plan option: Medicaid website at http://www.in.gov/fssa/ddrs/4862.htm.

MAY | JUN.15 CONTINGENCIES 43 Special Section: 2015 SOFTWARE SHOWCASE

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MAY | JUN.15 CONTINGENCIES 45 Workshop CATHY MURPHY-BARRON

ACA and More—Health Care Reform in 2015

LAST NOVEMBER, the 2014 midterm elections brought significant long term, we are right on track. The fol- change to Congress. As Republicans gained control of the Senate and lowing are four key priorities the HPC has identified for 2015: maintained control of the U.S. House of Representatives, it was clear that ■■ ACA implementation—The HPC will we could expect significant change in the legislative agenda for 2015. continue to focus on the ongoing implementation of the ACA, includ- Only days after the elections, the Acad- elimination of the Cadillac plan tax, the ing providing input to policymakers emy held its Annual Meeting and Public individual and employer mandates, and and regulators on the risk-sharing Policy Forum, which featured breakout the medical device tax. mechanisms, the rate review pro- sessions with experts discussing the lat- But panelists also were quick to note cess, minimum and actuarial value est policy efforts in retirement security, that the ACA was not the only health- determinations, and the implications property and casualty issues, and health related issue on the agenda for 2015. of various market reforms. For ACA care reforms. The health track in particu- Other issues subject to discussion, de- implementation, we often target our lar convened a panel of five congressional bate, and even legislative action include communications to regulators, which staffers—bicameral and bipartisan—to dis- Medicare, specifically the sustainable is why, in addition to the panel with cuss what we might expect from the 114th growth rate and premium support re- congressional staff, the Academy’s An- Congress on health care-related issues. forms; long-term care; delivery system nual Meeting included two breakout The first message we heard was that reforms; electronic health records; and sessions that featured experts from the there would be plans to vote again on a even comprehensive tax reform. administration who walked attendees wholesale repeal of the Affordable Care After getting a sense of the legislative through the current regulatory envi- Act (ACA); however, the panelists noted landscape, the question is how we incor- ronment for several of these key ACA that without a veto-proof majority in the porate these insights into the Academy’s provisions, in some cases providing Senate, proposals to replace the ACA with work in the health care area. Fortunately, an overview of new changes (e.g., pro- new legislation would take center stage. the Academy’s Health Practice Council posed updates to the actuarial value And as Republicans gained control of both (HPC), in conjunction with the Annual calculator). But we do recognize that chambers of Congress, several provisions Meeting, held its own planning meeting information and education are still in the ACA were specifically targeted for to identify priorities for this year. The needed on many provisions of the modification this year—including the good news is that in both the short and ACA—both for policymakers and for regulators—and we will continue to communicate any actuarial implications on efforts to delay/repeal either of the mandates, the provision that would change the definition of small group to include groups up to 100, and more comprehensive proposals to replace the ACA. ■■ Long-term Medicare viability—We all know the Medicare program faces long-term solvency and sustainability challenges, and the HPC is committed to exploring various proposals introduced to address these financial problems. Such proposals include transitioning Medicare to a premium support program, reforming the sustainable growth rate (SGR) formula (i.e., the doc fix), increasing the eligi-

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Medicare’s premium and cost-sharing delivery system and payment reforms more commonly referred to in policy structure, among others. In addi- and how they would affect the private communities—including a focus on un- tion, in light of the 50th anniversary market as well as public programs like derstanding long-term care insurance, of Medicare this year, the Academy Medicare and Medicaid. In 2014, the product and plan design, and portability. will be preparing a series of papers Academy also entered into a three-year The legislative and regulatory landscape that provide basic information on the partnership with the Health Care Cost can change at a moment’s notice—espe- Medicare program for policymakers, Institute (HCCI) that provides access cially in light of significant events, such as consumers, and the media. to HCCI’s data, allowing the Academy elections—so it’s crucial to get feedback ■■ Delivery system and payment re- to more effectively focus much of its from congressional and agency staff on forms—There is much discussion own public policy work. changing priorities, and to take that in- about the need to move away from a ■■ Long-term care—Several of the congres- formation into account as we set our own system that pays for volume instead sional panelists mentioned long-term agenda. The Academy’s Annual Meeting is of value. Panelists during the Annual care as an issue on the legislative ra- just one opportunity to hear from policy ex- Meeting breakout sessions stressed dar. Generally, it seems as though perts at the federal and state levels. the importance of continuing to focus many staffers are trying to get a sense If you are interested in engaging in on stemming health care cost growth, of possible public and private financing more public policy work, we encourage suggesting further study on how mechanisms, the potential for differ- you to volunteer with one of the Acad- comparative effectiveness research, ac- ent outcomes based on different care emy’s many committees and task forces countable care organizations (ACOs), settings, and incentives for moving and help us broaden our efforts to share and medical homes, for example, have to more home and community-based the actuarial perspective with policy- affected health care costs. This is an- care. The Academy’s Long-Term Care makers and regulators. other area to which the Academy and Committee is working on a series of the HPC are devoting a number of papers that provide basic informa- CATHY MURPHY-BARRON is vice resources. We have volunteers work- tion on aspects of LTC—or long-term president of the Academy’s Health ing on papers that examine various services and supports (LTSS), as it is Practice Council.

