a u s t r a l i a n a c t u a r i a l j o u r n a l

1998 Volume 3 Issue 3

Feature Articles

Ethics, Actuaries (and Robots) – Ian Robinson

For the Records

Discussion Paper on Superannuation Tax Reform and Simplification – C Nance

Notes

Expense Apportionment for Life Companies - Some Observations and Potential Profit Impacts – David Hotchkies.

ETHICS, ACTUARIES (AND ROBOTS)

Prepared by Ian Robinson, FIA, FIAA, ASIA, ASA

October 1998

This paper reviews the subject of ethics and ethical decision making from the perspective of actuarial work. Issues discussed include the general nature of ethics, business and professional ethics, and guidelines for resolving ethical problems. The paper then attempts to consider the ethical standing of the actuarial profession; a key focus of this section of the paper is the results and review of a recent survey of the actuarial profession in Australia. The paper concludes with some suggestions for how the profession should proceed to enhance the ethical profile of actuaries. i

ETHICS, ACTUARIES (AND ROBOTS)

TABLE OF CONTENTS

PART A REVIEW OF ETHICS AND ETHICAL DECISION MAKING ...... 1 1. INTRODUCTION...... 2 1.1. A Lesson from Robbie ...... 2 1.2. Outline of Paper ...... 3 1.3. Professionalism and Ethics ...... 4 1.4. Purpose and Scope...... 5 1.5. Structure of Paper...... 6

2. WHAT IT MEANS TO BE ETHICAL...... 8 2.1. Why ethics matters ...... 8 2.2. The nature of ethics ...... 9 2.3. Right vs wrong decisions ...... 11 2.4. Right vs right decisions...... 13 2.5. Values ...... 14

3. THE NATURE OF BUSINESS ETHICS ...... 17 3.1. The relationship between business and ethics...... 17 3.2. General comments...... 18 3.3. But why can it be so hard to be ethical?...... 19 3.4. When in Rome …...... 21

4. THE NATURE OF PROFESSIONAL ETHICS...... 23 4.1. Ethics as power sharing ...... 23 4.2. The importance of openness and trust...... 24 4.3. Ethical dilemmas in professional work...... 26 4.4. How is the shared morality of a profession maintained?...... 26

5. SOME PROFESSIONAL DILEMMAS...... 28 5.1. Whistleblowing...... 28 5.2. Maintaining confidentiality...... 30 5.3. Conflicts of interest...... 30

6. THE CODIFICATION OF ETHICS...... 32 6.1. The origin and nature of codes of ethics...... 32 6.2. What can be achieved by a code of ethics...... 33 6.3. The weaknesses of codes ...... 34 6.4. When codes work...... 35

7. RESOLVING ETHICAL ISSUES ...... 37 7.1. What should businesses do?...... 37 7.2. Ethical dilemma paradigms...... 37 7.3. Criteria for ethical decision making...... 39 7.4. Models for ethical decision making ...... 41 7.5. Ethical fitness...... 42 7.6. Sleep-test ethics ...... 43 ii

ETHICS, ACTUARIES (AND ROBOTS)

PART B THE ACTUARIAL PROFESSION AND ETHICS...... 45 8. ARE WE AN ETHICAL PROFESSION? ...... 46 8.1. What is expected of us?...... 46 8.2. What has been the reality?...... 48 8.3. Some further questions to ponder ...... 50 8.4. How have our actuarial values served us?...... 51 8.5. Other Professions...... 53 8.6. Bulletin Survey...... 54

9. SURVEY OF AUSTRALIAN ACTUARIAL PROFESSION...... 56 9.1. The survey aims and scope...... 56 9.2. The sample characteristics...... 57 9.3. General perceptions about ethical standards of actuaries...... 61 9.4. Factors influencing the ethical behaviour of actuaries...... 63 9.5. Ethical issues in actuarial work ...... 65 9.6. The Code of Conduct...... 68 9.7. Ethics education...... 70 9.8. Comparisons with Accounting Profession...... 74 9.9. Conclusions...... 74

10. FINAL COMMENTS AND RECOMMENDATIONS ...... 76 10.1. Dispelling the Myths...... 76 10.2. Call to Action...... 76 10.3. Conclusion...... 78

11. POSTSCRIPT ...... 80 11.1. Acknowledgements...... 80 11.2. Further reading...... 80 11.3. Contacts and courses ...... 81

12. REFERENCES...... 82

APPENDIX A WHY ETHICS MATTERS ...... 89 APPENDIX B VALUES IN STRATEGY FORMULATION ...... 90 APPENDIX C THE ETHICS DEBATE IN BUSINESS...... 94 APPENDIX D WHISTLEBLOWING...... 102 APPENDIX E THE FIFTY-NINE-STOREY CRISIS...... 105 APPENDIX F THE TROOPER’S DILEMMA...... 107 APPENDIX G MODELS FOR ETHICAL DECISION MAKING...... 110 APPENDIX H ETHICAL RESPONSIBILITIES ...... 112 APPENDIX I SLEEP-TEST ETHICS...... 113 APPENDIX J CATEGORIES OF ISSUES IN PROFESSIONAL ETHICS FOR ACTUARIES ...... 115 APPENDIX K ETHICS CENTRES AND LEARNING ...... 117 APPENDIX L ETHICS WITH SACRIFICE...... 118 1

ETHICS, ACTUARIES (AND ROBOTS)

PART A

REVIEW OF ETHICS AND

ETHICAL DECISION MAKING 2

ETHICS, ACTUARIES (AND ROBOTS)

1. INTRODUCTION

“The Three Laws of Robotics:

1 − A robot may not injure a human being, or, through inaction, allow a human being to come to harm.

2 − A robot must obey the orders given it by human beings except where such orders would conflict with the First Law.

3 − A robot must protect its own existence as long as such protection does not conflict with the First or Second Law.

Handbook of Robotics, 56th Edition, 2058 A.D.”

− Isaac Asimov, ‘I, Robot’, 1950

1.1. A Lesson from Robbie

The first time the author came across these three, disarmingly simple “laws” inscribed at the beginning of the late Isaac Asimov's unforgettable futuristic book, he was intrigued. Asimov, a maestro of science fiction writing (and non-fiction), was not only able to demonstrate in his stories how well the laws of robotics could provide a solid design framework for rationale and safe behaviour of mechanoids of the future, but how they could protect human life. His classic first story was that of Robbie, who protected, to the risk of his own “life”, the child entrusted to his care.

When flipping through the somewhat faded, but cherished, book, the author was able to see Asimov's Laws with a new insight, with a newly attained vocabulary, and realised they stated the code of ethics of robots. Asimov himself confirmed that he judged them as very much part of the core of values by which all humans should live.

Asimov was also able to show that, while the robots in his stories resolutely “lived” by these laws, they could still be confronted with the possibility of a “mental” meltdown or freeze when the laws seemingly came into unresolvable conflict. Often the problems arose because the degree or type of harm needed to be delineated by urgency, importance or time sequence. Sometimes confusion arose because of ambiguous or insufficiently precise instructions given to the robots.

A premise of this paper is that we humans and actuaries are likewise constantly confronted with decisions that can sometimes be difficult, if not impossible to resolve to everyone’s liking - not because we are trying to decide what is right, but because we are trying to decide which right alternative is best. In other words, as Kidder (1996) puts it, the problem is often not deciding between ‘right’ and ‘wrong’ but between ‘right’ and 3

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‘right’. Kidder labels the former problems as moral temptations and the latter as ethical dilemmas1.

1.2. Outline of Paper

The original spark for this paper came from reading the U.K. presidential address of Duncan Ferguson (1996) in which he stated:

“Although the code of conduct provides a framework, individual behaviour will essentially be a question of personal and business ethics, a subject which is discussed by all new Fellows at our professionalism courses, but rarely, if ever, at our sessional meetings or conventions ... Self-analysis, and open discussion of it, is more part of the national psyche in America than it is here, so it is perhaps not surprising that Business Ethics is a regular topic at Society of Actuaries’ meetings.” (p4)

After briefly explaining the role of ethical thought, he then proposed the following:

“It would be timely for us to indulge in a little ethical self-examination, perhaps at a sessional meeting, before burnishing our image and then seeking to enhance our reputation as the ethical guardians of the public interest in those matters which fall squarely within our purview.” (p6)

The subject of ethics was recently introduced as a distinct component of the Institute's professionalism course but the author suspects that many actuaries (and the public in general) have little understanding of ethics and ethical decision making as an area of study in its own right or indeed how it impinges upon the notion of professionalism. As a result, many may believe one or more of the following:

„ ethics is a private matter: it is concerned with nothing more than people's personal feelings, attitudes and beliefs;

„ ethics and business don’t mix: the leading U.S. economist Milton Friedman puts it bluntly, “The only obligation of a business is to make a profit”. In fact classical economic thought, on which business theory is based, is about optimising the allocation of scarce resources and, by itself, may conflict with ethics;

„ ethics is mostly “motherhood”: a paper such as this is therefore of little practical value;

„ ethics is complying with the law: the minimalist view that mere compliance with the law of the land is all there is to being “ethical”. 4

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This is not surprising, because while ethics has been studied as far back in time as the ancient Greeks and Romans, it is only in the last decade that it has become all the rage – some say an obsession – in business colleges and universities, particularly those in the US2. Major corporations are developing and promoting codes of behaviour and corporate core values (most probably for the first time). Iqbal (Carmichael 1997b) commented: “Ethics is a fascinating subject. Twenty to twenty-five years ago we would not have discussed it at all. The current interest in ethics is a by-product of the 1980’s, an era when the only thing that mattered was profit generated by your own endeavours, and how you got there was irrelevant, so long as you did not get found out.”

Whether or not this is too harsh a view, the fallout seems to be well illustrated by the list of references that the author was able to access but which barely touch upon the range and depth of source material available today.

Interest in the subject within the actuarial profession worldwide seems to be gathering pace. Since Duncan Ferguson's address (and possibly as a consequence of it), the UK Institute held a meeting in June 1997 with a guest speaker to discuss ethics for the profession. Subsequently, there were a couple of articles in The Actuary – Sharp (1997b), Booth (1997) – leading to a number of responses in the letters section. There has also been a paper prepared for the International Actuarial Convention this year by Sharp (1998) who had also authored a book on the subject of values (1997a). In the US, professional ethics has been a regular subject at Society of Actuaries meetings for a number of years – the profession there is large and malpractice suits are not uncommon.

1.3. Professionalism and Ethics

Some might suggest that ethics has long been a part of the Institute faith. After all, the Institute has had a Code of Conduct in place since 1970 by which all members are required to operate; this is just a code of ethics by another name. In addition, professionalism has been a regular topic for presidential addresses. And of course, as noted above, there is the professionalism course for newly qualified actuaries.

The author would agree with all such observations. Of course, we would probably all recognise that concepts of trust, honesty and fairness are fundamental to professionalism. But these concepts are values for personal, professional and business behaviour – they commit each of us to certain types of action generally acceptable to individuals we come into contact with and to the community at large. They are the corner stones for “good” behaviour. The laws of the land codify certain types of minimum acceptable or “good” behaviour patterns.

The paper will explain that ethical thinking and behaviour goes further than laws; further than the codes of conduct. The Institute of Chartered Accountants (ICA 1997) states that: 5

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“acting ethically means one is able to act appropriately and effectively in various situations, with confidence, responsibility and competence, and can provide a clear, coherent and reasoned justification for one's decisions and actions, with reference to commonly accepted standards.”

1.4. Purpose and Scope

“It started simply enough. Robot DV-5 multiplied five- place figures to the heartless ticking of a stop watch. He recited the prime numbers between a thousand and ten thousand. He extracted cube roots and integrated functions of varying complexity. He went through mechanical reactions in order of increasing difficulty. And, finally, worked his precise mechanical mind over the highest function of the robot world − the solutions of problems in judgment and ethics.”

− Isaac Asimov, ‘I, Robot’, 1950

The aim of this paper is therefore to bring the subject of ethics, particularly professional ethics, squarely into the field of view of the Australian actuary. In particular, the author hopes to:

1. increase the understanding in the profession of the nature of ethics and what constitutes ethical problems;

2. explain why ethical decision making is good for the profession and generally why, in the author’s opinion, it is good for business;

3. increase the awareness of actuaries as to when they are dealing with potentially ethical issues;

4. offer some general guidance as to how one could go about resolving ethical problems or dilemmas − warning: there is no cook book of solutions!;

5. allow the profession − for the sake of the profession − to feel less inhibited about talking about ethical issues of the past that, at least with the benefit of hindsight, may have been done differently, with more courage, and possibly with more honesty (at least to oneself); and

6. to suggest how the profession might go forward from here. 6

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While the paper considers the Institute’s Code of Conduct as a minimum ethical framework for members, the paper does not attempt to comment upon the specific elements of Code. Indeed it is suggested that it probably does not need any major overhaul. While the author believes ethics is at the “soul” of professionalism, the paper does not undertake a review of the meaning of professionalism as such – this has been well covered by many other writers, particularly in Institute presidential addresses. The interested reader is referred to the references at the end of this paper. For the same reason, the paper does not consider how the Institute and its disciplinary committee should deal with situations of unprofessional conduct.

Readers may be pleased that, while a substantial part of the paper considers general matters from the study of ethics, it avoids entering the academic debates that surround these somewhat perplexing philosophical issues. The author does nevertheless sometimes take the liberty to express a practical way forward to provide a framework for the latter sections of the paper where the focus shifts to actuarial issues.

The author certainly does not claim any originality in the field of ethical thought. The aim (in Part A) is to distil most of the concepts and major areas of thought and debate into a useful and practical first guide for actuaries (as well as students who have just completed or are perhaps nearing the end of the examinations).

Finally, Sir Adrian Cadbury, Chairman of Cadbury Schweppes, says that it is foolhardy to write about ethics at all, because you lay yourself open to the charge of taking up a position of moral superiority, of failing to practice what you preach, or both. The author dares not take such a position, either explicitly or implicitly, but feels the subject matter of this paper is too important to wait for someone who might.

1.5. Structure of Paper

The paper is in two distinctive parts:

Part A deals with the nature of ethics, the importance of ethics to professions, and ethical decision making:

Section 1 – Introduction Section 2 – What it means to be ethical Section 3 – The nature of business ethics Section 4 – The nature of professional ethics Section 5 – Some professional dilemmas Section 6 – The codification of ethics Section 7 – Resolving ethical issues 7

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Part B then considers ethics from the context of the work of the actuary

Section 8 – Are we an ethical profession? Section 9 – Survey of Australian actuarial profession Section 10 – Final comments and recommendations

Sections 11 and 12 include acknowledgments, recommended further reading, contacts, courses, and a list of references.

While Part B largely stands on its own and – particularly the survey results – may be the only area of interest of actuaries with limited time to review the whole paper, the author firmly believes that actuaries will generally benefit from attempting to obtain a grasp of the more general subject matter of ethics as outlined in Part A.

The author apologises in advance to those readers who prefer short, sharp papers. It was felt that the subject matter was such that it deserved a fairly full treatment. Part A, even as it stands, provides only a sketch of the subject – the course notes for the CPA professionalism ethics module is 99 pages long (of small type face) covering many of the issues in far greater depth. 8

ETHICS, ACTUARIES (AND ROBOTS)

2. WHAT IT MEANS TO BE ETHICAL

“I only know that what is moral is what you feel good after and what is immoral is what you feel bad after.”

− Ernest Hemingway, Death in the Afternoon

2.1. Why ethics matters

We all “know” about ethics. The very fact that we are prepared to passionately pit our moral values against someone else’s in debate about society, politics, justice etc demonstrates that ethics is intrinsically a part of our being and that we take it seriously. The Institute of Chartered Accountants says (ICA 1995):

“Because we have to make a personal choice about our values, because we have to take risks with our decisions, and because we are asked to make public commitments to the ethical policies of any group to which we belong, these matters do matter to us personally.”

“We cannot avoid debate in ethical matters, because we are responsible for our actions and are expected by other people to be able to give a response to the basic question: Why did you do that?”

So ethics matters because it is a part of each and every one of us. It is baked into our very being. We each have to make our own commitment to the laws of the land, company policy and personal moral values and take full responsibility for our actions.

But why should ethics matter to society and its institutions? The answer probably cannot be any more compelling than that given by The Institute for Global Ethics’ Internet site home page that says:

“The immense power of modern technology extends globally. Many hands guide the controls and many decisions move those hands. A good decision can benefit millions – while an unethical one can cripple our future. We will not survive the 21st century with the 20th century ethics.”

(An expansion of and justification for this belief is provided by the Institute and is included in Appendix A.)

For professionals though, there is an additional imperative to be aware of the ethical dimension to their work. It is simply that they hold positions of trust. People expect professionals to act with high standards of competency and integrity. This is what is 9

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meant by professionals having a fiduciary responsibility. More will be said of this in Section 4.

But many would suggest perhaps that, while granting all the above, our ethical knowledge and skills is both unreflected and intuitive. Why should we therefore need to study it?–– surely this is the domain of philosophers and academics.

There are a number of reasons:

1. As professionals, we usually have to be able to justify our decisions. A grounding in practical ethical studies can both help the professional to make a ‘right’ decision and at the same time provide the justification for the decision.

2. To assist us to understand the principles by which the professional body expects us to operate.

3. To increase the operating efficiency of our ethical antennae so that we become aware when there is an ethical component to our professional problems.

A basic underlying proposition of the author is that an increased focus on ethical and “pseudo-ethical” issues (described later) is necessary for long term business survival and health. Even so, it is not being suggested in this paper that ethics is central to business strategy (refer Appendix B). It will always be the case that strategic imperatives are what really drive a business forward and what provides it with sustained competitive edge is ultimately its ability to be creative, imaginative and adaptive.

2.2. The nature of ethics

The word ethics derives from the Greek word ethikos referring to the authority of ‘custom’, ‘tradition’, ‘usage’, or ‘character’3. The word is used in this paper in the context of “a formal cooperative endeavour of a moral community to define its values, necessary conditions, practical requirements, and protective rules which will ensure its well-being or the flourishing of its members” (ICA 1997).

There have been numerous attempts to define and describe ethics but probably one of the more useful and astute was by early twentieth century English jurist, John Fletcher Moulton, first baron of the Bank of England, and for many years a lord justice of appeal. He referred to it as “obedience to the unenforceable” (Kidder 1995).

Kidder goes on to describe the relationship between ethics and law, and ethics and free will: ethics is a kind of middle ground lying between the region of absolute choice and the region of positive law. 10

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In fact, laws (including codes of conduct, rules etc) are the formal codification of certain minimum ethical standards that a ‘community’ has decided (by democratic or other means) will apply to all members in that community or to those who want to join that community4. Obeying the laws, complying with regulations of whatever kind, is taken for granted. That is the baseline, says Carmichael (1997) who goes on to say:

“Ethics concerns itself with the way people and organisations operate in the grey area above the base line – where right and wrong are debatable, where well- intentioned people might reasonably hold different opinions.”

Most of us have ‘built-in’ ethical responses; they are ‘baked into’ our very souls. We generally and instinctively know the difference between ‘right’ and ‘wrong’. So while ethics is related to personal beliefs, it is not the same as personal beliefs – thinking something is right does not make it right. It is related to public opinion, personal relationships, expectations we have of each other and the trust we have in each other. As Rion (1989) puts it:

“Ethical principles are essential to human interaction precisely because they embody the respect for persons that enables all parties involved to participate in the fabric of human community with dignity.”

So one might say that while laws spell out what one has a right to do, ethics help us decide what is right to do. Rousseau (1762, pp98-100) recognised that ethics though is more fundamental than laws and pointed out that all written laws depend for their success on the ethics of a society. His metaphor was that while laws form the “arching of the vault … morals, which develop more slowly, ultimately become its immoveable keystone.”

In practice, there is not the clear distinction between ethics and free will as suggested but rather a continuum as in the following diagram.

FREE WILL

ETHICS

ABSOLUTE LAW 11

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This middle ground (what extends what the law says is “right to do”) is not clearly defined and is therefore subject to constant encroachment from both sides – for example over-regulation, over-codification, youth seeking rights without responsibilities etc. As Kidder puts it “surely a powerful indicator of ethical decay is the glut of new laws”. Kidder goes on to reassert Moulton’s view that a nation’s strength lies in the size of this ethical middle domain. In fact he believes, citing the examples of Italy in the 1980’s (not enough effective law) and the communist experiment of the Soviets (too much law), that without ethics, societies simply perish.