November 12-13 | Marriott Wardman Park | Washington, DC ANNUAL MEETING AND PUBLIC POLICY FORUM L Learn about the latest PUBLIC POLICY developments from federal and state policymakers L Earn PROFESSIONALISM CE L HONOR your distinguished Academy colleagues and mentors L NETWORK with Academy members from all practice areas 50th Anniversary Gala Dinner Celebration

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Actuarial Managed Services: Business Case and Leading Practices

OVER THE PAST FEW DECADES, insurers—like companies in other industries—have fundamentally changed their sourcing approach for many important operations, turning to managed services as a solution. Managed services, such as outsourcing and software-as-a-service (SaaS) initiatives, have reshaped the information technology (IT) function at many companies.

Third-party administrators (TPAs) Key alternative sourcing options: there are the perennial internal cost took on many billing, accounting, and managed services versus pressures on finance, risk, and related claims management tasks for insurers. offshoring functions for more established providers. These companies also took on broader Executives must always find ways roles within the life insurance and an- Managed Local third-party providers to do more with less. And doing more nuity sectors, such as assuming greater Services are contracted to give is very much an issue for actuarial lead- responsibility for the administration of partial or complete ers, as new market pressures, operational closed blocks, thereby creating a new actuarial support for demands, and changing regulatory re- sourcing model in the process. Some selected actuarial functions quirements are increasing the actuarial insurers have also outsourced functions on an ongoing basis workload. Most insurers simply do not that require a heavy, upfront investment have enough actuarial bandwidth and ex- in infrastructure and people, such as Offshoring Large global companies pertise to handle all of the required work. variable annuity hedging programs. create their own offshore Outdated legacy systems are prevalent Traditionally, insurers have viewed actuarial teams, often in and driving the need for actuarial trans- the actuarial function as a core compe- low-cost geographies, formation; the resulting transition to a tency, and for the most part, it has not assuming responsibility transformed operating model also places been sourced to third-party providers. for overhead related to near-term constraints on in-house actu- Today, however, market complexity, cost associated infrastructure arial resources. Even if there were enough pressures, and a shortage of talent are and resource management actuaries to go around, hiring them full causing many insurers to rethink the best time might not make economic sense, approach for all kinds of work and func- given the need for flexibility to meet sea- tions—including actuarial. Why actuarial managed services? sonal demand spikes. This article examines the emergence Why now? The talent gap pinches insurers in oth- of actuarial managed services as a via- In a time of considerable industry er ways, too: Senior actuaries are spending ble component of an insurer’s operating change, multiple catalysts are driving a significant amount of time on adminis- model in a broader context. Specifically, insurers to consider new sourcing mod- trative processes and relatively low-value it will outline the foundational business els as a means to drive efficiency gains tasks, while the high training costs for case, highlight processes that are good and boost performance. At a macro level, new recruits have long payback periods. candidates for migration to managed the entry of nontraditional market par- There is also the issue of retaining and re- services, and suggest a few effective first ticipants—such as private-equity firms cruiting staff in select geographies. steps for insurers considering moving and start-up reinsurers that lack infra- At the same time, increasing product forward with a new sourcing approach structure and operational expertise—has and business complexities have raised the

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Figure 1: Actuarial Managed Services—Who and Why?

Organization Type General Applicability of Managed Services Functional Candidates for Managed Services

Large established Managed services to be used selectively to address non-core ■■ Model validation/model risk management program insurers activities, and/or free up skilled resources to increase internal support bandwidth on core activities. ■■ Valuation support of closed blocks

Medium-sized insurers Managed services to be used to provide necessary bandwidth ■■ Financial model maintenance on core and non-core activities as needed, help meet increasing ■■ Valuation support for select open blocks demands on actuarial function. ■■ Process and control efforts

Small-sized insurers or Managed services to be used to administer core actuarial ■■ Full valuation support new market entrants functions in the near term, with an eye toward ‘recapture’ once ■■ Experience study analysis achieved.