The ICA (1995) confirms that applied ethics is:

„ a community enterprise, based on universal principles and reasoned public debate;

„ about real power relations between people and the basis of power-sharing between them (refer next section);

„ about participation in a moral community and ownership of the policies it develops;

„ a problem-solving activity, based on knowledge of principles and skills in their application; and

„ an educational process in which we develop insight into what it means to be responsible moral beings.

2.3. Right vs wrong decisions

The believer: “Morality is not properly the doctrine of how we may make ourselves happy, but how we may make ourselves worthy of happiness.”

− Immanuel Kant, Groundwork of the Metaphysic of Morals

The sceptic: “No actions are bad in themselves − even murder can be justified.” 5

− Dietrich Bonhoffer, No Rusty Swords

“Right vs wrong” decisions that involve alternatives that may be illegal, bend the laws, go against the spirit of a code of conduct etc are clearly out of bounds to all professionals. There is no choice but to comply with the law and adhere to the code. 12

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Many right vs wrong decisions are further along the ethical spectrum where latitude in decision making is permitted; for example, departures from the truth, or misstatements of fact. Some are simply deviations in moral rectitude, for example where a doctor might over treat a patient or where a scientist might pass off someone else’s idea as his own. Whatever the nature of the temptation, it is driven by strong self-interest and seeing others as a means to an end.

The “correct” course of action may be somewhat greyer and depend upon your values yardstick and your “ethical fitness” (refer section 7.5). Nonetheless, the typical challenge is finding that practical or commercially (and socially) sensitive way to do “the right thing”, not discerning what is right or wrong.

Right vs wrong decisions have a “smell” about them; they may require us to be deaf to our inner voices; in our hearts, we know what we should be doing but we are tempted to do otherwise. The following litmus tests may be useful to weed out these types of decisions:

„ the stench test – Does the course of action go against the grain of your moral principles (even though you can’t put your finger on it)?

„ the front page test – What would your response be if what you took to be a private matter were suddenly to become entirely public?

„ the mum test – What would your moral exemplar (anyone who cares deeply about you and whom you respect and from whom you seek respect) do about this?6

Some may counter that the reality of business pressures does not permit this type of “purist” stance. After all, we have all broken a law at some time or another, rationalising it away in any one of the following ways:

“It won’t matter to anyone” “I won’t get caught” “It’s only a trivial deviation” “Everybody else does it” “If I don’t do it, we will lose business” “If I don’t do it, I will jeopardise my career” “The potential penalties or sanctions are acceptable” “Laws were not made perfect”

Such ethical ‘compromises’ or accommodations with our consciences occur all the time on matters or laws we regard as minor, silly, cumbersome, expensive, or outright impossible to obey. For example copying software, a video movie, or an audio tape; 13

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exceeding the speed limit, crossing against the “Don’t walk”, or parking in a No Standing zone for 5 minutes; taking 10 items through the 8 item check-out counter etc.

It seems that a person’s inherent sense of right and wrong usually focuses on more significant things: “We are perfectly willing to excuse a little law breaking if we think it is in our self-interest, if we don’t believe we are hurting anybody, and if we don’t think we will get caught.” (Brotman 1993).

It seems that, in such situations, one has to be guided by the strength of one’s values perhaps applying one of the ethical decision making models available (refer section 7.4 and Appendix G). That said, many issues are simply trivial.

2.4. Right vs right decisions

On the other hand, “right vs right” decisions, as both Kidder and Badaracco (1992) explain, pit our central values one against the other in ways that will never be resolved by pretending that one is ‘wrong’. They therefore involve conflicts of responsibility versus responsibility. The central challenge is to decide which right, which responsibility, ie not whether to be ethical but how to be ethical. They usually require a decision involving tough choices. As Badaracco (1997) says, they can have powerful and often irrevocable consequences for the lives of the men and women who must make the decisions and for their organisations as well.

In such cases, we cannot avoid ‘getting our hands dirty’. In meeting some responsibilities, we will fail to meet others. Doing one right thing will mean leaving another right thing undone. They are true ethical dilemmas7 or, as Badaracco refers to them, defining moments (such as the Arnott’s extortion threat in 19978 or that of the more recent example of Sanitarium).

Badaracco talks about four ‘spheres of morality’ or ‘spheres of responsibility’ which lead to these clashes in business life:

„ Private life – the sphere which is truest, deepest, and most intuitive.

„ Economic agents – the sphere that recognises that shareholders entrust their assets to managers, and managers promise, implicitly or explicitly, to work for the shareholders’ interests. The laws obligating directors and managers to serve shareholders’ interests are woven deeply into the legal fabric of commercial life. These laws reflect the preferences and considered judgements of society.

„ Company leaders – the sphere that recognises the power that executives exercise over the lives of others they employ and lead. Work is a powerful source of meaning and self-respect in individuals. “While companies must serve shareholders’ interests, 14

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neither their executives nor their employees leap from bed in the morning in order to maximise the risk-adjusted present value of streams of future cash flows9. The animating, creative forces of great human institutions originate elsewhere.”

„ Beyond the firm’s boundaries – the sphere that recognises the relationships firms have with customers, suppliers, government, unions etc. Particularly given the globalisation of corporations in recent years, the influence of power is immense.

Badaracco believes that firms and their managers often wield enormous power, and with this power which society sanctions, comes responsibility not to abuse the power lest trust be damaged. He states that the decisions which evolve from these so-called ‘defining moments’ have three characteristics:

„ they reveal one’s values (and maybe those of the organisation) and compel one to arrange them in a single file and reveal the priorities among them;

„ they test the strength of the person’s (organisation’s) commitments and whether particular values are only receiving lip service; and

„ they shape one’s character (or that of the organisation) – “cumulatively, [defining moments] form character, just as drops of water eventually reshape a stone”.

Section 7 of the paper will provide guidance for resolving ethical dilemmas.

2.5. Values

Before continuing, a definition:

A belief is a personal statement for which we make a truth-claim. Values are based on beliefs, but unlike beliefs, they commit us to action. Values serve as the basis from which we make personal assessments of the worth, importance, or efficacy of things as means to achieve our life-long goals or well-being of others (derived from ICA 1997).

In comparison to attitudes and opinions, Thomas (1998) also notes that values tend to be more fundamental and less susceptible to change, at least in the short term.

So, more simply perhaps, a value is a personal criterion for discriminating ‘good’ and ‘bad’ behaviour or actions. Sharp (1996) concludes (after reviewing the evidence of nature and nuture) that our personal set of values is largely an unconscious framework derived from intuition and faith rather than logic, but is shaped by genetic predispositions, experience, and environmental factors including social demands and options. 15

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Kidder (1995, pp88-99) considers the old debate regarding the absolutism and relativism of values and shows that empirical evidence from anthropology strongly suggests that absolute values do exist. All societies and cultures seem to approve of kindliness, sympathy, hospitality, promise-keeping, truth-telling and regard for others and their rights. Of course, even if individuals, groups, societies or cultures assert the same fundamental values, there can be differences in how they interpret those values and how strongly those values are kept. For example:

„ there is no society which permits the killing of an individual in its society who has not committed a crime, but the definition of crimes may differ; also the legality of capital punishment or abortions differs from society to society;

„ no society or culture permits (at law) the act of bribery but the differences in toleration to bribery or what constitutes bribery can be substantial;

„ all societies and cultures recognise property rights (except possibly Buddhist monks), perpetuated in the Western world in the saying “Don’t steal”;

Even if one accepts the existence of absolute values, the interpretation of values can change over time. Consider this brief outline of a history of changing acceptable practices (not necessarily connected or in strict time sequence):

cannibalism Î ritual sacrifices Î slavery Î child labour Îowning women Î White Australia Policy Î discriminatory work practices Î sexual harassment in the office Î blowing cigarette smoke in someone’s face Î smoking in public places

Sharp, a relativist, proposes that humans have developed sufficient tolerance of each other’s relative values as a safety valve10. This implies that tolerance itself is an absolute (notwithstanding the existence of degrees of tolerance) and seems to leave two questions unresolved:

„ Where exactly should one draw the line at tolerance; and „ Why should we believe one (our) moral standard is better than any other?

Grace & Cohen (1995, pp32-35), while admitting the possibility of absolute values, support the fundamental importance of tolerance. Indeed, tolerance is a critical value for social harmony and peace, the more so when values seem to be in conflict11.

Ultimately, any attempt to define terms such as ‘right’, ‘wrong’, ‘good’ and ‘bad’ is probably doomed to failure, overloads the study of ethics into definitional problems, and is of little day-to-day consequence. As Kidder (1995) puts it, “most people already have a working understanding of good … they know it when they see it”. It is much like a 16

ETHICS, ACTUARIES (AND ROBOTS) famous church Father many centuries ago who was troubled by the nature of time; he confessed that if no one asked him he knew, but if he tried to explain it to someone then he had to admit that he did not know.

The author’s own view (hoping to skirt around the absolutist/relativist debate) is to propose that, for practical purposes, there are at least some universal values which are so widely shared and broadly understood that they define right and wrong. These values may be shared by a society, a company, a church, a club etc. They may or may not be formalised in writing. By implication, it is proposed that most other values have more limited domains over which they can range e.g. at the extreme, those which are held personally. Tolerance of each other, to varying degrees, is necessary to ensure barriers do not stand in the way to communication and worthwhile interactions.

At this point, the reader might well be pondering what all this has to do with professional ethics. This should become evident later in the paper when it considers the topics of whistleblowing and working in different countries. 17

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3. THE NATURE OF BUSINESS ETHICS

The believer: “Business must respect rights and assume its appropriate duties if it is to meet the expectations of society and enjoy the confidence of stakeholders. Making a profit is not the only criterion by which business is judged.”

––Grace & Cohen, Business Ethics (1995)

The sceptic: “There is one and only one social responsibility of business – to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

––Milton Friedman, Capitalism and Freedom

3.1. The relationship between business and ethics

Three interrelated questions on the subject of business ethics have exercised the minds of philosophers, management schools, and executives for many decades:

„ Does business have a social responsibility? „ Is business ethics somehow perhaps different from that of personal ethics? „ Is good ethics good business?

Despite the extensive number of articles and books that have been devoted to these questions particularly over the last 30 years or so, there does not seem to be a consensus view, at least amongst business leaders and managers. Whatever the balance of opinion, the author believes that some form of personal resolution of each of these is vital if each of us is to operate effectively as professionals in the business environment12.

The difficulty the author has found though is to distil the debates that surround these issues into a few pages commensurate with the desirable length of the paper while at the same time providing the reader with enough information to form their own view. Section 3.2 therefore provides the author’s own view while Appendix C provides more background commentary particularly on the rationale for individuals and business to be ethical (apart from the overriding consideration espoused in Appendix A). 18

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3.2. General comments

The effect of compartmentalising ethics into personal and business domains is that fundamentally decent people become willing to do things in their jobs that they would not properly do in their personal lives.

While the questions posed above remain somewhat unresolved, it seems that the fallout from the amoral 1980’s, the “greed is good” attitude that seemed to prevail then, and the more recent failures of big business in S.E. Asia and Japan have lead to a shift in society’s expectations. The general public and governments are demanding increased levels of regulation, corporate governance and accountability (Toohey 1997).

“Is good ethics good business?” Maybe, in the short term; probably almost always in the long term. A little easier perhaps: “Is bad ethics bad business?” Maybe not, but in the long term, probably it is. But is this really a surprise? Should we expect that the answer could be any different? Bhide & Stevenson point out that:

“Concepts of trust and, more broadly, of virtue would be empty if bad faith and wickedness were not financially rewarding. If wealth naturally followed straight dealing, we would only need to speak about conflicts between the long term and the short, stupidity and wisdom, high discount rates and low. We would worry only about others’ good sense, not about their integrity. It is the very absence of predictable financial reward that makes honesty a moral quality we hold dear.”

So why be ethical? According to Booth, the intrinsic benefits of doing right, ie for its own sake, are sufficient. Given that many of the ideas of ethics have their roots in theology, this view is not surprising. In reality, and perhaps unfortunately, this is often not enough. Businesses will look to the payoffs in terms of avoiding risk and improving reputation. As Carmichael says:

“The cost of an ethical process can be seen as disaster insurance, as a crucial part of risk management.”

Further, our corporate laws are generally framed to penalise heavily those who transgress them but give little direct reward, encouragement, or acknowledgment for implementing “good” practices13. Of course, this type of thinking is still ultimately self-serving, even if it does clearly serve others. After all, as Grace & Cohen noted:

“There is some point to the view … that unless business cleans up its own act the regulators will move in. Unfortunately, this view seems to be more sensitive to the implications for profits and costs of operation than to the protection of the standards of practice.” 19

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Given that self-interest is probably the most central and powerful of individual forces, maybe it is, in the end, impossible or idealistic or even irrational to try to side-step it.

In the author’s view, most of us are already used to the idea that a company’s compliance regime is part of its overall risk management policy. An ethical process layers this up by taking compliance beyond ‘law’ and company policy into higher realms of conduct.

Other benefits follow to business and society in general: the public have a common interest in the integrity of the market place; predictable levels of ethical behaviour reduce costs of transactions, hedging and insurance; the costs on government and taxpayers by way of regulations is limited.

The following summary points are suggested as “guiding lights” for moving forward:

„ The challenge for an ethically centred person is to resist the temptations to subordinate principles to expediency and still find ways to be successful.

„ Good ethical practice sometimes imposes short-term costs that are not justifiable solely through a bottom-line analysis.

„ While the profit motive is entirely legitimate, it is not entitled to be treated as a moral imperative. Simply put, the ends do not always justify the means.

„ Perhaps most importantly, we must constantly remind ourselves that people are our most valuable asset (despite an electronic world of free capital flows and ever advancing technology which seeks to replace them), not simply because they can help or harm us, but because they are part of our human family.

3.3. But why can it be so hard to be ethical?

Most of us tend to assume that ethical transgressions in business are caused by simple greed or self-indulgence. Actually, this accounts for only a small portion of unethical conduct. Though money and jobs may be at stake, the motivations for improper conduct generally arise due to one of three very human forces at work:

„ the compulsion to win – people who need to win at any cost have little difficulty rationalising away ethical inhibitions; „ fear – in this context, ethical abstractions do not stand a chance; or „ self-esteem.

While the compulsion to win, fear and self-esteem may be the underlying causes for indiscretions, the person may not recognise it as such. Instead, a rationalisation will be constructed in the mind of the ‘good’ person for justifying an unethical decision. 20

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Gellerman (1986) considers a number of US corporate examples that, in his view, failed in some way due to ethical indiscretions, and which gave clues to the four commonly held rationalisations:

„ A belief that the activity is within reasonable ethical and legal limits – that is, that it is not really illegal or immoral.

How can one know where the line is between smart and too smart? asks Gellerman. Between sharp and shady? Between profit maximisation and unethical or illegal conduct? He suggests the simplest and most reliable guideline is: when in doubt, don’t. He also states that the smartest managers know that the best answer to the question, “How far is too far?” is “Don’t try to find out.”

„ A belief that the activity is in the individual’s or the corporations best interests – that the individual would somehow be expected to undertake the activity.

Unfortunately, as he points out, many managers have been promoted on the basis of “great” results obtained in unethical ways only to leave the successors to clean up the mess.

„ A belief that the activity is “safe” because it will never be found out or publicised.

He suggests that the most effective deterrent is not to increase the severity of punishment if caught but to heighten the perceived likelihood of being caught in the first place. This, he believes, is better achieved by making an example of those detected.

„ A belief that because the activity helps the company, the company will condone it and even protect the person who engages in it.

Companies must warn against disservice to customers and suppliers. Further the company must make it clear that perceived loyalty to the company will not be an excuse for jeopardising the company’s brand.

According to one manager of a company’s ethics program, the vast majority of people are generally ‘good’ and well-intentioned but they get trapped by short term business pressures into rationalising things that they should not be doing.

There are limitless opportunities and ample motives in business relationships for unethical behaviour. The issues are “everyday” in nature, involve competing claims amongst employees, their employers, their customers and the shareholders. 21

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3.4. When in Rome …

Earlier this paper referred to the idea of relativism. Relativism in business is most often discussed in terms of foreign trade or the conduct of operations in other countries.

FAILURES OF COMMUNICATION

Cultural differences between peoples can often lead to communication difficulties for no other reason than the idiosyncrasies of the languages and business practices, to which one must become accustomed.

Henderson (1998) provides some guidance for resolving ethical conflicts that arise from these “innocent” situations, which firstly requires identifying how urgent and important the finding of the resolution is, and secondly the comparative strength of your position and relationship to the other party.

GIFTS AND BRIBES

Grace & Cohen (1996) believe that if a person respects the religious and cultural conventions of a host country (as well as its laws) then no excuses are necessary – relativism does not even enter the picture. For example, although they may be seen as a normal part of the business culture of Asian countries, bribery and substantial inducements are not part of their laws, religions or traditional cultures. What are often termed, and recorded as, “facilitation fees” may nonetheless be necessary in order to effect a transaction efficiently.

But, as Rion (1994) asserts, these practices may be a part of their customs which simply suggests that their cultures and laws tolerate a wider divergence from their acceptable norms.

Grace & Cohen provide this guiding rule (similar to that provided by Rion (1989,1994)):

“If you would not be ashamed to declare your actions to the world, you have probably not done anything which stands in need of an excuse … Normal hospitality and gift-giving that is part of business needs no excuses or appeals to relativism. When gifts become more substantial … then it is wise for a company to draft policies and procedures which are made known to clients and staff so that there is no room for misunderstanding.”

The general policy as recommended by Fadiman (1986)14 is that any response should further social progress in the country while offering local status instead of funds. 22

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“Certainly, host governments will look most favourably on companies that seek to serve as well as to profit, especially through “gifts” that show concern for local ways. …What may initially appear as begging, bribery, or blackmail may be revealed as local tradition, cross-cultural courtesy, or attempts to make friends.”

The author would add that all policies should be formulated and communicated to all relevant staff before even entering a country and, once there, be applied strictly and consistently. At the same time, expatriates should be provided with education in the culture and traditions (personal and business) of the country they intend to visit.

Sir Adrian Cadbury (Cadbury 1987) proposed two rules of thumb to test whether a payment is acceptable from the company’s point of view:

„ Is the payment on the face of the invoice? In other words, will there be an auditable record? This is not a sufficient test, Sir Adrian states, but a necessary one. “Payments outside the system are corrupt and corrupting.”

„ Would it embarrass the recipient to have the gift mentioned in the company newspaper? This test is aimed at distinguishing bribes from gifts.

Sir Adrian notes that the logic behind these tests is that openness and ethics go together – something we referred to earlier in this paper on the importance of trust – and asserts that actions are unethical if they will not stand up to scrutiny.

Finally, it should be noted in passing that the Federal Government has introduced the Criminal Code Amendment (Bribery of Public Officials) Bill 1998 in line with all other OECD countries which would make the estimated $120 billion world-wide flow of bribes of foreign government officials a criminal offence. Interestingly, although perhaps not surprisingly, objections have been raised by business lobby groups that it would not solve the problem, it being easily side-stepped, and would otherwise merely lead to lost export and foreign investment opportunities15. 23

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4. THE NATURE OF PROFESSIONAL ETHICS

“Business is the oldest of the arts and latest of the professions”

− President Lowell of Harvard University (c.1940)

4.1. Ethics as power sharing

Well over 2000 years ago, Aristotle made an observation about ethics summarised as follows:

“Ethics is fundamentally about how we exercise power, about power relationships between people, and how we share power with one another in daily life and work. This emphasis is to counteract the popular but superficial view that ethics is purely subjective and concerned with personal feelings and attitudes. It emphasises the central importance of public accountability in ethics. This is of particular significance for the work of accountants [read also ‘actuaries’], for the ethics of their relationships with clients, colleagues, partners and other professionals is about the responsible use of power and the exercise of power and influence within business and financial institutions.” (extract from ICA Course 1997)

The situation is common to all professionals and those with fiduciary responsibilities whether they be actuaries, accountants, lawyers, doctors, engineers, directors, or trustees. McDonald (1995) echoed these points at a meeting of the SOA in 1995 to discuss professional ethics:

“Our responsibility increases in a particular situation as our knowledge of the situation increases, because we know more about the situation, we know more of the facts, we understand more of the facts, and we have the power to affect the situation. Knowledge and power are the key variables here. As they increase, so does our responsibility, and that’s going to be very important for bringing it up for professional responsibility.”