robust decision support, and quality out- support while its organization grows and cases, co-sourcing actuarial processes puts. Constant adaptation to emerging becomes more established over time. Fig- can reduce actuarial costs on a net ba- change competes with resources’ atten- ure 1 provides a view of the applicability sis as well. tion to provide this value-added analysis and deployment of a managed services ■■ Access to leading practices, market and enhancement of the actuarial para- model for insurers of varying sizes. insights and advanced technology: As digm. The challenge is even greater We see that the appropriateness of with the most effective sourcing part- for global organizations, which expect managed services to an individual orga- nerships, companies can also benefit consistency and are looking for market nization should take into consideration from improved access to leading prac- insights and trusted business advisers company size, current actuarial function tices, market insights, and advanced with front-office accountability. staff levels and capabilities, current and technology. In this way, actuarial anticipated future demands on the actu- managed services can be designed to Organizational applicability arial function, and considerations for the enhance the quality, consistency, and Companies of all sizes and types face growth of the underlying organization. timeliness of information. This un- diverse issues and market challenges, dertaking can even increase the value making the applicability of managed ser- The business case actuarial services contribute to the busi- vices and related considerations different Managed services, or “actuarial-as-a-ser- ness, through strengthening analytical for each organization. Large established vice,” offer a clear and compelling value and decision support capabilities. providers typically have a wider inter- proposition amid the challenges on select ■■ Management focus: Robust operation- nal resource pool to handle fundamental organizations and associated functions. al support allows senior management to actuarial requirements but may have a The key components of the business focus on new transactions and chang- wider array of demands to deal with, such case include: ing business priorities, in lieu of more as Federal Reserve oversight or a broader ■■ Resource flexibility and cost savings: commoditized work, such as reserve product base to service. An efficient and flexible cost structure calculations or model maintenance. Relative to a smaller insurer or new may look especially attractive given market entrant, the prospect of managed the impact of the talent shortage on What works in a managed service services for established large insurers may costs and the likelihood that regula- model? present an avenue to carve out repeatable, tory change will increase demand on As with IT and finance, the processes or non-core tasks, freeing up resources to fo- actuarial teams. Indeed, gaining cer- functions best suited to a managed ser- cus on other value-added activities. The tain access to critical resources through vice model are repeatable or periodic in new market entrant, on the other hand, peak demand cycles and as business nature, and have clearly defined work could see managed services as an ave- needs change is another important requirements. For instance, within fi- nue to provide core actuarial back-office variable in the value equation. In some nancial reporting and enterprise risk

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Which actuarial processes are leading candidates for managed services?

Good Candidate? Product Function Financial Reporting Modeling Function Risk Management Function Function

No Production function Financial reporting Assumptions Risk and capital framework basis changed Risk appetite

Maybe Pricing Analysis of results Ad hoc projections Reinsurance program reviews Illustration and Current topics Decision support & Profitability and risk analysis compliance analytics

Likely Rate filings In-force valuations Model maintenance Model validation Experience studies Reconciliation and Production runs Customer analytics controls

management, functions that may be well pabilities to provide stable support suited for managed services include re- As profound changes during the transition and initial phas- serve recalculations, cash flow testing, reshape the insurance es, as well as over the long term. Lastly, and periodic validation of financial mod- there is a benefit in having a clearly de- els Other processes, such as product industry landscape, fined “ramp-down” process if insurers repricing, experience studies, and period- companies are more wish to reassume control of certain ic profitability and risk analysis, may also reliant on the efficiency tasks and functions. fit well within a managed services model. Clearly, the processes that speak to and effectiveness of their The bottom line the core of the business model and are sourcing relationships. As profound changes reshape the in- more bespoke in nature, including prod- surance industry landscape, companies uct strategy and design and the definition are more reliant on the efficiency and of risk appetite, are not good candidates ments can be clearly defined and effectiveness of their sourcing relation- for managed services or co-sourcing. mapped at the onset ships. Even with traditionally critical Still, by using managed services for other Experienced managed services pro- competencies within the actuarial func- tasks, companies benefit by freeing up se- viders can and should help in identifying tion, there is a real opportunity to gain nior actuarial staff to focus on these more the applicable functions and assessing a competitive advantage by optimiz- vital steps, rather than dealing with non- each function’s feasibility under a man- ing subprocesses and the capabilities. strategic matters like product tax or cash aged services solution. Such partner also Indeed, it has become a strategic im- flow testing. should have a clear and proven approach perative given the high-complexity to transitioning processes and ongoing market and ever-changing regulatory Taking the right first steps oversight. environment. These forces are push- Once an insurer decides to pursue a man- A leading practices approach fea- ing many insurers to embrace managed aged services model, the first step often tures clear and complete specifications services for their actuarial functions— involves evaluating and identifying the for all targeted processes, implementa- a strategic evolution that is likely to right processes and functions for inclu- tion models, and regular planning and continue and gather steam given the sion in a managed services model. Ideal review meetings, as well as frequent clear business justification. The value characteristics of functional candidates touch points to triage issues and stay proposition is there for insurers ready for managed services are: ahead of requirements. Clear protocols to move forward. ■■ Repeatability—the work is periodic for knowledge transfer are another en- Dave Czernicki, Kush Kotecha, and in nature abler of success. Dave Cosentino work in Ernst & Young’s ■■ Leverageable—the majority of the It’s also worth asking managed ser- Chicago office in the Insurance and work can be handled by junior staff vices providers if they have sufficient Actuarial Advisory Services practice. ■■ Non-subjective—the work require- technology and data management ca-

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Models at Work By Jawwad Farid

FOR ABOUT 15 YEARS NOW, I have always lost an argument. You see, in almost every project relating to developing or promoting the actuarial role in risk management, the question comes up: Should the project focus on the insurance and pension sectors, where actuaries have widely recognized expertise, or should there be a broader scope— risk management of all financial services, all businesses, or even all Farid walks us through example after example of a quantitative, model-driven organizations? approach to measuring and managing For 15 years now, I have always sug- anyone who was. Nor did I know exactly risk in a variety of situations. Farid is gested that the profession should first what actuaries would do outside of insur- an actuary, and his examples focus on establish our role in insurance and pen- ance and pensions. So I figured we were commodities such as jet fuel, palm oil, sions before we tried to claim expertise in better off trying to become masters of that wheat, corn, natural gas, crude oil, and other arenas where our profession has lit- somewhat limited world. precious metals, along with financial in- tle experience. But I was always overruled. But a 2014 book, Models at Work from struments including currencies, bonds, In theory, I agreed. It seemed plausible Jawwad Farid, provides one of the nec- stocks, and derivatives. Needless to say, that actuaries could make a contribution essary stepping-stones to the eventual Farid is not exactly sticking to insurance outside of insurance … I just didn’t know invalidation of my position. In MaW, and pensions.