Carmichael (1997b) puts the same point this way:

“What is it that distinguishes the ethics of a profession from general business ethics? The fact is that, as professionals, you have knowledge and understanding which the general public does not share and cannot be expected to have. You have expertise which they do not; they have no choice but to trust you, because they have no way of evaluating the information which you provide for them. They are relying on you to take their interests into account, to ask all the questions they would ask if they had the knowledge that you have, and to ensure that they are fairly treated.” 24

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The following chart shows the relationships between these concepts and how power sharing and trust bridge the gap:

Responsible use of power

PROFESSIONAL Skills and CLIENT (specialised skills knowledge gap (“unskilled”, lacks and knowledge) knowledge)

Trust in competence and honesty

So a professional brings technical competence, moral trustworthiness, objectivity, confidentiality, duty of care, fidelity, and independence to a situation as foundations for confidence by the client or employer. By implication, good communication skills are paramount to this process.

Further, professional codes typically require that the interests of the public be paramount in formulating advice. Power sharing in such situations implies an ethical responsibility in addition to the legal responsibility; an understanding and application of ethical behaviour by the professional in whom the client must place their trust.

4.2. The importance of openness and trust

The name Cicero is associated with a letter he wrote to his son known as “On Duties” which has become a classic in the study of ethics. The letter looks at the relationship between seller and buyer using two case studies. The examples are useful to us because they highlight the issues surrounding differences between access to information, knowledge and skills. Richards (1995) closely analyses Cicero’s letter and makes the following observations (very similar to those of Carmichael 1997b) about the unique position of professionals:

“[The doctor-patient] relationship extends beyond that of a seller and a buyer, even though the relationship is partially one of money exchange. The doctor possesses expert knowledge that the patient needs to make a decision on buying services. Unfortunately, the patient is in no position to evaluate the quality of that information. He must trust completely the doctor’s advice in making his decision. Under these conditions, the doctor has a heightened responsibility to provide the patient with as much information as the patient requires and present it in a way that 25

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the patient can understand and make an ‘informed decision’. These same constraints apply in the case of lawyers and any fiduciary agents.”

Richards goes on to explain that:

“The ethical requirement for higher standards of disclosure by doctors (and other experts) is based not on the [lack of?]‘ease’ with which the information can be obtained. The more essential consideration is depth of expert knowledge rather than its availability. … The problem for patients is that they lack the depth of knowledge and experience to give meaning to the medical facts.”

Of course, a client can gain some comfort from the existence of a code of professional conduct and the knowledge that all members are required to abide by it. But a code is only meant to establish a minimum framework for ethical behaviour – it cannot hope to cover all situations that confront the professional (nor should it).

In addition, as Carmichael points out, openness is a value that is crucial to building trust. She supports Sir Adrian Cadbury who said:

“What is out in the open may not always be ethical, but what is concealed is almost certain not to be.”

Openness means, for example, admitting you don’t have all the answers – paradoxically, professionals can gain more respect by admitting that they need help in reaching a decision, or that they need to take a little longer to consider all the consequences. So openness also implies integrity or honesty.

“Without openness, there is no way of establishing the commitment of an organisation to its other professed values.”

It is perhaps therefore easier to see that most professions, as part of their practice, are obliged to do things that others are not. Further, Grace & Cohen state that “what distinguishes [professions] from each other and other occupations is their values16. But these values do not exempt professionals from normal standards of conduct; on the contrary, professions take on extra personal and social obligations.” They give the examples of a medical practitioner being present at the scene of a car accident, or an off- duty policeman witnessing an assault.

Without some sense of shared values, we cannot easily trust. We would just do whatever we felt like doing to each other. We would likewise be in continual fear of being harmed by others or being taken advantage of. 26

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4.3. Ethical dilemmas in professional work

Perhaps the majority of professional ethical conflicts may arise because of conflicts of (supposedly higher) professional values with the (supposedly lower) business values of their clients. Perhaps a professional’s personal values if higher than business values causes those conflicts. Where exactly does the professional stand between the direct client and the public?

The client seeks to impose its business values on the public (the end customer) which can be different from the personal values by which the public judge businesses. At the same time, the actuary tries to impose his/her professional values on the client but may feel compelled to balance that against the business realities of the client. Even so, the professional must be conscious of the fact that his/her duty may, in some cases, be to act in the “public’s interest” (assuming that notion is properly represented by the client’s customer); the professional seeks to protect the public through his/her professional values.

The author suggests though that the reality may generally be represented by the following scheme, which while not changing the relationships, does put the professional closer to the public (although not directly between the client and the public):

PROFESSIONAL

Business Values Professional Values Professional Values Personal Values CLIENT PUBLIC

Business Values

There is, of course, nothing profound about this. But it does help to better understand the nature of some of the ethical dilemmas we face from time to time. The paper will take a closer look at some ethical dilemmas that professionals may face at sometime in their careers.

4.4. How is the shared morality of a profession maintained?

Through education, encouragement, support, reward and sometimes punishment, says McDonald (1995a). New entrants have to learn that their self-esteem is tied up very much with their own moral behaviour. They need to feel shame or guilt if they have done 27

ETHICS, ACTUARIES (AND ROBOTS) something wrong, even if it does not go all the way to the disciplinary committee. But also, following the modern school of encouragement, which aims to catch people doing right, they need to be rewarded for exemplary moral behaviour. Not so easy. How does the profession identify such people?

McDonald says that the profession needs to create a

“critical mass of nice guys [and gals], of people you can rely on as colleagues, and you’re trying to select the nice from the nasty guys. … We have to have a shared understanding, we have to be on common ground, we have to receive the same signals and have the same standards. We need a critical mass of people to internalise those standards, and we have to effectively externalise it both socially and legally.”

Finally, it should also be apparent that a client or employer places trust not only in the individual professional but also in the professional grouping to which he/she belongs. The client/employer expects the professional group to satisfy itself of the expertise and professionalism of its members and that they will adhere to their code of conduct, else disciplinary action will result. Therefore, there seems to be a strong, implied guarantee by the professional group that its members will fulfil their obligations.

It therefore seems to follow that the professional group must be prepared to stand behind the individual member if he is clearly following the professional standards and ethics of the group. But there may be consequences: An actuary spoke of a situation in Australia (Carmichael 1997b) in which he refused to sign a statutory certificate for his employer. After writing to the local Institute, he was advised that his position was correct and in accordance with Institute standards. The actuary then confirmed with the employer that he could not sign the certificate and it was not his fault. The employer then apparently wrote a vitriolic letter to the Institute suggesting that it was setting itself up as a judicial body. 28

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5. SOME PROFESSIONAL DILEMMAS

5.1. Whistleblowing17

At what level of effort and commitment can one discharge one’s ethical responsibilities? Whistleblowing is possibly the ultimate test.

Whistleblowing has been defined by Grace & Cohen (1995) as:

“… reporting on misconduct or potential harm or failure from within an organisation or after separation from it.”

The characteristics of whistleblowers (sometimes called ‘troublemakers’ or, at best, ‘well- meaning renegades’) that they note include:

„ they are insiders in the organisation and therefore in some sense party to the responsibility which causes the harm; „ it is usually moral revulsion which leads them to speak out; „ they do not challenge established law but established practices; and „ they are usually prepared to take the consequences of their acts.

There are no explicit laws in Australia to protect (private) whistleblowers18. As Grace & Cohen note,

“Going to the media might invite an injunction against publication (as happened in the ‘Westpac letters’ case) or even a defamation suit. The wise course is to see a lawyer before a reporter.”

Then why take the personal risk for the benefit of others? After all, American experience shows that 90% of whistleblowers lost their jobs or were demoted; 27% faced lawsuits; 26% faced psychiatric or medical referral; 25% admitted to alcohol abuse; 17% lost their homes; 15% were subsequently divorced; 10% attempted suicide; and 8% went bankrupt19. While the cause-effect relationships are not clear, the results are nevertheless disturbing.

The actual act of whistleblowing is a last resort action of a set of discrete actions:

1. Information of concern is reported to superiors through established channels.

2. If dissatisfied with response (and other alternatives have been tried or dismissed), report information to someone else (usually higher up) within the organisation.

3. If dissatisfied with response (and all other alternatives have been exhausted), “blow the whistle”, ie go to the media to attract public attention. 29

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Even taking the first step can be extremely difficult. There may be no-one that the person believes can be entrusted with the information. If it should ever get to considering the final step, many would counsel the person considering blowing the whistle to instead resign either before taking that action, or simply resign and shut up.

Further general comments on the process and considerations for the potential whistleblower are provided in Appendix D.

In respect of professionals reporting violations by their professional colleagues, Frankel (1989) says they have a poor track record probably because of any one or more of the following reasons:

„ a desire to shield the profession from embarrassment and a decline in public trust; „ it may undermine the profession and may invite increased external control; and „ fear of being ostracised by one’s professional colleagues or fear of legal retaliation.

Frankel suggests these problems can be overcome if the member can be sure of support from the profession itself. This in turn strengthens loyalty to the profession and leads to increased compliance with its code and rules. Unfortunately, Frankel comments that

“Self-regulation suffers because of too few rewards and too many risks associated with reporting errant colleagues. …[This] has led to the institution of other means of social control – licensing, peer review, malpractice, new mandatory reporting laws, and so on. But undue reliance on external regulation runs counter to the exercise of professional discretion, which lies at the core of providing individualised service to clients.”

In conclusion, the evidence confirms that the odds are heavily stacked against the “ethical resistor”. The author believes that whistleblowing should only be taken as a last resort after all other avenues have been exhausted, and only after seeking the advice of family, colleagues, friends, priest, and of course a lawyer. It will require deep supplies of fortitude and moral courage (and possibly a deep bank balance). In the case of professional work, the issues may be a little clearer but no less difficult. Thankfully, the likelihood of the circumstances arising that would warrant whistleblowing is small for each of us. 30

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5.2. Maintaining confidentiality

The maintenance of confidentiality is a key element in any adviser-client relationship. In fact, it could be viewed as the flip-side of whistleblowing although the latter term is restricted to apply to situations where the employee goes public. Whistleblowing envisages a situation in which the public’s interest is believed to transcend the loyalty to client/employer.

A lawyer is required to maintain the confidentiality of information provided to him/her by the client. Likewise a doctor cannot disclose information about a patient without approval. The term used is ‘privilege’ in the sense that the client/patient can speak openly with the professional without fear and retains the privilege that the information will not be passed on. The idea here is that if society did not sanction such confidences, or permitted exceptions, the legal or medical system would be much weaker. The foundation for this concept is that while occasionally this might mean that some harm was done to society, more harm would result by not strictly maintaining it.

Sometimes a law can grant the professional a ‘qualified privilege’ which would trump a client privilege. For example, a doctor in Australia is required to divulge to the appropriate authorities a patient who carries a serious infectious disease. Even so, in the process of deciding whether to act upon such a privilege in a particular situation, the professional would need to carefully consider the circumstances. In the end, since the professional cannot be sure of the likely outcomes, the best thing for the professional could simply be to notify the authorities. While this is a form of legally sanctioned whistleblowing, the comments in section 5.1 may nonetheless be relevant.

5.3. Conflicts of interest

Confidentiality of information also gives rise to the notion of conflicts of interest. A conflict of interest could be generally defined as a situation in which a person has a private or personal interest sufficient to influence the objective exercise of his or her official duties (as a professional, employee, public official etc). In the case of a professional acting for a client, the conflict of interest could also lead to competitive advantage to the consulting firm or competitors of the client.

The definition says that the obligations to the interests of the client/employer trump all other interests. It also says that the criterion that is to be satisfied is that of the impartiality or objectivity of the professional. In this respect, it is important to appreciate that conflicts of interest could be actual, perceived, or potential.

A conflict of interest could also actually lead to breaking the law such as the use of confidential client information (about a potential merger or acquisition perhaps) which breaches insider trading laws in Australia. 31

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McDonald (1995b) suggests that a good test for whether there is a conflict of interest is to ask would relevant others (client, employer, colleagues, or general public) trust my judgement if they knew I was in this situation. Even so, different individuals may answer this question differently depending upon their different value sets and their public record. Trust is at the ethical core of this issue. Conflicts of interest involve the abuse, actual or potential, of the trust people have in professionals and indeed the whole profession.

This test, McDonald suggests, also implies two possible ways to avoid a conflict of interest.

1. Reveal your alternate interests to the client/employer 2. Completely absent oneself from the situation

In fact, the second of the two courses may be the only one that is acceptable to all. 32

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6. THE CODIFICATION OF ETHICS

6.1. The origin and nature of codes of ethics

“Unwritten ethical standards are not worth the paper they are not written on.”

––Ivor Kenna, Institute of Actuaries meeting 30 June 1997

Where do codes of ethics (or conduct) fit into this discussion? Why have another layer of regulation between statutory laws, regulations, rulings and ethical decisions of individuals? Do codes of conduct convert ethics into quasi-law? Can ethics be imposed from without? Do codes infringe the autonomy of those within its sphere of influence? Do professionals need to have a moral dimension over and above that set out in the code of ethics?20

The paper earlier referred to codification of ethics being a way to self-regulate a ‘moral community’ (such as company or profession) in order to avoid being regulated. In fact, it has been said that crisis is often midwife if not mother to an ethics program.

A code of conduct is not meant to state the sum total of corporate or professional behaviour. It does highlight though some general principals which are fundamental to the particular moral community and by which the members are expected to operate. It embodies the collective conscience of the organisation (having been derived from the accumulated wisdom and experience of some or all of its members) and is a testimony to the group’s recognition of its moral dimension.

Some codes are aspirational, with little if anything in the way of sanctions for errant behaviour, and can be accused of being window-dressing. Others are prescriptive, spelling out the ‘lowest common denominator’ of acceptable behaviour, but may not embrace any ethical ideals. Some codes are so general or obvious (read “public relations exercise”) that they could not be disagreed with (and thus risk being ridiculed) while others provide specific practical guidance (and thus risk being controversial). Finally, some codes are vague and require interpretation (and thus risk being useless). Many codes include some or all of these elements. (Cody & Bloch 1996)

Nonetheless, written codes now have an importance which they did not have before, because of the rapidly changing business environment: technology, structures (freer forms, out-sourcing, alliances). Trust has taken over from control. The days of a ‘steady state’, hierarchical company in which values could be passed on to each generation of employee have gone. 33

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“To British [and Australian] eyes, the full ethical process … may seem strained and unnatural. It entails formalising things which in the past have been informal. It entails devoting management time to issues which may appear peripheral to the core business. But if the intention is to align and internalise ethical behaviour so that each individual, objectively, is playing to the same rules, a period of discomfort may be necessary.” (Carmichael 1997a)

Since over-regulation focuses the minds of directors and management so much on their liabilities, there arises the risk to entrepreneurship, innovation and company performance – “over-regulation results in the ethos of conformance as opposed to performance” (Stubington 1996). It is suggested that corporate codes of ethics provide a way out of this situation.

6.2. What can be achieved by a code of ethics

From the discussion above, the case for codes of conduct (or ethics) should now be clear. As Kidder (1995) states:

“Codes of ethics provide us with shared reference points. They also give us small beacons of certainty in a troubled world – allowing us to dismiss out of hand issues that might, in other circumstances, grow into agonising dilemmas. Where all things are relative, after all, everything requires debate and decision.”

Frankel (1989) puts it in a similar way:

“A code may be compared to a compass, in that it provides the direction but does not presume to locate the ultimate destination.”

He also describes other purposes for codes, namely: source of public evaluation, professional socialisation, enhance reputation and public trust, preserve entrenched professional biases, deterrent to unethical behaviour, support system, and adjudication.

Thus, to take a metaphor Kidder used, we have referees and umpires for sporting events to prevent the bigger issues of playing the game and moving toward a conclusion from getting overwhelmed in a mass of petty squabbles about whose foot was where. If the code of ethics is in operation, a good deal of energy once given to such debates can be released for productive work

Frankel comments that, in respect of professions, a code of ethics has an additional purpose: 34

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“[There is a] tension between the professions’ pursuit of autonomy and the public’s demand for accountability. Society’s granting of power and privilege to the professions is premised on their willingness and ability to contribute to social well- being and to conduct their affairs in a manner consistent with broader social values. It has long been recognised that the expertise and the privileged position of professionals confer authority and power that could readily be used to advance their own interests at the expense of those they serve. …Professional autonomy correctly understood is not a right of the profession, but is a societally granted privilege, and that as such, its proper use becomes a moral duty.”

Codes of conduct can provide the following benefits to an organisation (Frankel 1989, Stubington 1996):

„ Focuses on expected standards of behaviour and a basis for punitive action thereby offering criteria that may be applied to particular situations;

„ Enhances the organisation’s reputation for fair and responsible dealing and thereby helps employees and community know what the organisation is setting out to do and how they will do it; and

„ Equips the organisation to positively embrace change and to recognise and deal with new issues and conflicts of value and perspective.

In addition, a code can give people a reason––perhaps a decisive reason––to act in one way rather than another.

None of the above comments should be taken to imply that a code of conduct requires constant policing and penalty. In fact Kidder believes a code’s very existence leads to inner self-regulation and very little policing in practice.

6.3. The weaknesses of codes

Empirical evidence cited by Grayson (1995) actually suggested that while the existence of an accounting code increased the awareness of required ethical standards, it did not actually lead to more ethical behaviour. Other evidence he cited also suggested that MBA’s were more likely to ignore unethical behaviour perhaps because new students were more idealistic.

Grace & Cohen (1995) refer to the Australian Institution of Engineers (IEAust) which has the following tenet in its code of ethics: 35

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“The responsibility of engineers for the welfare, health and safety of the community shall at all times come before the responsibility to the profession, to sectional or private interests, or to other engineers.”

While this sounds admirable as a deterring and disciplining statement, the reality Grace & Cohen suggest21 has been somewhat different. They state that, in their view, the IEAust has been more likely to censure those who take a public interest voice rather than to encourage the silent majority to speak up.

Finally, one should not be beguiled into thinking that a code of conduct will help resolve all ethical problems that an organisation or a professional will encounter.

Maybe part of the problem is that codes of conduct are typically cast at such a level of generality that they are “context-free”. As Gioia puts it, they cannot be associated with any specific script. Andrews (1989) also comments:

“In and of themselves [written codes] are not effective, and this is especially true when they are so broadly stated that they can be dismissed as merely cosmetic.

6.4. When codes work

It is the author’s view that the existence of a code of ethics increases the likelihood that people will at least think about the ethical dimensions of a decision.

There is a rare example from architecture that gives one hope that a courageous application of personal and professional standards of behaviour can lead to the right outcome for everybody – refer Appendix E for an outline of the case.

As Sir Adrian Cadbury notes, the ethical standards of a company or profession are judged by its actions, not by pious statements of intent put out in its name. In other words, ethics has to be ‘institutionalised’ in a way so that it permeates throughout the organisation and all that it does. Enforced codes of ethics (through education, rewards, and penalties) should lead to better behaviour patterns overall but, as Grayson (1995) notes, “nothing sends the wrong signal to employees like unenforced policies or codes. Violations are sure to increase if management ‘look the other way’.”

The ICA (1995) also notes that:

“Laying down Codes of Ethics and Disciplinary Rules in itself does not necessarily create an ethical culture in an organisation or business. Neither do they suffice to ensure individual moral integrity. What is required is promotion of an environment in business, and accounting as a profession, that favours the development of personal and corporate intergrity.” 36

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Based particularly upon US experience, codes have been found to work and be seen to be relevant only if:

„ all stakeholders are a party to their compilation; „ those at the top abide by them; and „ they are reinforced by a reward system.

Carmichael also makes this point:

“The secrecy with which their enforcement is shrouded lessens the moral validity of professional ethical codes. So does the fact that their … clients … are excluded from the process.”

Finally Carmichael (1997b) comments that the problems with professional standards and guidance notes (which extend a code of conduct into specific areas) is that they operate on the law of diminishing returns as loopholes are found and have to be plugged. She recommends that the way to break this cycle is to simplify matters by going back to basics:

“The public expect to be able to trust you. They expect to be fairly treated. Fairness and trust are at the heart of [the actuarial] profession.”

Some philosophers argue that the very existence of a code which forces people to be ‘good’ could weaken the ethical dimension of a profession (Cody & Bloch 1995). This suggests that codes cannot and should not replace ethical practice or moral deliberation. Indeed, it is not possible for a code to be comprehensive enough to cater for all ethical problems. It can only direct its attention to the more obvious or common ones that experience has highlighted (or else can be anticipated from the experience of other professions). 37

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7. RESOLVING ETHICAL ISSUES

“Do no evil, prevent evil, remove evil, and do good – in that order.” — hierarchy of ethical duties cited by Grace & Cohen from William Frankena, Ethics, Prentice-Hall, 1973

7.1. What should businesses do?

Not every ethical dilemma has a right solution. Reasonable people often disagree; otherwise there would be no dilemma. In a business context, however, it is essential that managers and professionals agree on a process for dealing with dilemmas. McCoy (1997) makes this point:

“Because corporations and their members are interdependent, for the corporation to be strong the members need to share a preconceived notion of correct behaviour, a “business ethic”, and think of it as a positive force, not a constraint.”

Businesses have “scripts” for decision making which must provide for ethical dimensions if “good” decisions are to be made. Gioia (1992) puts forward the idea that such scripts require ethics be included in job descriptions, management development training, mentoring etc22.

7.2. Ethical dilemma paradigms

An ethical dilemma usually revolves around concerns about relationships and responsibilities. The dilemma may be complex and fraught with contradictions. Kidder (1995) says that almost all right vs right dilemmas have the characteristics of one or a combination of the following four value-patterns or paradigms.

By attempting to classify an ethical dilemma into these paradigms, we are going some way towards its resolution because:

„ they help to cut through the complexity and confusion by reducing the dilemma to a recognisable pattern; „ they help to strip away extraneous detail and get to the heart of the matter; and „ they help weed out right versus wrong decisions. 38

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23 TRUTH VS LOYALTY

Truth, to most people, is conformity with facts or reality. It could also include notions of self-respect (or loyalty to oneself). Loyalty to others involves allegiance to a person, employer, client, the public, or country etc.

If the dilemma arises in our experience because we are asked to make statements or give advice that is inaccurate, incomplete or irrelevant, the truth-loyalty paradigm is probably relevant.

INDIVIDUAL VS COMMUNITY

The assertions of individualism versus the claims of community have been the most potent forces shaping history says Kidder.

This pattern naturally brings to the forefront the primary responsibility some professionals have to act in the public’s interest.

SHORT-TERM VS LONG-TERM

This paradigm is the most familiar of all, particularly in actuarial work. Actuaries are constantly making decisions which involve a tension between these alternatives. Kidder quotes W.H.Donaldson, chairman and CEO of the New York Stock Exchange:

“There is a close connection between moral and ethical capitalism and the issue of short- versus long-term behaviour and professional standards of business. … There is an important difference between a transaction-based mentality – looking only at the expediency of the short-term profit opportunity – and a business mentality that fosters long-term relationships beneficial not only to clients or customers but to others involved with, and dependent upon, a corporate enterprise.”

JUSTICE VS MERCY

Justice urges us to stick to the rules despite the pressures of the moment, pursue “equity” without attention to personalities or situations. Thus the eyes of Justice are usually blindfolded, so that she can judge only according to an even-handed impartiality that cherishes equality and plays no favourites.

Mercy, on the other hand, is never blind to claims of compassion, to the peculiar needs of individuals and the circumstances of the situations. Mercy compels us to love without condition or restriction. 39

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7.3. Criteria for ethical decision making

Analysing the type of dilemma we are confronted with is a necessary first step to achieving its resolution. The next section actually discusses models for helping us achieve a suitable outcome but we first need to also understand some of the ethical principals or theories that moral philosophers have devised and upon which the models of ethical decision making are founded. Here we consider a number of approaches, criteria, rules or tests that can be applied to a situation (as part of the ethical decision making process) to help clarify, analyse and balance the moral issues upon which we must decide.

Before considering each of these criteria, refer to this hypothetical case study.

Case Study

While walking through the forest, you come across a desperado with 10 captives. He says, “If you’ll take my gun and shoot one of them, I’ll let the other nine go free”. You can’t shoot the desperado. What do you do?

Ends-based thinking

This rule is known by philosophers as utilitarianism, a form of consequentialism. It is commonly expressed by the maxim:

DO WHATEVER PRODUCES THE GREATEST GOOD FOR THE GREATEST NUMBER

It focuses on consequences by asking what ifs. It requires a form of ‘cost-benefit’ analysis which might be appealing to many professionals (particularly actuaries). It suggests that the achievement of the ends will justify the means. Most legislation is crafted with this ideal in mind.

It has been criticised though on the grounds that it is not possible to predict all the possible outcomes of a decision, the worth of those outcomes (What is “good”?), those people likely to be impacted whether directly or indirectly (What is “number”?) nor even the likelihood of their occurrence. In particular, it will lead to some being worse off, maybe minority or disadvantaged groups, or those with little influence in society.

In the case study, the ends-based thinker would probably shoot one of the captives (which one is another problem!) using the reasoning that that would save nine lives and therefore be for the greater good. 40

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Rule-based thinking24

This rule is known by philosophers as deontological thinking (from the Greek deon meaning “obligation”) and is often associated with the German philosopher Kant25.

FOLLOW ONLY THE PRINCIPLE THAT YOU WANT EVERYONE ELSE TO FOLLOW TO CREATE THE GREATEST GOOD.

It is based firmly on duty – on what we ought to do regardless of the consequences, rather than what we think might work. It suggests that the means will justify the ends. It is often heard in the form “to set a good example”. It has also been used to advance arguments for individual rights and liberties.

The approach is to formulate a universal principle that you wish to apply to the situation and to test it by asking: What would it be like if everyone behaved like this? Would it be possible? Would it be desirable?

In the case study, the rule-based thinker might rely upon the “universal” rule that human beings should not kill other human beings. In any event, one cannot be sure that if you did shoot one, that the desperado would not change his mind.

Care-based thinking

This rule is sometimes known as the “Golden Rule” of putting love for others first. It is often associated with Christianity but in fact appears at the centre of every one of the world’s major religions.

DO TO OTHERS WHAT YOU WOULD LIKE THEM TO DO TO YOU.

Kidder states that “it is, for many people, the only rule of ethics they know, deserving consideration for the moral glue it has provided over the centuries”.

On the other hand, Sir Adrian Cadbury commented (Cadbury 1987) that the actions that result from applying this type of thinking could be ethical or unethical, depending upon the standpoint of the initiator. He offers to reframe it for business people with the question: If you did business with yourself, how ethical would you think you were?

In the case study, the care-based thinker has to try to put himself (mentally) in the shoes of the captives. But which ones? All those who will be saved? Each would have a different view of the odds of being selected, especially if they were ugly or beautiful, young or old, sick or healthy perhaps. 41

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General Comments

When one applies these tests to any situation, it is quite likely that they will produce different decision outcomes as the simple case study suggests. The temptation might be then to select the decision with the greatest number of “votes”. But as Kidder says:

“The usefulness of these principles is not that they will deliver an airtight answer to your dilemma. They are not part of a magic answer kit that produces infallible solutions: if they were, ethics would be infinitely easier than it is. …No, the principles are useful because they give us a way to exercise our moral rationality. They provide different lenses through which to see our dilemmas, different screens to use in assessing them.”

The important thing is to balance these tests. No single one of them has a claim to pre- eminence in any ethical situation. An alternative approach proposed by Badaracco, who dismisses these tests as ultimately useless, is briefly set out in section 7.6.

In reality ‘good’ people will inevitably make ‘bad’ decisions, no matter the effort put into ‘getting it right’. At the same time, making a ‘bad’ decision does not make a ‘bad’ person. On the other hand, as noted earlier, people can and do make ‘bad’ decisions through some process of rationalisation.

The example in Appendix F as quoted by Kidder is useful in order to clarify some of these ideas.

7.4. Models for ethical decision making

There are numerous models, scripts or frameworks for helping people make ethical decisions that are more practical and responsible. This refers to those ‘right vs right’ dilemmas where different people, with the best intentions will come up with different answers. Therefore none of the models can give the single ‘right’ answer where none exists.

Often there is little or no time to apply any these models. The models can be time consuming to apply and so should not necessarily be applied for simple or insignificant decisions such as those one makes every day – you are making many of these each day (although these are most likely to be ‘right vs wrong’ decisions). Sometimes – most times – we may do the right thing by instinct, without reflecting upon what we are doing. For any number of trivial decisions, this is appropriate. For example, most of us (most of the time) do not require intensive moral deliberation to avoid lying.

All the models have a structure (ICA 1995) which is common to all problem solving: 42

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1. Define the problem carefully 2. Collect and assess the evidence 3. Review the options and choices available 4. Devise an action plan with clear goals 5. Act effectively and observe the process 6. Analyse and learn from the results

It is important to also understand that following any one of the other popular scripts, while it may lead to efficient decision making, will not necessarily lead to the best decision. In fact, by definition, all ethical dilemmas give rise to decisions, which result in sacrifices and most likely with some people being “put out”.

Appendix G provides a couple of the models available that the author has a preference for; Kidder’s, for it being well thought out and relatively straight forward to apply; and Rion’s, for its practicality and simplicity. Kidder’s model has been slightly modified to partially accommodate some of the concerns of Badaracco (refer section 7.6).

The Kidder model asks the question about who are the actors. The Rion model tries to get at the same issue by asking “Is it my problem?”. The resolution of this issue can be assisted by referring to the table in Appendix H.

7.5. Ethical fitness

Often we do not have the luxury of time for weighty deliberation over a decision, or to apply one of the models of ethical decision making. Even so, lack of time should not divorce us from the responsibilities that go with any decision.

Kidder believes that, above all else, we need to focus on what he calls the “ethical fitness” of individuals and organisations:

“What’s needed is a capacity to recognise the nature of moral challenges and respond with a well-tuned conscience, a lively perception of the difference between right and wrong, and an ability to choose the right and live by it.”

The example cited in Appendix F and referred to in the previous section demonstrates the decision maker (the trooper), while having little time to resolve the dilemma, had the “ethical fitness” to do so. How does one become ethically fit? Kidder suggests in the same way one becomes physically fit: practice. Sometimes the effort is conscious, sometimes natural or accidental. But unlike physical fitness, he states that ethical fitness requires the mind to be engaged. 43

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Andrews (1989) makes the point this way: “Making ethical decisions is easy when the facts are clear and the choices black and white. But it is a different situation when the situation is clouded by ambiguity, incomplete information, multiple points of view, and conflicting responsibilities. In such situations—which managers experience all the time—ethical decisions depend on both the decision-making process itself and on the experience, intelligence, and integrity of the decision maker. …The calibre of the decision- maker is decisive—especially when an important decision must arise from instinct rather than discussion.”

Andrews then suggests that being ethically fit requires in particular:

„ competence – to recognise the ethical issues and to think through the consequences of alternatives;

„ self-confidence – to seek out all points of view, and then filter and balance them according to the circumstances of place, time, issues, and relationships; and

„ tough-mindedness – the willingness to make decisions when all that needs to be known cannot be known and when the questions that press for answers have no established and incontrovertible solutions.

To this list, Kidder would add two overarching qualities:

„ moral courage – because the sacrifice that must be made could be your own; and

„ you’ve got to care – a person must be committed through feelings as well as through the intellect.

7.6. Sleep-test ethics

Badaracco (1997) strongly believes that applying ‘grand principles’ of ethics is futile. While acknowledging they may be marginally useful by clarifying problems (they cut to the quick revealing the ethical trade-off or the boundaries between right and wrong) and possibly providing a justification for a decision, he devotes little space in his book to discussing them. He believes they provide little aid or comfort because

“they are too general and tend to float above the problems. They often contradict each other, tightening the Gordian knot rather than cutting through it. And, most importantly, the decisive factors in the right-versus-right situations are practical and personal. One must be immersed in a situation, and one must know who one is, in order to determine the right thing to do.” 26 44

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The ICA (1995) also states that like a compass, the principles only help us to orientate ourselves. They do not provide us with a map, nor dictate a particular course for us. It believes we each have to choose our own destinations and routes for getting there. This idea was also stated in a similar way by Frankel (1989) referred to earlier in the paper.

Badaracco has coined the term ‘sleep-test ethics’. As he puts it, the approach rests on a single, fundamental belief: that we should rely on our personal insights, feelings, and instincts when we face a difficult ethical problem – it is the ethics of intuition.

This concept or approach was originally proposed by Aristotle and pre-supposes – in order to avoid a trap that the test leads to selfish ‘me-ism’ resolutions – the development of one’s character into a thoughtful, mature person. In this way, the intuition arises after serious attention to the relevant facts, not in place of them. It is therefore not a substitute for common sense, logic, or consideration of basic ethical principles. It is also important that the intuition be such that it can be articulated and explained to others in ways that draw on important social and ethical practices in society. Badaracco states that the approach:

“shifts the focus of ethical deliberation from abstract principles to issues of personal character, from logic toward psychology, from the universal to the individual, from the intellectual to the emotional, from objective truths to personal choice and commitment, and from the marble temple on the hill to the hurly-burly of everyday life.”

Badaracco offers a framework of phrases and questions to help resolve the ethical dilemmas with this concept at the heart – refer Appendix I.

The author believes Baradacco’s approach is pragmatic and worth close consideration. It is suggested though that a close reading of his book is necessary in order to appreciate the force of his arguments. 45

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PART B

THE ACTUARIAL PROFESSION AND ETHICS 46

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8. ARE WE AN ETHICAL PROFESSION?

"Trust me, I'm an Actuary."

––From a badge produced by Ernst & Young

8.1. What is expected of us?

It has been said that more people, at least indirectly, rely upon our advice than any other profession, with the exception perhaps of the medical profession. Whether or not this is a valid observation, it remains true that, for example, life office actuaries are involved in the risk management of a crucial industry at a time when systemic risks have never been higher and never so dependent upon the decisions of perhaps a few key individuals (putting aside the rogue individuals in cases such as Barings).

It is perhaps not surprising then that the IAA mission statement refers to both ethics (obliquely) and the public interest:

“The Institute: „ sets and enforces professional standards and a code of conduct, which embody integrity, expertise and relevance; „ provides professional accreditation for the protection of the public.”

The Code of Conduct also refers to the Institute and its members having

“an obligation in the public interest to provide the best possible service and advice”

and then going on to state

“Professional conduct involves the member’s own sense of integrity in relationships not only with those to whom professional services are rendered but also with other members of the profession and with the public.”

The Institute recognises the concept of the knowledge and skill gap between actuaries and their clients (and by implication the concept of power sharing referred to earlier) but goes further in confirming the notion of an actuary’s duty to the public. On serving the public interest, Pickup (Carmichael 1997b) stated that:

“Some people within the profession believe that we should seize the moral high ground and become guardians of the public interest in financial matters …It is not clear where this idea comes from. Perhaps it is part of the price we pay for having what is, effectively, a closed shop … If I have to take into account the interests of 47

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my clients’ clients, or the public interest, perhaps that will conflict with my primary duty. It also presupposes that I can know what is in the public interest.”

McDonald (1995a) responds to the type of view expressed by Pickup by returning to the argument expressed at the beginning of this section::

“The area you occupy, in which you are knowledgeable, is extremely important to the long-term stability of society ... Actuaries have the knowledge, and in some ways you have the power, ... to make a difference between stable institutions and unstable institutions in our society. You’re very important in helping to maintain the trust and confidence we feel in our way of life. So you have, in other words, a great deal of responsibility, and you have to take that very seriously.”

Arthur (quoted in Carmichael 1997b) also commented on the pensions mis-selling in the UK and the missed opportunity of the actuarial profession to get on the front foot to

“… exhibit clear, pragmatic and unambiguous leadership, by laying aside factional interests and forcing a swift solution in the public interest… I would suggest that we have, generally, become too absorbed in the ethics of duty to our principal, with too little regard to the consequential (and often ‘big picture’) effects on the public.”

Of course, such counter views presuppose that one can define who “the public” is. Thomas (1998) notes that:

“This phrase, familiar in all talk of professional conduct, is so vague that it can be interpreted to mean so many different things that it is often of little use in the really difficult cases. It would certainly be hard to establish a precise meaning if, in court of law, any professional conduct penalty was challenged.”

This debate may never find a satisfactory resolution but that does not prevent one from considering how actuaries, from an empirical perspective, may be interpreting the Code of Conduct in practice. Linden Cole of the Society of Actuaries has also devised a list of ethical issues that confront actuaries or the profession generally from time-to-time – refer to Appendix J – and this may be useful to readers.

The paper will now move on:

„ to consider the types of issues that actuaries generally have had to confront in the past and which may have ethical connotations; and

„ to present and review the results of a survey recently conducted of the membership on ethical views and practices. 48

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8.2. What has been the reality?

Brimblecombe (1997) has raised some important issues about our past behaviour as a profession in the life insurance domain and which all actuaries (whether or not they were a part of that past) should reflect upon.

Brimblecombe comments in particular upon the apparently reduced influence of actuaries over the 1980's and draws a parallel with the ever increasing trend in sales, the rise in shareholder influence and then with the diminishing reputation of the life insurance industry in general. He asks where were the actuaries’ voices?

C Pickup (recorded in Carmichael 1997b) when referring to failures in the financial services industry in the UK, particularly the Maxwell case and the pensions mis-selling, asks:

“[A]re these failures as a profession? In other words, could we have prevented them, or are they the failures of the businesses that we work for?”

M Iqbal (at the same discussion) points out the simple truth that:

“If actuaries are to be blamed, I suspect that is because they were at the scene of the crime.”

C Sharp (also at the same discussion) quotes H H Scurfield’s presidential address in 1990 that:

“in the areas where we have special knowledge and experience, the profession should be pro-active; meaning that we should recognise problems and deal with them before they became serious.”

Consider for example the following questions cited by Brimblecombe from the life insurance field where the actuarial profession may have a case to answer such as:

„ The invention of so-called “capital units”, which, as Drury points out (Carmichael 1997b), while being capital efficient, served primarily to obfuscate management charges, and mitigate the competitive forces towards lower cost.

„ Applying front-end loadings to small premium savings plans where little if any value could be returned should early termination of the contract be necessary.

„ Designing complex products which may appear to the actuary to be entirely “equitable” in a technical sense but which are not transparently fair to the consumer, 49

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eg high surrender penalties for terminating a policy early, and “market value adjustments”, which bewilder the investor on early termination.

Other examples that have been cited from various actuarial fields include:

„ Possibly overly conservative release of accumulated surpluses to participating policyholders which become evident in the large free estates accumulated by some companies.

„ Participation in the “cherry picking” superannuation schemes, which were designed for the benefit of the employer.

„ The provision of very high uninsured death/TPD benefits from small funds, with actuaries providing S279 certificates allowing deductions for notional insurance costs to be claimed27.

„ Practices in support of CTP insurance premium filing in NSW.

In the finance/investment field, one actuary working in this area noted to the author that it was difficult to find examples not because actuaries are necessarily more ethical than, for example, brokers and fund managers, but because there are no obvious areas where actuaries work as actuaries rather than financial mathematicians. Nonetheless, potential examples cited to the author where actuaries could become involved included:

„ Brokers/ fund managers acting on their own account rather than their clients, or trading between accounts at non-market prices;

„ Investment brokers building usurious returns into complex financial instruments; and

„ Asset consultants making manager recommendations on the basis of favours, rather than a manager's bona fides.