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7439-KPMG-AxisActuarialAd-Rev3-25.indd 1 3/25/15 5:24 PM If a risk consultant doesn’t come questions for a risk analyst: risks, it is also peppered with commen- from a trading background or is not 1. What is the exposure? tary and advice that reads almost like the exposed to risk practices and ends 2. What is the trend of the exposure? best cookbooks or travel books. up working with a client who is 3. What is the impact of the risk factors just as unfamiliar, together they can A derivative instrument is very on an exposure? do a lot of damage. similar to bottled water in the Gobi 4. What is our risk appetite? Desert. Its value is completely But, at the same time, he is not try- That list of questions very much re- determined not by itself but by an ing to impress readers with his technical minds me of my study notes for the external factor. The environment. acumen. MaW is instead a matter-of-fact actuarial exams. It’s a general list that guidebook to building and using models can be applied to any risk situation, even Most of the analysis is pretty standard for all these applications. It contains for- when you have no prior knowledge of the fare, presented in a thorough fashion. For mulas, but also full discussion of how to particulars of that risk. example, there is a list of market risk lim- execute the analyses with a spreadsheet. Over and over again, through more its for a money market product: He starts out walking us through an than 600 pages, Farid demystifies the ■■ Stop-loss limits analysis of the possible considerations modeling process for each risk. And ■■ VaR limits of an airline that decides not to hedge while MaW provides step-by-step direc- ■■ Regulatory limits its fuel price risk. In that example, he tions for a novice to perform the analysis ■■ Inventory age limits explains the importance of four basic and risk management for a variety of ■■ Concentration limits

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7439-KPMG-AxisActuarialAd-Rev3-25.indd 1 3/25/15 5:24 PM Booklinks CONTINUED

■■ Duration limits A hundred pages of the book are de- risk managers. But a quick look at Wiki- ■■ Convexity limits voted to explaining how to build and pedia tells us that humans have been ■■ PVBP limits use Monte Carlo simulations for inter- using palm oil for 5,000 years! MaW The commentary urges caution est rates, currencies, commodities, fuel helps explain the action of Malaysian with these metrics and processes. hedging, and finally a stochastic model palm oil futures in 2008 and 2009. The Farid is realistic about the flaws of the to simulate Pakistan’s monetary policy price for palm oil futures at the end of most common practices. MaW is not and inflation. 2009 ranged from $2,578 for one-month a “neutral” how-to manual, but nor is That’s no accident—Farid is based futures to $2,670 for six–month con- it a call to reform inadequate proce- in Pakistan. MaW comes from his work tracts, with the range of prices over the dures. Instead he presents the standard teaching and training throughout the year going from a low of $1,330 to a high approach so that the reader can under- Middle East, and South and East Asia of almost $4,000. The analysis shows stand the mainstream analytics and over the past 20 years. He often works the trend of price volatility over the risk management techniques, along with businesses that want to apply mod- two-year period and sample VaR calcu- with cautions and warnings about the ern risk measurement and management lations under three methods. With this shortcomings thereof. techniques in economies without the analysis, the reader can be prepared to rich history of data collection and avail- set the limits for trading palm oil. The challenge in market risk is that ability that is common in the U.S. He has In a chapter titled “Energy Insights,” in most cases Risk is wrong. This is an MBA from Columbia University. Farid shows the volatility of energy because the models relied upon are This book is the first I have read that supply, usage, and prices in the same wrong—they are inaccurate by defi- addressed the problem of managing risk 2008-to-2009 time period—a tumultu- nition and design. They represent from palm oil futures contracts. Before ous time in the energy markets that saw approximations to the real world. reading MaW, I had never considered the price for a barrel of crude oil trade Not Risk’s fault, but this is how the palm oil as a commodity that required as high as $145 and as low as $30. Dy- game is structured. namics of the energy markets for the U.S., China, India, and Pakistan from that period point out the exponential growth of energy use in those four very populous countries. While this discussion was written prior to the current spike in oil and natural gas production from the U.S., Pension software solutions it seems likely from this discussion that the glut will be temporary at best. from WySTAR Global Models at Work can provide an analyst with the cookbook to apply risk DBVAL Defined benefit valuations and web benefit projections management in many different places DCVAL Defined contribution, balance forward recordkeeping, and for many different risks that are ESOPs and compliance of importance to businesses of many OPEVS Post-employment benefits kinds—most especially financial ser- TestWyz DB/DC compliance testing vices. And while it is not especially written for actuaries, we know well Find out more how to use tools like the four-point list Discover how your organization can benefit from partnering with a leading- of basic questions that boil complex edge technology provider. For more information, call us at 800-505-9076 analytics down to sets of rules that we or email us at [email protected]. You can also visit our website at can remember. www.wystar.com/solutions/software. Now we can add one more question to that list, one that’s discussed over and over again throughout MaW: What trends may cause the risk factors to change?