Does the profession have a case to answer on any or all of these examples? If so, why haven’t we been brought to account? Have we been lucky or sufficiently “invisible” up till now? 50

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8.3. Some further questions to ponder

The following represent a grab-bag of additional questions that came to the mind of the author on this area and which is believed, if answered honestly, expose our own individual stance on the above questions:

1. Have actuarial ethics declined/increased over recent years or has the frame of reference merely shifted due to the changing attitudes of consumers, regulators, society in general etc? (By the way, the author understands that the Professional Guidance Committee has received very few inquiries over the years, even fewer on what could genuinely be called ethical issues.)

2. Were actuaries able to recognise that their decisions at the time may have involved ethical issues? What’s different now? If they did recognise them as such at the time, would they have really known how to respond, ie go about making an ethical decision?

3. Do we understand who our real client is? The one who pays the bills or our salary or Mr and Mrs Public (however one might define them)?

4. Do many (if not most) of the ethical conflicts arise because of conflicts of our (supposedly higher) professional ethics with the (supposedly lower) ethics of businesses? Does it follow that we need to interpose ourselves more between the employer/client and their client/customers/members in the application of our Code of Conduct so that effectively the ethical standard the public can expect from our clients/employers is closer to that of the professional level? Or is this unreasonable, not commercial and not in the best interests of the profession? If not, what do we really stand for?

5. It seems actuaries have had little influence over such matters as disclosure and indeed may have been willing partners to non-disclosure? Did we forget that we are not working in “ivory towers”? Does, for example, the Life Insurance Act 1995 reinforce or blow away the ivory tower view?

6. Can or should actuaries be the ethical “conscience of the company”? Or should this role be better placed with the Board, particularly the non-executive directors?

7. What role can the following have in providing a rod for the actuary’s back:

„ colleagues and peer reviewers? „ the Institute and/or the President? „ APRA and the Act? 51

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8. Is there a role for a “compliance actuary” within a life office or general insurer reporting to the CEO and Board as Brimblecombe’s paper proposes or, at least in the case of life offices, can this role be fulfilled adequately within the powers and duties of the appointed actuary? Is it just another aspect of risk management? Or is this all too much for the appointed actuary who often these days wears a number of hats: compliance, legal, strategic planning etc?

9. What would you do today if, returning to the office, you were told any one of the following:

„ Your unit pricing system has had a material error in the last two years or so which has led to inequitable treatment of policyholders?

„ A major report for the Trustees, Board or your client which you are due to speak to this afternoon has drawn a materially incorrect conclusion (for which only you are to blame)?

„ The data which your life company has been providing to the IAA mortality experience committee (assume you are a major contributor) has been significantly in error for the last few years?

„ Your CEO wants the company to urgently design a new product with features which seem to echo the “bad times” commented upon in Brimblecombe’s paper?

„ Your annual valuation of policy liabilities (or outstanding claims reserves, superannuation benefit liabilities etc) reported in the financial results just published was materially in error? In the case of a life office, would your answer be different if the capital adequacy requirement was still satisfied?

8.4. How have our actuarial values served us?

This topic has recently been explored in depth in two papers submitted to the ICA Convention by Sharp (1998) and Thomas (1998). Sharp concluded that actuarial values include (at least in the UK context):

„ prudence „ (social) conservatism „ the pecuniary perspective „ equity „ collective over individual concern „ anti-consumerism „ hostility towards human rights legislation 52

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He believes that most of these have served the profession well but asserts that the last two need to be modified because they put the profession in a position of conflict with wider society (the self-interest argument) but they also mean potential personal and commercial sacrifices for no other reason than “doing the right thing”.

Some comments Sharp’s paper makes on each of these are as follows:

„ Actuaries tend to see the world largely through a financial prism (not surprising given their training) and assume that others must see the world in the same way;

„ Actuaries tend not to distinguish between actuarial fairness (“technical equity”) and other concepts of fairness;

„ Actuaries concern themselves with the collective welfare rather than, say, in medicine and law where the individual welfare predominates (again not surprising given that all statistical disciplines are meaningful and useful only in the context of groups of individuals);

„ Anti-consumerism may be seen in the example of anti-disclosure of commissions and have been criticised (rightly or wrongly) in the media for this position.

„ Disapproval of human rights legislation has been voiced in a number of presidential addresses around the world

On the second point, this could be considered an instance of the ‘justice vs mercy’ paradigm referred to earlier. For actuaries and their work, this paradigm might be better expressed as ‘equity vs fairness’. The author suggests that the term ‘equity’ gives the sense of a (mathematically) robust solution that properly takes account of all the quantitative inputs. On the other hand, use of the term ‘fair’ (while not ignoring the quantitative solution) seems to suggest recognition of what the layperson (ie the client or customer) would believe is a reasonable result relative to their own experiences and benchmarks. Carmichael (1997b) notes:

“Whether you get it right or not is not an ethical issue. Getting it right is your baseline – for actuaries to calculate correctly is the same as ordinary people having to obey the law.”

Thomas (1998), while acknowledging that ‘fairness’ is a value judgement, asserts similarly that ‘fairness’ can be determined by the profession only by the particular circumstances of a situation but that it should appear to be fair to those on whom the professional reputation depends. 53

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Looking to the future, Sharp also suggests that:

“[P]rofessions which prosper will be those with the most successful values – that is, values which restrain individual self-interest behaviour in ways which maximise the chances of long-term success for the profession as a whole.”

8.5. Other Professions

US SURVEY OF PROFESSIONALS

Cooper & Frank (1997) conducted a study during the period 1990-94 of US actuaries, accountants, auditors and chartered underwriters in an effort to determine the extent to which they rely on various factors in their business and professional environments for help in behaving ethically in the course of their work28.

An analysis of the survey results indicates, amongst other things, that

„ some professionals found their codes of conduct to be more significant than others as a form of help in ethical decision making; and

„ the ability to report unethical activity varied significantly between professions; and

„ companies and managers can assist employees best by neither implicitly or explicitly pressuring them to go against their own ethical values.

The key findings of the survey were:

1. Business must take the lead in providing an environment that encourages and rewards ethical behaviour from its professional employees.

2. Opportunities exist for many businesses to either make available or improve the helpfulness of various formal organisational mechanisms related to ethics, especially ethics training programs and places within the company where unethical activity can be reported.

3. Opportunities often exist for professional associations to improve the helpfulness of the resources related to ethics which they provide to their members, for example training in counselling skills for those leading other professionals who might face ethical problems. 54

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THE INSTITUTE OF CHARTERED ACCOUNTANTS (ICA)

The Australian ICA devotes a whole module to the subject of ethics in its professional year for those completing the academic studies. The course material is very detailed and comprehensive––certainly far more detailed and comprehensive than is reasonably permitted in a sessional paper such as ours. Pre-course preparation must be completed prior to joining two 3 hour workshops, which is then followed by a two week period to prepare for a 1½ hour examination.

In addition, the journal of the ICA includes a regular ethical problem and articles on ethics. Finally, it has launched videos of ethical hypotheticals and founded the Academics Ethics Network with its own newsletter.

It would be easy to respond that ethical issues and, at worst, law suits in accounting are an occupational hazard. To an extent this may be true but some informal (although limited) empirical evidence obtained by the author of the cost of professional indemnity insurance in Australia does not suggest that they are at risk any more than perhaps architects. The evidence does suggest though that lawyers, auditors, engineers, insurance brokers/advisers and management consultants are at higher risk, and perhaps surprisingly, property valuers even more so29. It is well known that doctors and surgeons (most particularly obstetricians) are at the highest end of the risk spectrum.

But this is probably a smug attitude for actuaries to take based on the relative size of the two professions and relative size of the relevant case law. Further it may be true that while the examples of claims are relatively tiny in number, the size of the typical claim in the corporate and auditing world is likely to be many millions of dollars. The important point is that the ICA takes the subject seriously and has taken actions that it believes are appropriate to its circumstances and the exposure of its members.

In an editorial (AFR 1997) on the flood of lawsuits faced by the accounting and auditing profession in the 1980s and early 1990s, it was concluded that “the best insurance for accounting firms and other professionals remains the striving for higher standards than prevailed in the 1980s”. Is the IAA itself doing enough? Should it wait until the legislators start agitating for change, perhaps as a result of unprofessional conduct which finds its way to the media?

8.6. Bulletin Survey

A Bulletin-Morgan poll on ethics and honesty amongst over 20 professions has been run since the mid-1970’s. The latest results were published in the June 10, 1997 edition (Milne 1997). While actuaries are not one of the professions included (not surprisingly), and while one could question the veracity of the conclusions that can be drawn, the results are nonetheless interesting in terms of public perception: 55

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“[P]rofessionals, once perceived as about the closest Australia had to an ‘aristocracy’, have taken a battering. On the slippery slope since 1976 are state and federal MPs, business executives, accountants and dentists, while the ethical status of lawyers and bank managers has plummeted.”

Coady (one of the authors in the References section) is quoted as saying in this article that:

“Life for professionals is much more uncomfortable than it was. People no longer defer to professionals in the way they did 30 years ago. Consumers are much more better informed than they were. They ask questions.” 56

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9. SURVEY OF AUSTRALIAN ACTUARIAL PROFESSION

9.1. The survey aims and scope

The survey was conducted during July 1998 and included all members (whether qualified or not) of the Institute of Actuaries of Australia. The aims of the survey were to gather information on the following issues:

„ an overview of various aspects of the ethical conduct of actuaries; „ perceptions of changing ethical standards; „ factors that influence ethical conduct; „ identification of ethical issues encountered; „ perceptions of the importance of various ethical issues to professional practice; „ identification of the type of people consulted when faced with an ethical dilemma; „ perceptions of the extent to which various influences affect the responsiveness of Institute’s Code of Conduct to the needs of the profession and society; and „ perceptions of the importance of ethics education and the topics to be examined.

The survey parallels a like survey conducted in 1992 on the accounting profession in Australia and described in Leung & Cooper (1995). The designer of that survey kindly made the template available for conducting the actuarial survey.

While the author believes the survey is the first of its type for Australian actuaries, there has been a sociological survey of a small number of actuaries by Jureidini & Knox (1985) and referred to by Bellis (1997). On p224 she quotes from the survey that actuaries saw themselves, amongst other things, as “imbued with strong work and professional ethics”. Reference to the survey paper actually reveals that the term “ethics” was used by the authors’ to capture the concepts of “hard working”, “persistent”, “honest”, “reliable”, “highly motivated”, “very responsible”, “serious”, “stable”, “tenacious”, and “conservative” as expressed by respondents. To be precise, such concepts are really the values upon which the ethics of the profession have developed and which it sees itself having.

Bellis also notes that by 1985:

“some members of the profession saw as a decline in ethical standards a new willingness to act as advocate for a client’s point of view rather than delivering some objective actuarial ‘truth’. The cult of user-pays had an impact.”

The current survey hopes to gain insights into how the profession sees itself. While it looks at some of the influences on members, it does not consider the reasons why actuaries are the way they are; that will be left for other researchers. 57

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9.2. The sample characteristics

The survey was conducted in July 1998. The survey population was the total membership of the Institute which, at 30 September 1997, comprised 1,828 members of which 1,025 (56%) were qualified actuaries (Fellows or Accredited). The total number of responses was 377 which represents about 20% of the membership30 (although note that not all respondents answered every question).

The spread of occupations shown in Table 1 seems reasonable when compared to Institute statistics (although the classifications are somewhat different). For example, the Institute had recorded 32% as working in life insurance, 22% in superannuation, 12% retired, 9% in general insurance, 7% in investment, 7% in management, and 3% in banking.

The retired group is not well represented perhaps because, as one retired actuary commented to the author, they feel their views are no longer relevant. The author finds this a little disappointing as those who retired in perhaps the last five years should have much to comment on in relation to the changes they have seen.

Table 1. Respondents Categorised Under Field of Employment Number % (a) Life insurance 101 27 (b) Financial services 79 21 (c) Asset consulting 8 2 (d) Funds management 21 6 (e) Superannuation 78 21 (f) General insurance 37 10 (g) Software development 0 0 (h) Banking 5 1 (i) Corporate finance 10 3 (j) Industry & commerce 2 1 (k) Government department/public utility 5 1 (l) Education/research 4 1 (m) Retired 5 1 (n) Other 16 4 Total 371 100

The spread of organisational sizes shown in Table 2 seems reasonable with nearly 60% of respondents working for organisations with 100 or more employees. 58

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Table 2. Respondents’ Organisation* Size Number % (a) less than 5 36 10 (b) 5 – 19 52 14 (c) 20 – 49 40 11 (d) 50 – 99 27 7 (e) 100 – 249 45 12 (f) 250 – 999 61 17 (g) 1,000 or more 107 29 Total 368 100 * “organisation” was defined as the grouping of persons who are subject to same code of conduct (or values)

Table 3 looks at the profile of ages and sexes represented in the sample. A comparison was made with Institute statistics which suggested that, while the spread of ages in the sample was reasonably consistent, there did seem to be a materially higher relative proportion of the youngest members (aged less than 25) represented and a likewise lower relative proportion of members aged in their early 30’s and in their 50’s. Even so, the divergence did not seem significant enough to bias the results.

The weighting of females towards the younger ages is believed to be consistent with the generally much higher growth rate of females undertaking the professional exams in the last decade or so as confirmed by Bellis (1997, p228).

Table 3. Respondents’ Age and Sex Profiles Males % Females % (a) 20 – 24 32 10 10 16 (b) 25 – 29 61 19 19 31 (c) 30 – 34 54 17 18 30 (d) 35 – 39 29 9 10 16 (e) 40 – 44 34 11 2 3 (f) 45 – 49 42 13 2 3 (g) 50 – 59 45 14 0 0 (h) over 60 16 5 0 0 Total 313 100 61 100

Each of the broad types of work in Table 4 is significant in the sense that they suggest different types of client relationship and possibly fiduciary duties. The types of work referred to are well represented although the relative proportion of consultants seems high. The reasons for this are not obvious except that, being a self-selected sample, 59

ETHICS, ACTUARIES (AND ROBOTS) consultants possibly perceive that ethical/professional issues are more at the forefront of their experience and therefore they may be more inclined to respond to a survey such as this. It is not clear to the author whether this sample bias should lead to any bias in the survey results.

Table 4. Respondents’ Type of Work Number % (a) Consultant 196 53 (b) Corporate employee/executive 158 43 (c) Academic or research 6 2 (d) Directorship(s) 11 3 Total 371 100

The range of experience and qualifications represented in the sample in Table 5 suggests an under-representation of actuaries in their middle years. The reasons are not obvious (except possibly they may be too busy on MoS work!).

Nonetheless, there were three times as many actuaries represented in the sample as students/associates whereas the membership ratio is 56:44. Perhaps this result is not surprising if one can presume the younger members’ general perception that professional ethics is something to which they are yet to be exposed.

It is nonetheless pleasing that sufficient younger members took an interest in the survey since the reality is they do have views. What is interesting is that, according to evidence from the US, they tend to see situations as more black-and-white compared to the “grey heads” who, naturally, see more of the grey!

Table 5. Respondents’ Actuarial Qualifications & Experience Experience Number % (a) Less than 3 years 41 13 (b) 3 - 5 years 32 10 (c) 6 – 10 years 73 23 (d) 11 – 15 years 49 16 (e) Over 15 years 119 38 Total 314 100 Comprising … Students & Associates 79 25 Fellows & Accredited 235 75 60

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The author would have liked to analyse results of the survey according to age groupings, sex, type of work etc but time limitations did not permit it. The author hopes to produce a short follow-up note with such an analysis.

Table 6 shows that three-quarters of the sample see themselves as actuaries (or student actuaries) first and foremost, although of course as one progresses through one’s career, the balance tends to shift to management and leadership.

Table 6. Respondents’ Relative Position in Organisation & Actuarial Focus of Work I describe myself I describe as a leader/ I describe my myself as an manager/ work in other actuary (or Relative Position Number executive/ terms student) entrepreneur % % % (a) Top 64 66 34 0 (b) Senior 122 69 26 5 (c) Middle 127 75 17 8 (d) Junior 54 85 9 6 Total 367 73 22 5

The levels of formal education attained by the respondents are indicated in Table 7. The sample spread seems reasonable.

Table 7. Respondents’ Highest Level of Formal Education (excluding actuarial) Number % (a) Secondary school graduate (or Year 12 equivalent) 26 7 (b) Bachelor Degree 256 68 (c) Post Graduate Qualification 46 12 (d) Master’s Degree, MBA 45 12 (e) Other 3 1 Total 376 100

Finally, Table 8 confirms that a good representation of actuaries responsible for “overseeing” the professionalism of other members was obtained. These actuaries may find themselves from time-to-time in the position of being consulted by colleagues within their organisation on professional or ethical matters. 61

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Table 8. Respondents’ Who are “Senior Actuaries” Number % (a) Yes 64 17 (b) No 309 83 Total 373 100

Now we move onto the specific findings of the survey. The broad areas examined by the survey were:

„ General perceptions about ethical standards of actuaries „ Factors influencing the ethical behaviour of actuaries „ Ethical issues in actuarial work „ The Code of Conduct „ Ethics education

9.3. General perceptions about ethical standards of actuaries

The perceptions of changing ethical standards shown in Table 9 seems to be evenly balanced around “little or no change”. The large numbers of “don’t knows” could possibly be attributable to those with little experience in the profession; this seems to be confirmed by the same number of “uncertain”s in Table 10.

The results of Tables 9 and 10 together suggest that, while members generally do not perceive a decline in standards over the last 10 years, there are a significant number (although not a majority) who believe standards should be increased.

Table 9. Perceptions of Changing Ethical Standards Over Last 10 Years Number % (a) Increased 38 10 (b) Little or no change 194 52 (c) Declined 49 13 (d) Don’t know 94 25 Total 375 100

Table 10. Perceived Need for Improvement of Ethical Standards of Actuaries Number % (a) Yes 119 32 (b) No 162 43 (c) Uncertain 94 25 Total 375 100 62

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The results of Table 11 are perhaps not surprising in terms of relativities between reference groups. It is noted though that almost all members see themselves as having the same level or higher ethical standards as all other members; and almost all members see themselves as having the same level or higher ethical standards as the superiors that many or most will become! A few members seemed to suggest that they might be seeking redemption!

Table 11. Relative Ethical Standards of Various Personal Reference Groups Higher Non- Much At the Lower Much Your Perception and *Average than replies higher same than lower Comparison Against Response than % level % % than % % % (a) Your university 3.56404911 4 classmates (b) Current work peers 3.3 3 28 66 2 0 2 (c) Current work 3.23206660 4 supervisors (d) Current work 3.41336020 4 subordinates (e) Faculty members of previous university 3.2116663014 at which you studied (f) Non-actuary friends 3.7 8 56 33 1 0 2 * The average score was derived by applying a 5 to 1 weighting to the percentages, scaling up for non- replies. A score of 3 therefore means “at same level”.

Table 12 suggests we see ourselves more aligned with auditors, doctors and nurses in ethical standards but would perhaps like to distance ourselves from accountants, teachers, and lawyers. Not surprisingly, politicians hardly rate a mention!

Table 12. Relative Ethical Standards of Various Professions Higher Non- Much At the Lower Much Your Perception and *Average than replies higher same than lower Comparison Against Response than % level % % than % % % (a) Accountants 3.7 8 59 32 1 0 0 (b) Auditors 3.3 3 32 61 3 0 0 (c) Doctors 3.2 2 27 62 7 0 1 (d) Nurses 3.3331577 0 2 (e) Lawyers 4.0 27 49 21 2 0 1 (f) Teachers 3.7 10 49 37 2 0 1 (g) Politicians 4.7 69 25 2 0 0 3 * The average score was derived by applying a 5 to 1 weighting to the percentages, scaling up for non- replies. A score of 3 therefore means “at same level”. 63

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But as the Bulletin survey referred to earlier concludes, the general public perceive the ethics of nurses is without peer. What would be the perception of our employers and clients of the profession? Perhaps that is a question for a different survey by the Institute.

9.4. Factors influencing the ethical behaviour of actuaries

The most striking result of Table 13 is that our behaviour is more influenced by those we come into contact with at work and home rather than any form of written codes or value setting by organisations. Nonetheless, the Institute’s own Code of Conduct is seen by a majority of the sample as being important for setting acceptable standards of behaviour.

Table 13. Significance of Factors Affecting the Ethical Conduct of an Actuary Importance Non- *Average Factors Great Some Little None replies Response % % % % % (a) Family upbringing 3.6 62 33 4 1 1 (b) Conduct of peers 3.6 61 35 3 1 0 (c) School and university 2.8 15 51 29 4 0 training (d) Religious training 2.6 21 36 23 19 1 (e) Practices in the actuarial 3.3 39 50 9 2 1 field (f) General moral climate of 2.9 21 50 24 4 0 society (g) Personal financial need 2.4 10 35 41 13 1 (h) IAA Code of Conduct 2.8 18 47 30 5 1 (i) Other 2.8 4 4 1 3 88 * The average score was derived by applying a 4 to 1 weighting to the percentages, scaling up for non- replies.

Other factors suggested that would influence the ethical conduct of actuaries included:

„ fear of consequences of getting caught „ genetics „ age and maturity „ general practices of working environment „ work and market pressures „ professional training „ influence of superiors

All of these factors can contribute to the development of our personal value set and thereby influence our ethical behaviour.

Table 14 suggests that a majority of members believe that the Institute should be more prepared to use the “stick” as a means to improve the ethical standards of actuaries such 64

ETHICS, ACTUARIES (AND ROBOTS) as imposing stronger disciplinary action on members or giving greater publicity to incidents where actuaries are found guilty of misconduct. They also see that prevention methods such as courses and seminars remain important to this end.

Table 14. Level of Importance of Various Means to Enhance the Ethical Standards of Actuaries Importance Non- *Average Factors Great Some Little None replies Response % % % % % (a) Introduce courses in actuarial ethics in 2.7 13 53 26 8 0 universities (b) Introduce more stringent 2.142452201 government regulations (c) More seminars and conferences to promote 2.7 10 52 32 5 0 ethics among actuaries to be conducted by the IAA (d) Stronger discipline to be imposed by the IAA where an actuary is 3.0 27 50 18 4 1 found guilty of misconduct (e) Greater publicity by the IAA where an actuary is 2.9 27 45 22 5 1 found guilty of misconduct (f) Other methods that could be introduced by the 3.1641287 IAA * The average score was derived by applying a 4 to 1 weighting to the percentages, scaling up for non- replies.

Comments on other methods that could be introduced by the Institute to enhance ethical standards were diverse and included:

„ providing greater support when ethical issues are brought to its attention „ praising an actuary for ethical conduct „ greater stress on ethics within existing academic courses „ organising audits of companies by senior professionals „ emphasising the role of peer review „ organising refresher professionalism courses „ publicising examples of actuaries “doing the right thing” „ making examples of actuaries “doing the wrong thing”, and „ demonstrate how Institute office holders are leading by example. 65

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In Table 15, we see further evidence that the Code of Conduct is providing a useful service to members. Almost half the sample indicated that they had cause to refer to the Code of Conduct on one or more occasions during the preceding 12 months.

Table 15. Frequency of Consulting the Code of Conduct in Preceding 12 Months Number % (a) Not at all 199 53 (b) 1-3 times 149 40 (c) More often 24 6 Total 372 100

Whether members believe it actually helps or not is considered in section 9.6 below. Nonetheless, as commented earlier in the paper, it is the author’s view that the existence of a code increases the likelihood that people will at least think about the ethical dimensions of a decision.

9.5. Ethical issues in actuarial work

Table 16 (next page) indicates that the most dominant ethical issues encountered by members are conflicts of interest and client proposals about valuation assumptions and methods. Also dominant are admitting mistakes and fee problems. All of these pertain to consulting actuaries and, given the bias of the sample to including a higher proportion of consultants, these results should not be unexpected. Some of the other issues can pertain to all types of work.

The survey records a proportion of the sample who perceive that Institute office holders (which could mean council or committee members) may have in the past used their position to gain credibility, business or justify actions. Whether this perception is well founded or not may be something that the Institute would like to consider.

Other ethical issues encountered included:

„ unqualified members representing themselves as “actuaries” „ setting of surrender values, pricing structures, crediting rates „ mistreatment of staff – sustained and unreasonable demands on their time and energy „ apparently turning a blind eye to breaches of the Code of Conduct by other members

Note that there is no suggestion here that actuaries acted unethically or unprofessionally, but merely that they encountered situations which required a decision with ethical consequences or else they perceived others may have erred in making such a decision. 66

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Table 16. Ethical Issues Encountered by Actuaries Issues Number % (a) Client proposals about valuation assumptions/methods 220 59 (b) Conflicts of interest 253 67 (c) Client proposals to manipulate financial statements 81 22 (d) Fee problems (billing, collection, contingent fee problem or 161 43 competitive bids) (e) Failure to maintain technical competence in the discharge of 102 27 professional duties (f) Integrity in admitting mistakes made by yourself or your firm 189 50 (g) Coping with superior’s instructions to carry out unethical acts 73 19 (h) Deciding which external activities will cause a significant 86 23 conflict of interest with employer or client (i) Maintaining an adequate degree of confidentiality of 117 31 information about your employer or client (j) Presenting financial information in the most proper manner so 142 38 as not to deceive the users (k) Using inside information for personal gain 56 15 (l) Receiving unreasonable favours, gifts and entertainment 22 6 (m) Unethical solicitation of professional work 35 9 (n) Other circumstances which would compromise independence 27 7 (o) Using one’s official standing in the IAA to gain credibility, 42 11 business or justify actions (p) Other ethical issues 15 4

The analysis in Table 17 lends support to the issues most often being encountered in Table 16 being considered of great importance in maintaining the ethical standards of members. Nonetheless, all the issues listed are considered of at least some importance.

Also noted by the sample were:

„ the perception of a conflict of interest, real or not „ mistreatment of staff 67

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Table 17. Significance of Ethical Issues in Maintaining Ethical Standards of Actuaries Significance Non- *Average Issues replies Response Great Some Little None % % % % % (a) Client proposals about valuation 3.1 24 54 16 1 5 assumptions/methods (b) Conflicts of interest 3.5 58 35 5 1 2 (c) Client proposals to manipulate 3.3 52 25 13 5 6 financial statements (d) Fee problems (billing, collection, contingent fee problem or 2.7 11 46 32 5 6 competitive bids) (e) Failure to maintain technical competence in the discharge of 3.2 39 41 14 2 4 professional duties (f) Integrity in admitting mistakes made 3.3 42 45 7 1 3 by yourself or your firm (g) Coping with superior’s instructions 3.3 49 30 13 3 5 to carry out unethical acts (h) Deciding which external activities will cause a significant conflict of 2.8 18 46 26 5 5 interest with employer or client (i) Maintaining an adequate degree of confidentiality of information about 3.1 36 37 18 5 4 your employer or client (j) Presenting financial information in the most proper manner so as not to 3.2 38 41 14 3 5 deceive the users (k) Using inside information for personal 3.1 47 21 17 9 6 gain (l) Receiving unreasonable favours, gifts 2.7 26 27 28 13 6 and entertainment (m) Unethical solicitation of professional 2.7 19 38 27 9 7 work (n) Other circumstances which would 2.8 13 35 16 6 30 compromise independence (o) Other ethical issues 2.43214 91 * The average score was derived by applying a 4 to 1 weighting to the percentages, scaling up for non- replies. 68

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Table 18 shows that members seem to seek advice on ethical problems firstly from their work colleagues or superiors (despite the apparent relatively low opinion of them referred to earlier in the above analysis). Some distance back are spouses or friends.

The Institute (or its President) was mentioned as an alternative by very few in the sample. There are possibly a number of inferences that can be drawn from this result but the most obvious one would be that of all the ethical issues that confront members, very few come to the attention of the Institute. That is probably the way it should be.

As was noted by Leung & Cooper, caution must be exercised when discussing ethical dilemmas outside of work or with legal counsel because of the possibility of divulging confidential information. They also pointed out that the answers to this question might also reflect respondent’s perception of the magnitude of the ethical issues they encounter, and also their desire to seek objective and professional advice from those who possess the expertise to provide the advice.

Table 18. Personal Mentors When Faced With an Ethical Problem Average Ranking* (a) Superior 2.4 (b) Friend or mentor outside work 1.4 (c) Colleague (or mentor inside work) 2.4 (d) No one 0.5 (e) Spouse (or relative) 1.3 (f) Clergy 0.1 (g) Legal counsellor 0.5 (h) Other 0.1 * Respondents were asked to rank their top four. The highest was given a score of 4. The rankings were then averaged over all respondents.

9.6. The Code of Conduct

Is the Code of Conduct serving the purposes intended? Amond (1983) remarked that the Code of Conduct was being revised in the mid-1980s to recognise that

“continuing attempts to draw rigid lines between ‘professional’ and ‘business’ are unrealistic in today’s competitive and consumer-orientated world.”

Table 19 seems to confirm that most members have a good awareness of the Code of Conduct and its requirements. Even so, it is perceived that a significant number of members have little awareness of its requirements. This would seem to lend support to the previous assertion that the Institute should do more to educate members on 69

ETHICS, ACTUARIES (AND ROBOTS) professionalism and ethics.

Table 19. Perceived Awareness of Code of Conduct Amongst Actuaries Number % (a) Well known 49 13 (b) Known 170 46 (c) Little known 126 34 (d) Not known 10 3 (e) Don’t know or not sure 18 5 Total 373 100

The results in Table 20 also confirm strong agreement amongst members that the Code of Conduct is generally perceived to serve the purposes listed very well, notwithstanding the existence of individuals’ own value set.

Even so, there are relatively large numbers who are not sure whether or not the Code of Conduct does serve the purposes listed. This general result, particularly that for perception (h), would suggest that a formal review of the aims and content of the Code of Conduct may be warranted. The author’s own view is that no amount of writing or re-writing of the Code of Conduct will materially help instil better ethical practices amongst the profession. Greater emphasis should be placed upon prevention (largely by means of education) possibly supported by a review of the disciplinary procedures.

One comment from a respondent on this question suggested that we should not waste time on ethics but rather spend more time on projecting our image. While the author thinks such steps would have positive benefit to the profession (and the Institute has been making significant efforts in this regard), he also believes that the protection of our image must go hand-in-hand with that strategy. Indeed a large majority of the sample perceived (sub-question (f)) that the Code of Conduct was indeed useful in that purpose. 70

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Table 20. Perceptions of Code of Conduct of Actuaries Strongly Strongly *Average Agree Not Disagree Perception agree disagree Response % sure % % % % (a) Helps actuaries sort out 3.6 5 58 28 9 0 ethical concerns (b) Enables the actuarial profession to minimise 3.4 8 46 28 17 1 government regulation (c) Is meaningless since the IAA has no effective 2.4 2 11 22 57 8 method of enforcing it (d) Is window dressing; each actuary acts according to 2.7 5 23 16 49 7 his or her own personal belief (e) Assists actuaries to resist any management pressure 3.6 8 61 16 13 2 to perform unethical acts (f) Enhances the professional 3.8 18 53 17 10 2 image of actuaries (g) Can, to a large extent, address and provide a working guideline for 3.5 8 52 27 12 1 major ethical problems of IAA members (h) In general meets the needs 3.5 5 48 37 9 1 of the actuarial profession (i) Can be used to encourage higher ethical standards 3.7 7 66 19 7 1 in the actuarial profession (j) Must be subject to continuous refinement and updating since ethical 3.7 23 42 20 12 2 behaviour is dynamic in nature * The average score was derived by applying a 5 to 1 weighting to the percentages. A score of 3 therefore means “not sure”.

9.7. Ethics education

This brings us to education of members in relation to ethics. The conclusion from Table 71

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21 is that a significant proportion of members have either never been on the professionalism course (22%) or else may like to have a refresher course given that they now have the benefit of a number of years experience after qualifying (14%). This is confirmed by the results in Table 22.

Table 21. Attendance at Professionalism Course Year attended Number % (a) 1997 – 1998* 39 10 (b) 1990 – 1996 110 29 (c) Before 1990 53 14 (d) Have not attended (still a student) 90 24 (e) Have not attended (didn’t exist at time) 82 22 Total 374 100 * The ethics module was introduced in 1997

Table 22. Need for Re-fresher Courses in Professionalism Number % (a) Yes 216 58 (b) No 78 21 (c) Don’t know 80 21

For those who have been on the professionalism course, it seems that Table 23 confirms that they have derived benefit from it and perceive others have too.

Table 23. Effectiveness of Professionalism Course In enhancing own In enhancing the professional professional standards standards of others % % (a) Very effective 7 9 (b) Somewhat effective 24 31 (c) A little effective 18 16 (d) Not effective 7 4 (e) Never attended / Don’t know 44 40 Total 100 100 72

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The pleasing result of Table 24 is that members are seemingly beginning to take a general interest in ethical training. With the increasing focus of universities and colleges on ethics since the 1980s and the increasing general awareness of students, it probably is becoming harder to avoid it.

Table 24. Attendance at Non-Actuarial Ethics Courses Number % (a) Attended any meeting, course etc during the past 2 years which was related (entirely or in part) to actuarial ethics (or 42 11 professionalism) other than the IAA Professionalism Course? (b) Attended any meeting, course etc during the past 2 years which was related (entirely or in part) to ethics other than in 78 21 the actuarial profession? (c) Studied any subject on ethics at college or university (other 43 11 than in (a) or (b) above)?

Table 25 lends support to the perceived usefulness of ethical training to the profession itself but interestingly there seems to be divided opinion about whether this would provide benefits to the organisations we serve. Is the conclusion that ethical training is merely self-serving?

Table 25. Encouragement of Actuarial Ethics Training Useful to your Useful to the actuarial organisation profession % % (a) Yes, definitely 29 19 (b) Maybe 48 37 (c) No 21 41 (d) Don’t know 2 3

Finally, Table 26 confirms that professional ethics is seen as very desirable amongst members, supported by exposure to the study of real world ethical issues. This is indeed what the current professionalism course aims to provide.

There also seems to be some support for training on ethical theory, whistle-blowing issues, confidentiality, and corporate social responsibility. This seems to imply an increasing awareness amongst members that they need to be consumer-orientated along with the organisations they serve.

There seems to be little concern about matters that could be described as closer to general legal requirements or prohibitions. 73

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Table 26. Topics to Include in Actuarial Training Average Ranking* (a) Ethical theory 0.8 (b) Analysis of ethical issues 1.9 (c) Professional ethics 2.6 (d) Insider trading 0.4 (e) Whistle-blowing # 0.7 (f) Confidentiality 0.9 (g) Employee rights and duties 0.5 (h) Corporate social responsibility 0.8 (i) Integrity of actuarial records 0.3 (j) Bribery 0.1 (k) Government regulations 0.3 (l) Other 0.1 * Respondents were asked to rank their top four. The highest was given a score of 4. The rankings were then averaged over all respondents. # Whistle-blowing was defined as the unauthorised and voluntary reporting of illegal or improper acts perpetrated within an organisation to authorities outside the organisation or to the general public.

General comments from the sample included:

„ Few professions are better ethically because we are reasonably well paid and have little to gain by acting unethically. „ Professional ethics is a very important matter to research and help raise the profile of the profession . „ Teaching ethics at the professionalism course does not help much nor does the Code of Conduct – the working environment and examples of behaviour we encounter will shape our values. Leading by example is the most effective tool. „ Last week, working in the CIS, one of my clients turned up for a meeting with two bodyguards and an Uzi. I felt the Institute’s Code of Conduct would prove somewhat inadequate in protecting me! (And I'm not joking.) „ Need to address the issue of members working in areas they are not experienced in (which should be the responsibility of the senior actuaries). „ The professionalism course should develop case studies which better recognise real business imperatives and expectations. „ It is very hard to stand strong when pressure comes from above to make figures show something different. „ The vast majority of members have very high standards. Only those in senior positions have the ability to do real damage (to their organisations/clients and profession). The only fix is to disclose the identities of those found guilty of misconduct. 74

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9.8. Comparisons with Accounting Profession

According to the Leung & Cooper survey, a third of accountants felt that ethical standards had declined, which is in contrast to the relatively low result in this survey. Complementing this result, nearly three-quarters of accountants felt that ethical standards should be enhanced (compared to one third of actuarial members). Maybe this also accounts for the view by members that actuaries are generally more ethical than accountants.

The accounting survey also suggests accountants were less confident than actuaries about their subordinates and previous lecturing staff.

The accounting survey also suggested that, while like actuaries they were generally positive about their code, a significantly higher proportion felt that it was meaningless and served merely as window dressing because their society had no effective means of enforcing it.

On the other hand, accountants, like actuaries,

„ placed greatest weight on family upbringing and conduct of peers in influencing their ethical behaviour but lower (although similar to actuaries) weight on their professional code of conduct;

„ would first approach superiors or colleagues for ethical help;

„ felt that the most common ethical issues encountered were conflicts of interest and proposals to manipulate financial results;

„ believed their profession had a generally good knowledge of their code of conduct; and

„ greatest attention in ethical education should be devoted to professional ethics and analysis of ethical issues.

„

9.9. Conclusions

From the survey, it appears that members are generally concerned about the importance of ethical standards and conduct. The conclusions drawn from the Leung & Cooper survey of the accounting profession would seem to be generally applicable to the actuarial profession: 75

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1. Reasons for the apparent lack of knowledge of the Code of Conduct requires further consideration.

2. Perceptions about the Code of Conduct, although positive, should be further enhanced to improve the general awareness amongst members, and also promote positive attitudes towards enforcement and the continuing benefits to the actuarial profession.

3. Actuaries frequently encounter fundamental ethical issues that put their integrity and independence to the test.

4. The promotion of ethical awareness must be done not just through the Institute, but as an integral part of professional education.

5. Ethics education should provide a broader view of business and professional ethics, and an awareness of an adequate ethical decision making process through the introduction of ethical theories and simulated practice in managing ethical dilemmas.

6. Ethics education imparts knowledge and develops skills in ethical decision-making processes, and continuing professional development provides on-going sensitisation to ethical issues in the practice of actuarial work.

The author also believes there was a strong message from the respondents that the examples set by leaders in the profession (at all levels of experience) together with the Institute itself providing strong support where necessary would have more effect than anything else in raising the ethical standards of the profession and in enhancing the image of the profession to the outside. 76

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10. FINAL COMMENTS AND RECOMMENDATIONS

“Always do right. This will gratify some people and astonish the rest.”

− Mark Twain, 1901

10.1. Dispelling the Myths

The introduction referred to a number of myths which the author hoped to dispel by writing this paper. To recap, they were as follows with brief conclusions of the author:

„ Myth: ethics is a private matter

Reality: Each of us lives and works through friends, colleagues, communities, and society. While our values may be personal, the ethical decisions they drive must impact other people as well as ourselves and therefore cannot remain private.

„ Myth: ethics and business don’t mix

Reality: The strong consensus of business leaders and management schools today places ethics alongside other key considerations such a strategic formulation if businesses want to secure their future in a more consumer driven, environmentally-aware and educated society.

„ Myth: ethics is mostly “motherhood”

Reality: Ethical decisions can be some of the toughest we are likely to be confronted with in our working lives. While there has been a sprinkling of the philosophy of ethics in this paper, the author believes he has presented enough practical background on issues in business and professional ethics that can be applied by actuaries in real life.

„ Myth: ethics is complying with the law

Reality: Ethics covers the grey area between compliance with the law and absolute free will.

10.2. Call to Action

Professor Stephen Cohen at the University of New South Wales says that professional occupations are usually best situated to determine their own minimum standards of service, and to foster the development of new practices and reform old ones. In today’s 77

ETHICS, ACTUARIES (AND ROBOTS) climate of public accountability, it is important for the professions and professionals to realise that they will surrender much of their autonomy and all that implies if they are indifferent to ethical concerns.

Ferguson (1997) makes a call to action for the UK Institute on the subject of ethics. As an initial step, after the soul searching of a sessional meeting (subsequent to his address), he proposes that:

“We should discuss, debate, and then produce a position statement setting out why we are the only profession able to manage the apparent conflict between being client-focussed and ensuring the public good is always uppermost.” (p6)

He then goes on to give a number of specific examples of how this might come about:

(a) Demonstrate that ethical business practice is good practice;

(b) Demonstrate the value of the long-term view that only actuaries can help clients “make sense of the future”;

(c) Coincide the interest of companies and their employees; and

(d) Lead the campaign to re-introduce ethics in the financial sector.