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©2015 SunGard. Trademark Information: SunGard, and the SunGard logo are trademarks or registered trademarks of SunGard or its subsidiaries in the U.S. and other countries. All other trade names are trademarks or registered trademarks of their respective holders. INS3259 Cryptic Puzzle CREATED BY JERRY LEVY; EDITED BY TOM TOCE

Der German Lesson

FROM TIME TO TIME, I take a board member for the University of Il- did employ connectors, they would all break from creating puzzles and run one linois LAS Alumni Association and also be of the “by,” “with,” and “and” variety, from a guest puzzler. This issue’s puzzle serves on the U of Illinois Department of with none of the “from,” “resulting in,” was created by Jerry Levy. Jerry was a Mathematics Advisory Board. Jerry had or other kinds of causal connectors. And pension actuary for over 40 years and several word puzzles published in The what fun would that be? So we have no recently retired. While working, he led Actuary many years ago and was inspired connectors. engagements for U.S. and global client by the cryptic crosswords in Contingen- The definitions below suggest two- companies in diverse industries helping cies to create another one. word crossword-style answers. The senior management reach consensus on This isn’t a cryptic puzzle, but it has “der” word is formed by adding “der” to changes affecting their corporate retire- some of the same elements, notably two the beginning or end of the root word. ment plans. definitions embedded in each clue. There For example, the definition “marsh bum- He was a frequent author on issues aren’t any connector words, though, be- per” suggests “fen fender.” Alternatively, affecting retirement strategy and pen- cause the words clued are different (one the definition “reduce the output swal- sion de-risking. Jerry is a volunteer being a subset of the other). If the clues lowed” might be “derate ate.” A clue such

Definition Root Word “der” Word First (or last letter) of Root Word

1 Michelin’s output comparatively banal 2 Gray-haired pack rat

3 Famous Argentinian one who got away 4 Smile, hero 5 Kind of river toll 6 Stranger dam 7 Famous cellist covering 8 One who rules meadow 9 Rubber cement can 10 Pasty tramp 11 Otherwise a group of monks 12 Duplicate pistol 13 Got off track, felt poorly 14 20C art interpreter 15 Midmonth gibes 16 In Spanish, the one born earlier 17 1940s café owner Crane 18 Belonging to a particular female cattle driver 19 Horse race next door 20 Average snake 21 German songs aren’t truthful 22 Health club he can dig 23 More astute harpy 24 Burly folk singer figures it out 25 Silvery metal combustible 26 Hello, concealer 27 Guys doctor 28 Gardener very early

60 CONTINGENCIESCONTINGENCIES MAY | JUN.15MAY | JUN.15 WWW.CONTINGENCIES.ORG as “Guard swamp,” however, could also “fen” is clued first, thus the first letter of The pertinent letters of the root yield “fender fen.” The order of the defi- “fen,” F, is needed. If the clue were “guard words spell out a sentence related to the nitions within a clue has no bearing on swamp,” the last letter of “fen,” N, would puzzle’s title. Four of the root words are whether “der” occurs at the beginning or be required. proper nouns. the end of the root word. Thanks to Eric Klis and Bob Fink for The order of the words within a clue Solutions may be emailed to test-solving and editorial suggestions. is important, though, as it indicates [email protected]. TOM TOCE is a senior manager for whether the first or the last letter of the In order to make the solver list, your solutions must be received actuarial services with Ernst & Young root word will be used for the final an- by May 31, 2015. in New York and is a member of the swer. In “marsh bumper,” the root word Jeopardy Hall of Fame.