On suggestion (a), close readers of this paper will appreciate that the validity of this argument is still debated but, in any event, probably irrelevant. For professionals though, we hope that we have shown it is self-evident.

On suggestion (b), it is not sure that actuaries represent the only profession that can lay claim to this, although the author strongly believes that we are the best equipped.

On suggestion (c), the author believes actuaries are already contributing in areas such as remuneration packaging and distribution.

On suggestion (d), it seems that the accounting profession has already substantially increased its focus in this area.

So it seems we have a lot to do if we are to take up Duncan Ferguson’s challenge. The issue of public good vs private profit was taken up in Heacox (1997) asking whether there was a conflict in the roles actuaries assume. 78

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As a starting point, the author believes that the Institute should consider the themes of this paper, the discussion at the meeting and resolve a response and plan. It is possible that it could form part of the Institute's Marketing Plan.

10.3. Conclusion

Economics is based on a theory of human behaviour that relates all motivation to personal pleasure, satisfaction and self-interest. It easy to understand then why economics as a field of study has attracted academic study while ethics, which concerns itself with the interests of others and which is studied in moral philosophy and sociology classes, has remained remote and in the backwaters – at least until perhaps 10 years ago, as the experience of the 1980’s unfolded.

McCoy (1997) states that:

“The word ‘ethics’ turns off many and confuses more. Yet the notions of shared values and an agreed-upon process for dealing with adversity and change – what many people mean when they talk about corporate culture – seem to be at the heart of the ethical issue.”

One final point that should not be overlooked is that each of us, by our daily actions and decisions, will affect in some way others who come under our influence, whether they be direct reports, peers, bosses, or clients, and how they view their own work. In other words, as Badaracco (1997) says, we are all ethics teachers whether we are saints or sinners, whether we intend to teach ethics or not. It simply comes with the territory.

This paper has also quoted a number of times from Duncan Ferguson's address − it clearly has been a major influence in fermenting the author’s own professional beliefs. So it seems fitting to conclude with a quotation of his own, namely of Ronald Abbot who won a Finlaison Medal for his work in enhancing the reputation of the profession in the UK (excuse the sexist bias):

“It seems to me that a professional man carries two distinct burdens. One is the burden of responsibility for the quality of work he does and the other is the burden of conscience for the way he does it, in other words for his professional conduct.”

It is hoped that this paper has helped, if not to relieve the collective and individual consciences of actuaries, to ease the burden in some small way by showing how it may be carried more efficiently and effectively as we enter the next millennium and beyond. The paper could possibly have been sub-titled “The Ethical Actuary - Oxymoron or Tautology?” It is hoped on reading this paper that readers may be able to answer this question for themselves. Maybe individual readers already know the answer; views will no doubt vary throughout the profession. The author is also sure we know what members 79

ETHICS, ACTUARIES (AND ROBOTS) would like the answer to be in the future but, more importantly, how we would hope our employers, clients, non-actuarial colleagues, and the general public would answer it. 80

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11. POSTSCRIPT

11.1. Acknowledgements

The ideas in this paper have been drawn from many sources. The author would like to give special thanks to Philomena Leung, Associate Professor, RMIT University, Melbourne, for providing her template for the similar survey she conducted on the accounting profession in Australia.

The author would also like to record his thanks to colleagues at Tillinghast–Towers Perrin for general support and their comments on various drafts of the paper, and to Trowbridge Consulting for providing support and assistance in undertaking the survey.

11.2. Further reading

The author recognised that Part A was at risk of being viewed as a sermon. While a few real life examples had been given, it was hoped the reader would be patient enough until Part B where the focus shifted from the ethics backdrop of Part A to the specifics of the actuarial profession. Case studies also take up much space, something the author was always conscious of.

For readers seeking further background and examples on the subject of ethics, the author suggests the following (from which he has quoted extensively):

„ Kidder (1995), a general text, provides a practical and highly readable review of ethics in general situations with many examples and case studies, as well as describing a practical model for ethical decision making;

„ Rion (1989), a business orientated text, also provides a practical model for effective ethical decision making in business (and other) situations with a number of real case studies in which to demonstrate its application31;

„ Badaracco (1997), a management text for resolving ethical dilemmas which discards the ‘grand principles’ approach of other writers and teachers, and instead provides a new and pragmatic approach (based on the ideas of Aristotle, Nietzsche, and Machiavelli) to weighing conflicting duties, ends and virtues in business life; and

„ Grace & Cohen (1995), provides an excellent Australian perspective of applied business ethics with numerous case studies (many quite contemporary and recognisable) from Australian business and the professions.

Of course, there are numerous other books (mainly from the US) which may be useful in providing alternative viewpoints and approaches. In addition, many of the articles the paper refers to are easily accessible, providing additional perspectives and insights. 81

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11.3. Contacts and courses

The author strongly encourages all members to do their soul searching on ethics. The list of references provides a useful ‘library’ of resources, as does the Internet sites.

While not overlooking the Professional Guidance Committee of the Institute, the President, or indeed other members for help on professional and ethical issues, the author is aware of two independent organisations in Australia devoted to applied ethics and which may be able to provide help and guidance in certain situations. Details are provided in Appendix K.

The Institute of Chartered Accountants provides a compulsory module of ethics studies in the professional year of post-graduate study. While our Institute does not currently provide the same depth of learning of ethics in its Professionalism Course, there are opportunities to complement it – refer Appendix K for details. 82

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12. REFERENCES

[Note: Copies of most articles and books cited are held by the author. To assist those seeking to do further research, the following guides are provided to get started: 1 means recommended reading 11 means highly recommended There are many books on ethics and the author has naturally limited himself to the few mentioned.]

THE GENERAL NATURE OF ETHICS AND ETHICAL DECISION MAKING

BOOTH, P. (1997) Ethics: the essential sacrifice, The Actuary, October 1997 p22, Staple Inn Actuarial Society. ICA (1997) Ethics - Professional Year Programme 1997, Institute of Chartered Accountants in Australia. †† KIDDER, R (1995) How Good People Make Tough Choices, Fireside Press, ISBN 0-684-81838-8. McDONALD, C. (1995a) A Guide to Moral Decision Making, http://ethics.ubc.ca/papers McDONALD,C. (1995b) Moral Decision Making - An Analysis, http://ethics.ubc.ca/papers McDONALD, M. (1997) A Framework for Ethical Decision-Making (Version 4), http://ethics.ubc.ca/papers. PODOLSKY, R. & SULLIGER, G. (1993) The Bloodless Revolution. SHARP, C (1997a) The Origin and Evolution of Human Values, Pen Press, ISBN 1- 900796-15-5

PUBLIC ETHICS

BLONSTON, G. (1991) Cheating isn’t up, but interest in scandals is, Chicago Tribune, 14 April 1991, “Perspective” p1 BLOOMBERG (1995) Women are more ethical, study finds Bloomberg Business News, 23 Apr 1995, “Business” p4 BROTMAN, B (1993) Breaking the Rules, ChicagoTribune, 15 February 1993, “Tempo” p1 JOSEPHSON (1990) Greed in, ethics out, study finds, Associated Press, 12 Oct 1990, “News” p14 JOSEPHSON (1991) Politics and the appearance of impropriety, Chicago Tribune, 12 Aug 1990, “Perspective” p13 JOSEPHSON (1992) Unethical acts common among young, study says, Chicago Tribune, 15 Nov 1992, “News” p26. Also quoted in Study says cheating has replaced 3 R’s, Associated Press, 13 Nov 1992, “News” p1 McNULTY, T. (1996) Backhanded apologies – politics means never having to say you’re sorry, Chicago Tribune, 14 April 1996, “Perspective” p1 RASPBERRY, W. (1990) Only by example can we lead our young into the light, Chicago Tribune, 15 November 1990, “Perspective” p27 83

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ROYKO, M. (1988) The Great American Pastime, The Chicago Tribune. ROUSSEAU, J-J (1762) The Social Contract, Penguin Classics, first published 1968, translated by M.Cranston, ISBN 0 14 044.201 4

BUSINESS AND PROFESSIONAL ETHICS

ANDREWS, K.R. (1989) Ethics in Practice, Harvard Business Review, Sep-Oct 1989. BADARACCO, J.L (1992) Business Ethics: Four Spheres of Executive Responsibility, California Management Review, Vol 34, No.3 Spring 1992 †† BADARACCO, J.L (1997) Defining Moments, Harvard Business School Press, ISBN 0-87584-803-6 BHIDE, A. & STEVENSON, H.H. (1990) Why Be Honest If Honesty Doesn’t Pay, Harvard Business Review, Sep-Oct 1990. †† CADBURY, A (1987) Ethical Managers Make Their Own Rules, Harvard Business Review, Sep-Oct 1987. † CAMPBELL, A & ALEXANDER, M (1997) What’s wrong with strategy? Harvard Business Review, Nov-Dec 1997. † CARMICHAEL, S. (1997a) Business Ethics: The New Bottom Line, Institute of Actuaries. First published 1995 by Demos. (Refer also Carmichael 1997b) CARTER, J. & COLLIER, J. (1997) Business Ethics, speakers notes for Institute of Actuaries of Australia Professionalism Course. †† CARR, A.Z. (1968) Is Business Bluffing Ethical? Harvard Business Review, Jan-Feb 1968. COHEN, S. (1996) Good Ethics is Good Business – Revisited, script provided by author from School of Philosophy, University of NSW. Presented at the Third Annual Conference of the AAPAE Wagga Wagga. COOPER, R.W. & FRANK, G.L. (1991) Business Ethics in the Insurance Industry, Journal of American Society, 27 March 1991 COOPER, R.W. & FRANK, G.L. (1997) Helping Professionals in Business Behave Ethically: Why Business Cannot Abdicate Its Responsibility to the Profession, Journal of Business Ethics, Vol 16, p1459ff (An extract of this paper appears in Values in the Workplace, “City Ethics”, The St James Ethics Centre, Issue 30 Summer 1998) DWYER, M. & HOWARTH, I (1997) Morgan, RBA deny any impropriety over gold, The Australian Financial Review, 18 July 1997, p1. ENGLISH, H (1997) Arnott’s doesn’t crumble under pressure, City Ethics, St.James Ethics Centre, Issue 28, Winter 1997 † FADIMAN, J.A. (1986) A Traveler’s Guide to Gifts and Bribes, Harvard Business Review, Jul-Aug 1986. † GELLERMAN, S.W. (1986) Why ‘Good’ Managers Make Bad Ethical Decisions, Harvard Business Review, Jul-Aug 1986. †† GIOIA, D.A. (1992) Pinto Fires and Personal Ethics: A Script Analysis of Missed Opportunities, Journal of Business Ethics. 84

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†† GRACE, D. & COHEN, S. (1995) Business Ethics - Australian problems and cases, Oxford University Press, ISBN 0-19-553738-6. GRELL, J.M. (1993) Ethics in Business May Improve Ethics in Society, “On the Horizon”, 2(1), p6. HENDERSON, K Managing the Ethical Dimension Offshore, “City Ethics”, Issue 31 Autumn 1998, The St James Ethics Centre JOSEPHSON (1989) Necessity can be the killer of ethics, Chicago Tribune, 29 Oct 1989, “Perspective” p3 LAGAN, A (1997a) Management Values – embracing the new paradigm, “City Ethics”, The St James Ethics Centre, Issue 29 Spring 1997 LAGAN, A (1997b) A brand new social licence to operate, Australian Financial Review, 22/12/97, p15 LEEUWEN, H (1998) ACCI attacks bribery ban plans, Australian Financial Review, 31/3/98, p3 MACEK, C (1997) Business – as part of the a social eco-system, Journal of the Australian Institute of Banking and Finance, Vol 111, No.6, Dec 1997, p216ff. MACKEN, J (1998) Dirty Money, Australian Financial Review, 31/3/98, p13 MALIK, F (1996) Vertrauen als Basis der Unternehmenskultur (Trust as the Basis of Business Culture), Stahl und Eisen (Austrian industry publication), March 1996. †† McCOY, B.H. (1997) The Parable of the Sadhu, Harvard Business Review, May-Jun 1997 (reprint from 1983 issue of HBR). Also see letter in response to article by L. Nash, Sep-Oct 1997. † McDONALD, M. (1995a) Must ‘Nice Guys’ Always Finish Last? The Case for Professional Ethics, “The Record”, Society of Actuaries, Vol 21/3A, p1ff. McDONALD, M. (1995b) Ethics and Conflict of Interest, http://ethics.ubc.ca/papers/ MILNE, S. (1997) No One is Sacred, “The Bulletin”, June 10, 1997, p15ff. PARKER, D. (1992) The ethical side of investment, JASSA September 1992 PETERS, T.J. & WATERMAN, R.H. (1982) In Search of Excellence, Harper & Row, New York, pp279-291 REILLY, B.J. & KYJ, M.J. (1990) Economics and Ethics, Journal of Business Ethics. † RICHARDS, R. (1995) Cicero and the Ethics of Honest Business Dealings, Institute of Business and Professional Ethics. †† RION, M.R. (1989) The Responsible Manager, Human Resource Development Press, ISBN 0-87425-351-9 †† RION, M.R. (1994) Business Ethics: Theory and Practice, “The Record”, Society of Actuaries, Vol 20/4A, p119ff (also on the same subject: Mind Your Ethics, The Newsletter of the Society of Actuaries, Vol.28, No.7, September 1994). Both records provide summaries of the book Rion (1989) SEYMOUR, S. (1988) The Case of the Wilful Whistle-Blower, Harvard Business Review, Jan-Feb 1988. SEXTON, E (1998) Who Shares Wins, Sydney Morning Herald, 25/4/98, p96 † SHARP, L (1995) Corporate Purpose and Responsibility, Harvard Business School, Nov, 1996 85

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†† SHERWIN, D.S. (1983) The Ethical Roots of the Business System, Harvard Business Review, Nov-Dec 1983. SIA (1990) Ethics and the SIA, JASSA December 1990 STANFORD NEWS (1992) Body Shop founder sells principles with profits, Stanford University News Service, http://www-leland.stanford.edu/dept/news/relaged/ ST.JAMES ETHICS CENTRE Annual Report and other literature. STUBINGTON, G. & COHEN, S. (1996) Principles before Profit, “Corporate Crime”, The Spinney Press, pp29-31 SYRETT, M. (1988) Anita Roddick: The Holistic Manager, “Ashridge Management Review”, Winter 1988/9, Ashridge Management College. TOOHEY, B. (1997) Honest efforts in fight against bribery, The Australian Financial Review, 5 August 1997, p17.

ACTUARIAL ETHICS

ADAMS, M.H. (1994) Professional Ethics, “The Record”, Society of Actuaries, Vol 19, p2929ff AMOND, B. (1983) Consulting Actuaries in Australia, Transactions of the Institute of Actuaries. BELLIS, C. (1997) The Future Managers (Actuaries in Australia 1853-1997), The Institute of Actuaries of Australia, ISBN 0 85813 0564 BLOOM, L. (1994) Professional Ethics for Pension Actuaries, "The Record", Society of Actuaries, Vol 20/4B, p1263ff BRIMBLECOMBE, R. (1997) Financial Services Regulation and the Role and Responsibilities of Actuaries, Transactions of the Institute of Actuaries of Australia (1997 Convention papers, Volume IV). † CARMICHAEL, S. (1997b) Business Ethics: the New Bottom Line, British Actuarial Journal, Vol 3 Part V, No.15 p1059ff, Abstract of presentation and discussion re Carmichael (1997a) given on 30 June 1997 at meeting of Institute of Actuaries. See also O’Keeffe (1997) COLE, L. (1997) Categories of Issues in Professional Ethics for Actuaries, unpublished note by Executive Director, SOA. CROMPTON et al (?) Peer Review, “The Record”, Society of Actuaries, Vol 20, p867ff CROWDER et al (1995) Academy Council on Professionalism, “The Record”, Society of Actuaries, Vol 21, p815ff EAGLETON, R. & BAXTER, M. (1997) Actuaries in Asia - Developing Financial Services, Transactions of the Institute of Actuaries of Australia (1997 Convention papers, Volume IV), “Political and Business Risks” p39-40. †† FERGUSON, D.G.B. (1996) For Goodness Sake, Presidential Address, Institute of Actuaries. † HEACOX, L (1997) The public good vs. private profit?, The Newsletter of the Society of Actuaries, Vol.31, No.1, January 1997) 86

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JUREIDINI, R. & KNOX, D (1985) A Contribution to a Sociological Profile of Actuaries in Australia, Transactions of the Institute of Actuaries of Australia. † O’KEEFFE, P (1997) The new bottom line, “The Actuary”, Sep 1997 p25, Staple Inn Actuarial Society, A summary of Carmichael (1997b) Professionalism in Practice, Outline of standard talk given by Society of Actuaries at Fellowship Admissions Course. † SHARP, C. (1997b) Actuarial ethics and values, “The Actuary” July 1997 p15, Staple Inn Actuarial Society. SHARP, C. (1998) Actuarial Values and Professional Conduct, Transactions of the 26th International Congress of Actuaries, Vol. 1 p71ff, 7-12 June 1998 THOMAS, R (1998) Actuarial Values, Transactions of the 26th International Congress of Actuaries, Vol. 1 p95ff, 7-12 June 1998 VAUGHAN, T.M., COOPER, R.W. & FRANK, G.L. (1993) Ethical Issues, Helps, and Challenges: Perceptions of U.S. Actuaries, Journal of Actuarial Practice, Vol 1, No.2, 1993, Casualty Actuarial Society.

CODES OF CONDUCT

LEW, E. (1989) Preface to Actuarial Standards of Practice, Special Subject Supplement to The Actuarial Update, American Academy of Actuaries, October 1989. COADY, M. & BLOCH, S. (1996) Codes of Ethics and the Professions, Melbourne University Press. FRANKEL, M.S. (1989) Professional Codes: Why How, and with What Impact?, Journal of Business Ethics. FREEMAN, M. & ADAMS, M. (1991) Industry’s Choice: Rules or Ethics, JASSA June 1991 GREENWELL, M. (1991) The Subtle Art of Redefining Truth, JASSA December 1991 Exposure Draft 31: Memorandum on Professional Conduct, Institute of Actuaries, 5 August 1997. IAA (1995), Code of Conduct, Institute of Actuaries of Australia, December 1995. SOA, Code of Professional Conduct, Society of Actuaries.

ETHICS IN OTHER PROFESSIONS

AFR (1997) Accounting for actions, editorial, Australian Financial Review, 22/1/97, p10 CAMPBELL, C.P. (1997) Ethos: Character and Ethics in Technical Writing, technical communication program, New Mexico Tech., http://cramer.nmt.edu/~cpc/ethos.html COHEN, S. (1998) The Ethics of Accounting: The Case of a Profession in Business, draft script for second edition of GRACE, D. & COHEN, S (1995) (see above) kindly provided with consent of author GRAYSON, M.M. (1995) Business Ethics: Something New for Professional Accountants to Consider. 87

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ICA (1997) - see above. LEUNG, P & COOPER, B.J. (1995) Professional Ethics: A Survey of Australian Accountants, Australian Society of Certified Practising Accountants McGEE, R. (1997) CPA vs the Public Interest, http://www.gaiafriends.com/ethics/mcgee Securities Institute of Australia, Code of Ethics.