Previous Issue’s Puzzle—Two Wheeler q. PISA—A SIP (“a little swig”) s. EARTH—(D)EARTH (“Top reversed off a small quantity”) Clockwise Clues (“federal revenue agent”) r. NUDNIK—Anagram of t. RASP—Anagram of “Spar” 1. SPRAT—Anagram of “traps” 20. SLEAZE—Surrounding “Dunkin” 2. HARKEN—HEN (“any kind “sleepover craze” of female bird”) around ARK Counterclockwise clues (“Noah’s boat”) Solvers a. ZEE—Double definition IUD—I + U (“used at first”) + D My apologies to Craig Schmid and John Herder, whose names were 3. b. ASLANT—AS (“like”) + LA (“a bit of withdrawal somewhat omitted from the solvers list last time. Craig forgave me and submitted a (“the Italian”) + NT (“New solution this time. I probably have to work harder to get John back. before the finish”) Testament”) ANISE—Hidden in Michael and Jina Accardo, Dean Apps, Bob Campbell, Lois Cappellano, 4. c. MOAT—Anagram of “atom” “womanises” Jonathan Currier, Todd Dashoff, Mick and Kris Diede, Sean Donohoe and d. BIN—Contained in OSAMA Josh DenHartog, dba T.O.C.E (The Thousand Oaks Cryptic Enthusiasts), 5. PORCHES—P (“quiet”) + BIN LADEN (“notorious Dave Dougherty, Greg Dreher, Deb Edwards, Bob Fink, Phil Gollance, Walter ORCHES (“orchestra off by a terrorist”) third”) Haner, Rich Harder, Pete Hepokoski, Catharine Hornby, Paul Ivanoskis, e. QUASAR—Contained in Eric Klis, Paul Kolell, Ken Kudrak, Adrienne Lewis, Jeanette Manning, Jerry 6. TIARA—Anagram of “Atria” “Massapequa’s Arena” PRECOCIOUS—PRECIOUS Miccolis, Lee Michelson, Jim Muza, David & Corinne Promislow, Daniel 7. f. VINY—V (“victory”) + IN + Y Rhodes, Craig Schmid, Bill Scott, Karen Skoglund, Sally Jane Smith, Doug (“Like some gems”) around CO (“the middle of Runnymede”) (“Colorado”) Szper, Todd Trimble, Jon Turnes, Dave Wallman, Jim Wickwire. g. RAJA—reversal of AJAR from 8. STENO—Anagram of “Stone” clue #14 (“turning 14”) 99 1 3 97 5 9. ONE—Homophone of “won” 95 h. TAXI - TAX (“Assess”) + I E Z S R 7 93 S T 9 100 2 4 A 10. COMES ON—Pun on CO- 98 6 91 A 11 (“one”) 96 8 K T E P A MESON (“One of a pair of 94 A H 10 i. NEWER—N (“Boston’s last”) + 89 L R N 13 O 92 N 12 subatomic particles”) E U 87 M 15 EWER (“pitcher”) T 90 I 14 11. FLOOR—FL (“Florida”) + O A A 85 88 D 16 j. GOOF—GO (“Play”) + OF from I B 17 N (“love”) + OR (“Oregon”) 86 I 18 83 OUTFIELD (“left, right, or Q N 19 S GWEN—G (“Good”) + NEW 84 E 12. 20 center”) U 81 A P 21

reversed (“new retrospective”) 82 S 22 k. LONESOME—LONE O R A 79 13. EXIT—IT (“fornication”) 23 80 R 24 (homophone of LOAN from C H

V following EX (“former lover I

25 78

“Lend out over the phone”) + 26 E after swapping”) S

SOME (“A little”) 75

27 I

14. AJAR - A + JAR (“surprise”) T A

CONNOTES—Pun on CON R l. 74

R 30

15. ANY—(M)ANY A

NOTES (“prison songs”) J

P 72

VIA—V (“five”) + IA (“Israeli A A 16. 31

m. SOUCI—Homophone of E

Army leaders”) I

R 69

“Sioux see” 33

68 36

17. RA—(I)RA E I

COREA—Homophone of 67 66 n. 35 E 38

18. SQUINT—‘S (“quickly—it’s”) U

G C

Korea (“singing country”) S 65

62 O

+ QUINT (one of the Dionne 42

o. PARTIES—PAR (“score as 63 39

60 N

44 S C S M

kids) 58 46

56 expected”) + TIES (“bonds”) 48

54 50

59 O

19. BOATMAN—BOA (“Accessory 43

p. CHORE—C (“Conservative”) + O 57 45

for cabaret singer”) + T-MAN 47

53 49 HORE (“hero confused”) 51

MAY | JUN.15 CONTINGENCIES 61 Puzzles LENNY SHTEYMAN

Goodbye. See you later!

AS SOME OF YOU ALREADY KNOW, this is my last issue as edi- and writing about Jewish holidays and tor of this puzzle column. I am not saying goodbye; I’m saying “See philosophical thoughts. I want to use this last opportunity to recognize my older you later.” I plan to submit solutions and suggest interesting puzzles to brother Genadiy Shteyman. He is not the co-editors who will replace me—Josh Feldman and Stephen Meskin. only my best friend, my swimming bud- Based on the quality of their previous solutions, I’m sure that I’m leav- dy, and my avid reader today. He is the ing my loyal readers in very good hands. one who challenged my curiosity with calculus-themed optimization problems There are two final puzzles: are typically: in the 6th grade, and whose math team 1. In triangle ABC, a point D is selected 1. Rational, impartial, and logical notes I read when he went away to col- on the side BC, such that the original tri- 2. Intelligent and well-rounded lege. When it came time for me to go to angle is divided into two triangles: ABD 3. Problem-solvers by trade college, he paid my tuition balance for the and ACD. Prove that the sum of radii of 4. Often internal consultants in their whole first year. Cherish your older sib- inscribed circles in triangles ABD and organizations lings, people who could have easily made ACD is larger than the radius of the in- 5. Aware of project deadlines (any deci- your childhood horrendously traumatic, scribed circle in triangle ABC. sion is better than no decision!) but chose not to! Since you read my mus- 2. Let’s create a sequence of numbers I think some actuaries, especially the ings this far, I would like to reward you as follows. Let a1 be a randomly selected more emotionally intelligent ones, could with a bonus problem I remember from 3-digit number, and let a2 be the sum of make great life coaches, when focused on my brother’s math team notes. squares of digits of a1. Each new term of decision-making instead of therapy. For the sequence is the sum of squares of dig- as long as I can remember, my friends Bonus problem: its of the previous term. Prove that this used me as a sounding board for mak- For a given triangle, let M be the median, sequence must contain either a 1 or a 4, ing decisions in unusual or challenging L be the bisector, and H be the altitude eventually, irrespective of the choice of situations, and they typically liked my drawn from the same vertex. Prove that the original number. suggestions. M ≥ L ≥ H. If you don’t care about my final mus- Finally, during the past two years of It was a real pleasure correspond- ings, you need not read any further. writing puzzles, I have used my print ing with all of you. Please look me up at Goodbye. See you later! space wisely for things that matter, sing- the next industry conference. Good luck However, if you like me, I wanted ing praises to my parents and my wife, with everything! Goodbye. See you later! to update you on a few things. After 12 years with AXA US, I switched to an- Last issue’s puzzle: other company, Prudential. Part of the 1. Numbers 1, 2, 3, …49 are written in the number 1 through 7 is written on that di- reason I am stepping down from my post table 7×7 as below. Random number is se- agonal exactly once. at Contingencies is because I want to fo- lected and its row and column are erased 3. Table 7×7 contains only non-negative cus on my new and exciting job. Second, from the table. This operation is repeat- numbers. Sum of all the numbers is 100. I owe my readers a continuation of last ed 7 times until the entire table is erased. The table is also symmetrical about one issue’s article about decision-making. Find the sum of the 7 numbers that were of its diagonals. The sum of the numbers I will keep it short and less humorous selected. written on that diagonal is 19. Prove that this time, and put it as follows: Actuar- 2. Table 7×7 is filled with numbers 1 sum of the numbers in any row or column ies should seriously consider looking to through 7 so that each column and each is less than 60. become personal decision-makers (well row contains all numbers 1 through 7. 4. Table 8×8 contains only non-negative beyond all issues financial) for people The table is symmetrical about one of numbers. Sum of all the numbers is 100. who have a hard time systematizing their the diagonals, i.e. numbers in symmetri- The table is also symmetrical about both decision-making. As a group, actuaries cal positions are equal. Prove that every of its diagonals. The sum of the numbers

Solutions may be emailed to 1 2 3 4 5 6 7 [email protected]. 8 9 7 11 8 13 14 In order to make the solver list, … … … … … … … your solutions must be received by May 31, 2015. 43 44 45 46 47 48 49

62 CONTINGENCIES MAY | JUN.15 WWW.CONTINGENCIES.ORG written on each diagonal is 19. Prove that H A Solvers list: sum of the numbers in any row or column G B Robert Bartholomew, Bob Byrne, Lois H G F E D C B A is less than 35. (Corrected from 30 to 35). Cappellano, Bob Conger, Deb Edwards, E D Yan Fridman, Rui Guo, David Kausch, Solution: D E Alex Kozmin, David Lovit, Jerry 1. Imagine that we enumerated 49 con- A B C D E F G H Miccolis, Lee Michelson, Dave Oakden, secutive days. Each row represents a B G Jeff Plank, David Promislow, Bruce week and each column represents a day A H Rosner, Craig Schmid, Noam Segal, Joel of the week. By following the procedure, A proof by contradiction similar to #3. Smith, John Snyder, Al Spooner, Elliott we are going to select each of the 7 weeks If sum of the numbers A through H were Steiner, Doug Szper, Daniel Wade once as well as each of the 7 days once. 35 or more, the sum of all the elements in Lenny Shteyman, a fellow of the Society The total is (1 + 2 + 3 +….+ 7) + 7*(0 + 1 + both rows and columns, without double- of Actuaries, is an actuary with AXA US 2 +…6) = 175. counting, would be at least 4*35 – 2*19 = in New York. 2. Every number 1 through 7 appears in 102. This is a contradiction, because sum the table exactly 7 times. Since the table of all numbers in the table is 100. is symmetrical, there is an even number of occurrences for each of them outside of the diagonal. Therefore, there is an odd Ad Index number of occurrences for every number To add your company’s name to this list, call Mohanna Sales Representatives at 972- 1 through 7 on the diagonal itself. Because 596-8777 or email [email protected]. For links to these advertisers’ email addresses there are only 7 available spaces, each and websites, visit the Contingencies website at contingencies.org/linksto_advert.asp. number must appear exactly once. Actuarial Careers Inc.®...... 5 3. Just to clarify the confusion many peo- 914-285-5100 | actuarialcareers.com ple had, numbers in this puzzle need not Actuarial Resources Corporation...... C3 be integers. With respect to the diagonal 913-451-5566 | arcval.com axis of symmetry of the table, each row American Academy of Actuaries ...... 48 has a symmetric column with exactly the 202-223-8196 | actuary.org same elements and one cell in common. Andover Research Ltd...... 3 212-986-8484 | andoverresearch.com A DW Simpson...... C2 B 800-837-8338 | dwsimpson.com C Dancing Dragonfly Winery...... 45 D 715-483-9463 | dancingdragonflywinery.com A B C D E F G Ezra Penland...... 1 F 800-580-3972 | ezrapenland.com G GGY Axis...... 11 877-GGY-AXIS | ggyaxis.com Proof by contradiction. Let’s assume Insureware...... 47, 49, 51, 53 that a given row adds up to 60 or more. +61 3 9533 6333 | 386-673-1919 | insureware.com In that case, its symmetric column also KPMG...... 56–57 416-777-8500 | kpmg.ca/lifeactuarialservices adds up to 60 or more. Without double- MIB...... 13 counting, the sum of all the elements in 781-751-6130 | mibgroup.com/healthriskID the row and the column combined would Oliver Wyman...... 55 be at least 60 + 60 – 19 = 101, because the 404-239-6431 | [email protected] | oliverwyman.com/actuaries number E in their intersection appears Pauline Reimer/Pryor Associates...... 17 in both sets and it has to be less than 19. 516-935-0100 | ppryor.com This is a contradiction, because sum of PolySystems Inc...... C4 312-332-5670 | polysystems.com all numbers in the table is 100. SunGard...... 59 4. Because the table is 8x8, its diagonals www.sungard.com/insurance | [email protected] do not have a common point. Therefore, Swiss Re...... 7 914-828-8000 | swissre.com every row and will have 2 symmetrical Towers Watson...... 9, 15 columns, and vice versa, each column 212-725-7550 | towerswatson.com will have 2 symmetrical rows. See dia- WySTAR...... 58 gram below. 800-505-9076 | wystar.com

MAY | JUN.15 CONTINGENCIES 63 MY WIFEANDIMOVEDTONORTHCAROLINA Cabin Fever 64 in ourmountainhomethispastwinter. Letmeexplain. gan’s brutalwinters, whichexplainshowwegotstrandedforfourdays in AnnArborfor thefirst timesince2010. that night,aswe watched my Spartanswin Paper column).We enjoyed a roaring fire writinganotherEnd poned toolong(like catching upwithtasksthathadbeen post Tuesday was filled with indoor chores and the mountain.But we were prepared, so that was our4.25-mile escaperoute down was askating rink,aswas thegravel road the eye couldsee. Suddenly ourdriveway trees andbushescovered iniceasfar had created overnight, withshimmering snow. We marveled atthebeauty nature the teens overnight and froze the melted began tomelt.Temperatures dropped to tain communityonMonday, andthen snowed about two inches in our moun version ofsnow andcoldweather. relaxed andwaited forNorth Carolina’s the birdfeeders andraked theleaves. We and filledthecarswithgas. I replenished state. Isplitsomewood forthefireplace overnight lows below zero across the led at amapofMichiganthatshowed temperatures in the low teens. I chuck snowfallimminent 3-to5-inch with forecasters warning residents of the felt smugaswe watched localweather some ofMichigan’s bitterest winters, I bad coulditreally be?Having survived food andsupplies…butcomeon,how weather andadmonitionstostock upon filled withreports ofloomingsevere our usualwinterexperience. early thisyear was quiteachangefrom tex thatdescendeduponNorth Carolina the 60soreven tops70. Sothepolarvor years, whenthetemperature creeps into rounds ofgolfinFebruary thepast five highs around 50. I’ve averaged abouttwo usually range from lows in the30sto EndPaper CONTINGENCIES But we weren’t ready fortheice. It The weekend TVnewshadbeen February temperatures in Asheville

BOB RIETZ MAY | JUN.15 - - - - dinner, followed by yet anothercozyfire. wine thatnightwithasplendidstir-fry and localnews. We enjoyed abottleof We caughtuponinternational,national, the day, butitran continuouslythatday. office. Ourtelevision is rarely onduring necessary laundryandcleanedmy home … addingtothelayer ofice. Ididsomeun- temperatures thatfelltothesingle digits same: alittlesnow, alittlemelting, and Wednesday morningwas more ofthe toescape Michi- four episodes of announced thatshehadjust watched dents tostay home. Latethatday, Nancy The TVfeatured more warnings forresi- dred miles. We weren’t goinganywhere. county road may aswell have beenahun- The 4.25 milesdown themountainto er ofsnow madeiteven more slippery. our driveway was thicker, andathinlay with anotherinchofsnow. Theicein ings more seriouslynext time. off themountainandintotown. are you?”) Regardless, itfeltgoodtoget often hear, “You ain’t from around here, ter than we Michiganders were. (We more prepared for a North Carolina win- suggested thattheyhadprobably been lar preparations toleave. Theirsmiles and neighborswaved astheymadesimi- our way outofthecommunity. Friends driveway totheroad andcarefully made prison. We inched down our still-frozen gravel road, freeing usfrom ourdomestic and lots of sunshine. A tractor scraped the afternoon, withtemperatures inthe40s below zero. a record low, dropping toninedegrees overnight. Friday night’s temperature set night off and the heat pump was set to 60 our separate areas. Thefireplace gotthe and frozen pizza,andthenreturned to each otherbrieflyforadinnerofsoup certain I was somewhere else. We saw house she’d be spending theday; Imade er waffles. Iasked Nancy where in the dwindle; Friday’s breakfast was toast temperatures above 30degrees. pump, whichwas designedtooperate in worry about the house’s geothermal heat ocre movie we watched. Icontinuedto fireplace did little to enhance the medi and cottage cheese. Another fire in the previous week . more TV than she had watched all the Thursday was cold,down tozero, We resolved totake weather warn- The weather finally broke Saturday Our food supply was starting to WWW.CONTINGENCIES.ORG Dinnerwas hamburgers Bonanza, which was - - -

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