PROFESSIONALISM

The following references all include comment on aspects of professionalism related to the subject of ethics and may be of interest to the reader:

BROWNFIELD et al (1997) Education and Professionalism - Towards a Global Profession, Plenary Paper to the 1997 Convention of the Institute of Actuaries of Australia, p15-22. CORBY, F.B. (1980) Actuaries and Professional Conduct, Journal of the Institute of Actuaries, Vol 107, No 407. DAVIS, M. (1997) Professions and War, Perspectives on Professions, Center for the Study of Ethics in the Professions, Illinois Institute of Technology. GARDNER, J.R. & ESTEY, W.Z. (1989) The Challenge of Professionalism, "The Record", Society of Actuaries, Centennial Celebration, Vol ??? GLADING, R.G. (1994) Presidential Address, Transactions of the Institute of Actuaries of Australia. GRAHAM, J. (1984) Presidential Address, Transactions of the Institute of Actuaries of Australia. JENKINS, T. (1985) Presidential Address, Trandsactions of the Institute of Actuaries of Australia. KIMBER, D. (1981) Presidential Address, Transactions of the Institute of Actuaries of Australia. KIMBER, D. (1992) Professional Conduct and the Profile of the Actuary, Quarterly Journal, Institute of Actuaries of Australia, March 1992 LORD BOYD-CARPENTER (1974) The Professional Man: Will He Survive, address to the 125th anniversary meeting of the Institute of Actuaries, Journal of the Institute of Actuaries, Vol 100, No 415. PURCHASE, H.F. (1973) Professional Conduct and Practice, Journal of the Institute of Actuaries, Vol 99, No 413. Submission to Sub-Committee on Professional Conduct (1973) by the Association of Consulting Actuaries of Australia (now defunct), Transactions of the Institute of Actuaries of Australia. WERNER, M., (1972) Presidential Address, Transactions of the Institute of Actuaries of Australia. 88

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SOME USEFUL WEB SITES

† Association for Practical and Professional Ethics http://php.ucs.indiana.edu/~appe/home.html Australian Association for Professional and Applied Ethics http://www.arts.unsw.edu.au/aapae/ Chicago Sun-Times Ethics Articles http://www.depaul.edu/ethics/sun5.html Encyclopedia of Applied Ethics http://www.apnet.com/ethics/ † Ethics Center for Engineering & Science http://www.cwru.edu/affil/wwwethics/ Ethics on the WWW http://www5.fullerton.edu/les/ethics_list.html The Ethics Information Center http://www.gaiafriends.com/ethics/ European Business Ethics Network http://www.nijenrode.nl/research/eibe/eben/index.html Hopkins University - Ethics http://www.jhu.edu/~phil/subfold/ethics.html † Institute for Business and Professional Ethics http://www.depaul.edu The Institute of Chartered Accountants in Australia http://www.ica.au The Institute of Global Ethics http://www.globalethics.org KPMG US - Business Ethics Practice http://www.us.kpmg.com University of British Columbia’s Centre for Applied Ethics http://ethics.ubc.ca/papers

Some of the above sites include numerous links to other sites. For example, try http://condor.depaul.edu/ethics/ethi1.html 89

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APPENDIX A

WHY ETHICS MATTERS [Extract from The Institute for Global Ethics internet site http://www.globalethics.org]

One hundred years ago, humanity had less power and less reach. Catastrophe meant natural disasters such as the Krakatu volcano, the potato famine, and the San Francisco earthquake. But in this century, poor ethical judgment has produced such devastation as the grounding of the Exxon Valdez and the meltdown of the reactor #4 at Chernobyl. Technology will advance exponentially into the 21st Century. Imagine how much we’ll have at our fingertips then!

It’s not just national leaders who have us in their grip. Technology empowers people at many levels and in many locations. Do they understand that ethics has consequences, and that their actions can have enormous impact? Will they make ethical decisions based on their highest moral values? Or will they simply do what’s expedient for whatever serves their self-interest?

The people who affect our careers, our families, our environment, our government – we need them to act ethically on our behalf. After all, when we begin a course of action, we’re more comfortable acting in agreement with our principles. Shouldn’t they be, too?

Copyright © 1995, 1996, 1997 the Institute for Global Ethics, Camden, Maine 04843 90

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APPENDIX B

VALUES IN STRATEGY FORMULATION

Where does an organisation incorporate its values into its strategic and financial plans and objectives? How do they sit alongside profit objectives?

Firstly, on the nature of a corporation, K.Andrews, Emeritus Professor of Business Administration, Harvard University offers these observations (Andrews 1989):

“The corporation is an organisation in which people influence one another to establish accepted values and ways of doing things. It is not a democracy [author: although ironically it flourishes in a democracy], but to be fully effective, the authority of its leaders must be supported by its followers. Its leadership has more power than elected officials do to choose who will join or remain in its association. Its members expect direction to be proposed even as they threaten resistance to change.”

“The character of a corporation may well be more malleable than an individual’s. Certainly its culture can be shaped. Intractable persons can be replaced or retired. Those committed to the company’s goals can generate formal and informal sanctions to constrain and alienate those who are not.”

This strongly suggests that a business or strategic plan, to be given the best chance of success, must be “owned” (using contemporary terminology) by all people to whom they apply.

An organisation’s strategy is set with a view of what the organisation exists to do, what it is trying to achieve – its strategic goal. All organisations have at least a financial goal such as to maximise shareholder’s return or value (even non-profit organisations must meet their costs). Even so, such a goal does not really assist the organisation to begin formulating its strategy since wealth creation goals do little more than restate the rules of the economic game, the universal objective, that we all play, whether as organisations or individuals. They are indeed a key motivating factor as to how most of us structure our lives and businesses seek competitive advantage. But they are too general; they are not specific or focussed enough to begin the strategic planning process.

What happens in reality is that an organisation establishes a purpose (or mission) which reflects its competencies and circumstances, and which sets out the essence of why the organisation exists and therefore its direction. For example, (quoted by Campbell & Alexander 1997) the original purpose of Marks and Spencer, one of the most successful U.K. retailers, was to provide affordable everyday clothing of unrivalled quality to working people. That purpose set a clear market and product focus and defined the challenge for the company’s strategy, its management and staff. Another example is The Body Shop, with its purposes of producing and selling cosmetics that avoid harming animals or the environment, 91

ETHICS, ACTUARIES (AND ROBOTS) promoting Third World trade, and encouraging responsible entrepreneurship. Values in this case provide extra focus beyond product-market definition. As a final example, Canon’s original strategic purpose (in 1933) was to create a Japanese camera that rivalled the German Leica.

Of course, all business decisions need to take into account the financial goals of the owners, as well as economic factors, the political factors, the personnel factors, the human relations factors, employee satisfaction, and the values that the business espouses.

The financial goals must ultimately be met of course but rather than being up-front objectives of strategy formulation, profit measures form a check point, benchmark or filter for discriminating which alternative strategies and tactics are acceptable or not. Employees (and other stakeholders such as suppliers and creditors) all have needs that must be met; the consequences of strategies on these stakeholders cannot be overlooked. (So too do corporate laws, economic and political circumstances, union laws etc act as discriminators.) In the same way, the organisation’s stated ethical standards must also be met. These too can act as a filter or discriminator of strategic and tactical plans.

Campbell & Alexander (1997) suggested that profit benchmarks should, in this context, be seen as constraints. So too might the values filter be seen. One then might conclude that ethics and business stand in opposition to each other. This point has been addressed by Cohen (1996) and considered in the paper already. We believe that the values filter can and should be seen in the same way as the profit filter, namely setting minimum benchmarks to support optimum business decision making after all things are considered.

Heacox (1997) takes up a similar issue from an actuarial perspective, asking whether actuaries can serve the public good and private profit motives at the same time. One comment offered was that “pricing actuaries … have a final responsibility to the shareholders” and in fulfilling this role “they also fulfil responsibility to the public. Actuaries are the financial stewards of the insurance company. They make sure the company is sound and does things that are appropriate, and in doing so, is responding to the regulators”32.

In the best seller In Search of Excellence (Peters & Waterman 1982), one chapter is devoted to the observation that excellent companies pay explicit attention to values. While agreeing that, as a general rule, tough-minded business people rarely focus upon values, they say this is not the case with excellent companies. This is particularly the case with companies that have lasted many years and have had to adapt to constant change – the beliefs of the company are the only constant. Companies that have overriding financial objectives also seem to have difficulties in motivating staff at all levels (except those on bonuses). Articulation of and driving the company’s values goes a lot of the way to filling the gap. On the relationship between profit and values, they make this observation of excellent companies: 92

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“The idea that profit is a natural by-product of doing something well, not an end in itself, is also almost universal.”

Some would retort, like Friedman (1973), that the sole purpose of any business is to make money for its owners. If that is the case for any business (as it most likely is), then that is indeed its purpose (at least to its owners). But that would miss the point we are making, namely that such a purpose offers very little guidance about what sort of strategy to follow. A purpose along the lines we describe limits the range of strategic choices that need evaluating and therefore helps to simplify strategic formulation. So too does a profit benchmark. So too does a set of values.

To those who would suggest that organisations only have to obey the laws, no more, we would ask why should business be regarded any differently from individuals. Business cannot ignore the consequences of its actions upon society. Business is an intrinsic part of society’s fabric and always has been. If business, as a whole or in large part, were to ignore this point, that is simply obey the laws, eventually society, as history constantly reminds us, will step in. The principle is: regulate yourself or be regulated.

Andrews makes a similar point:

“Management’s total loyalty to the maximisation of profit is the principal obstacle to achieving higher standards of ethical practice. Defining the purpose of the corporation as exclusively economic is a deadly oversimplification, which allows overemphasis on self-interest at the expense of considerations of others.”

“To be implemented successfully over time, any strategy must command the creativity, energy, and desire of the company’s members. Strategic decisions that are economically or ethically unsound will not long sustain such commitment.”

We have already referred to Macek (1997) in the body of the paper who referred to business being part of the social eco-system. He goes on to comment that:

“When we think strategically about our business, and I don’t mean budgets or plans as a substitute for strategy, we need to think holistically as well as analytically.”

It should be clear by now that we are not merely suggesting that ethics should be treated as an add-on in decision making; rather it should permeate decision making. Even so, we are not suggesting that ethics should be central to business strategy. It will always be the case 93

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that what ultimately takes a business forward and provides it with a sustained competitive advantage is management’s ability to be creative, imaginative and adaptive. 94

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APPENDIX C

THE ETHICS DEBATE IN BUSINESS

Business’s social responsibility

“Financial institutions, like other business organisations, are designed to create wealth, not to redistribute it.” ––Submission by major bank to House of Representative inquiry on rural banking

“Ethical capital, which is closely linked to reputation, is likely to gather credence as an assessment of a company’s worth.” ––Lagan (1997b)

Does business have a social responsibility – a responsibility including but going beyond that to its shareholders and primary stakeholders (employees, creditors, customers)? It is also referred to as ‘corporate community involvement’. Or, as some put it, should business have a conscience? Indeed does any form of ethics per se apply to business?

In attempting to resolve the issue, business writers first look to the purpose of business but here immediately the problem is encountered:

Shareholder: The purpose of business is to maximise the return on capital for the owners.

Employees: The purpose of business is to provide secure employment and personal fulfilment.

Consumers: The purpose of business is to provide quality goods and services to consumers at a fair price.

Society: The purpose of business is to be of service to the community.

Further, Reilly & Kyj (1990) point out that twin tenets of classical economics of profit maximisation and acting in one’s self-interest simply and absolutely exclude ‘decency’ or ethics as a requirement for behaviour33. Despite this view and that of economist Milton Friedman’s blunt assertion that the only purpose of business is to make a profit, the contemporary view within business schools seems to be different.

The concept of business involves the way people – individually and in organisations – make money. But business is a part of society and is therefore bound by the principles of decency and ethics: 95

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„ Charles Macek refers to the idea of business being an organism that must operate within an eco-system – a change in one part of the eco-system can impact on the rest (Macek 1997).

„ Anita Roddick, of Body Shop fame, in a lecture on “Profits with Principles” in 1992 goes much further stating that “business can fly the flag of social change” (Standford News 1992).

„ Australian millionairess Janet Holmes à Court says that she is a huge believer in business contributing to society and she focuses her businesses on that common purpose (AFR 1997).

„ Others have commented that only by the grace of society’s laws and its granting of access to resources, are businesses permitted to operate to the benefit of society.

„ Sir Adrian Cadbury asserts that the primary purpose of a company is, first and foremost, to satisfy the needs of its customers, to retain its competitive edge, and to do so profitably (Cadbury 1987).

„ The view of the Harvard Business School (Sharp 1995) is that:

“Without a moral compass calibrated to society’s expectations, business leaders risk forfeiture of their broad authority to act as creators of wealth and managers of society’s resources.”

The purpose of business is taken up further in Appendix B.

A final quote on this issue from a recent report sponsored by 25 of the U.K.’s top businesses34 might be appropriate to conclude this section:

“Internationally competitive companies will be those which maintain their ‘licence to operate’ by securing high levels of support from all those with whom they interact, directly or indirectly …a Board must continually attend to its company’s financial performance and level of shareholder return, but an exclusive concentration on any one stakeholder will not lead to sustainable competitive performance.”

Clarifying “ethical” actions

Before commenting further, a distinction should to be made between: 96

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A. those actions which all corporations should consider as minimum moral behaviour (such as fair treatment of employees, suppliers and customers, health and safety; fair pricing), even if this means going beyond the requirements of law, ie actions which may have negative consequences for direct stakeholders in the company;

B. those actions which are taken to avoid harm to the wider society (such as limiting environmental damage, empathetic plant closures) and to satisfy society’s changing expectations35, ie actions which may have negative consequences for wider society and ultimately the company itself; and

C. those actions which seek a direct role in the community or are philanthropic and are thereby optional (Body Shop, Holmes à Court), ie actions which may have positive benefits for wider society perhaps without any obvious or direct benefit to the company itself.

This paper does not address actions of type C which Booth (1997) refers to as actions having “charitable or ethical characteristics”, or, in the words of the author, are “pseudo-ethics”. These are strategic actions which, while possibly and genuinely aimed to serve society, do not involve any notion of ‘right vs wrong’ or ‘right vs right’ dilemmas. They are most probably aimed to benefit the bottom line and may only involve a short term cost to the organisation. They are therefore essentially self-serving36 and referred to by economists as activities of ‘enlightened self-interest’.

As Booth then points out:

“The whole point of ethical behaviour is that, when your back is against the wall, you do the ‘right thing’ and often make a sacrifice, even if it is personally (or from a business point of view) disadvantageous… Laws, morals, and ethics tend to exist to … increase the chances and opportunities available to the group as a whole. However, they do this in way which has unpredictable effects on the particular individual or institution which upholds them …Any individual or company signing up to ethical principles may or may not be better off as a result, even though the acceptance of these principles by the whole group helps everybody’s chances within that group.”

Green (Carmichael 1997b, speaking on behalf of Booth) adds:

“There will always be times when somebody can circumvent ethical principles and make themselves better off … but to do so undermines the system which aims first to maximise the benefit to the group.”

The example in Appendix L highlights the need for sacrifice. 97

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The author believes Friedman is promoting the idea that companies need only pay attention to actions of type A; that modern business thinkers are promoting actions of both types A and B; while The Body Shop is promoting all actions up to type C.

In the author’s view, from a shareholder perspective, type A actions are mandatory if the company is to survive, type B actions are recommended if the company wants to avoid the ire of society and new regulation, and type C are optional and require the sanctioning of the shareholders. The table in Appendix H also shows another way to understand the priorities and obligations a business (and individual) has in any situation.

Business ethics and personal ethics

“Men seldom rise from low condition to high rank without employing either force or fraud.” ––Machiavelli, The Prince

“A good part of the time the businessman is trying to do unto others as he hopes others will not do unto him” ––quoted from Brinkmanship in Business, HBR 1967

Are the ethics of business somehow perhaps different from that of individuals? Should people be able to practice the same kind of values that they want to practice in their private lives? Carmichael (1997b) states:

“I should like to see us all being able to take our personal values into the workplace, and not feel that we have to compromise them on a daily basis, as does indeed happen for some people.”

Carr (1968) suggests that “the ethics of business are game ethics” (conscious misstatements, concealment of pertinent facts, or exaggeration) which are different from personal ethics. He likens it to a game of poker which “calls for distrust of the other fellow; it ignores the claim of friendship; cunning deception and concealment of one’s strength and intentions, not kindness or openheartedness, are vital in poker”:

For example, if sellers of goods are held to strict standards of honesty, they must be truthful and forthright with their customers and they must not deliberately deceive. Does modern advertising consistently meet this standard? One only needs to subscribe to Choice magazine to dispel any doubt.

Similarly, good ethical standards would seem to require people, in or out of business, to live up to the spirit and letter of their commitments, even when they are not legally enforceable. Is this the view taken by senior executives and their teams of lawyers? 98

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Carr’s view also implies that we all have at least two sets of moral values, one used in our private lives with family and friends, and another that we use in impersonal business dealings and relationships. The implication is that different rules of behaviour apply to business activities; that a person’s job or the well-being of the business take precedence over most other obligations.

Carr attempts to summarise the prevailing (1960’s) attitude of businessmen on ethics (later echoed by Friedman):

“Business is our main area of competition, and it has been ritualised into a game of strategy. The basic rules of the game have been set by the government, which attempts to detect and punish business frauds. But as long as a company does not transgress the rules of the game as set by law, it has the legal right to shape its strategy without reference to anything but profits. If it takes a long-term view of its profits, it will preserve amicable relations, so far as possible, with those with whom it deals. A wise businessman will not seek advantage to the point where he generates dangerous hostility among employees, competitors, customers, government, or the public at large. But decisions in this area are, in the final test, decisions of strategy, not of ethics.”

What Carr and Friedman are really saying (as pointed out by Bhide & Stevenson 1990) is that trust is enforced in the marketplace, through retaliation and reputation. If you violate a trust, your victim is apt to seek revenge and others are likely to stop doing business with you, at least under favourable terms. A man or a woman with a reputation for fair dealing will prosper. Therefore long-term profit maximisers are honest (QED).

Grace & Cohen (1995, p44ff) go to some length to destroy Carr’s view. They note, for example, that Carr sees business practices as a form of ‘gamesmanship’ no different from coughing just as a golfing opponent is about to swing, or sledging in cricket as long as they are within the law of the game. The irony of Carr’s view is that if the Golden Rule does not apply, then, using the same analogy, it is only a matter of time before they are excluded from the game, or if most business people play the game the same way, the game would collapse. In fact, empirical evidence would suggest the market does not work this way37.

They go on to state:

“For Carr and others like him, business is a zero sum game, and there can only be one winner. How different that is from the models of American corporate excellence Peters and Waterman identify as collaborative, attentive and values-driven. What Carr misses is that real people conduct business …People not only cannot leave their private values at home, they should not … There is now a large body of literature which would give the lie to Carr’s position … Carr is very successful at building a model, but that model is 99

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not one of successful business. It reflects a narrow view of rationality and the belief that hard numbers trump values.”

Management by values, an organisational model of values management, is apparently gaining some momentum in Australia. It aims to align an employee’s personal values with the organisation’s identified collective or espoused corporate values. Lagan (1997a) argues that:

“To fail in this task, is almost certainly to fail to realise the potential of any initiative because individuals will always give priority to their own values over those of the organisation’s. Not to do so creates enormous personal tension…Organisations that live their values give control back to their employees. They know what they need to do even when they find themselves in new areas and are empowered to make decisions on behalf of and in the interests of the organisation.”

Is good ethics good business?

“Virtue has never been as respectable as money.” − Mark Twain

“He without benefit of scruples His fun and money soon quadruples.” − Ogden Nash

Phrases like “business is business” or P.T. Barnum’s, “There’s a sucker born every minute”, and the old proverb, “Let the buyer beware”, suggest that personal loyalties, sentiments, and feelings cannot be allowed to interfere with profit-making.

Booth’s answer (refer section 3.3) to the question “Is good ethics good business?” would probably be “Maybe, but the question is irrelevant and self-serving”. His conclusion is that we should not persuade people and businesses to be ethical for the bottom line but rather for its own sake.

Booth, perhaps without realising it, is actually expressing a deontological approach to ethics (considered more closely in Section 6), that is one that does not consider the consequences of a particular decision to individuals, but rather the principle behind the decision which is always “right” for the benefit of the group. This may also sound like a socialist way of thinking. Perhaps a better way to think of it is “wet economics”.

In the author’s view, if the question is merely asking whether being a good corporate citizen by means of philanthropic and other ‘good’ public deeds pays off in enhanced profits then a 1990’s answer probably has to be “quite possibly”, even if not in the short term. The Body 100

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Shop, with its ‘value-led management style’ (Syrett 1988) is often put up as an example that proves the point in spades. In another area, Parker (1992) points out that

“many investors are following their consciences and buying ‘ethical’ shares, even though their returns might be modest. … It is likely – if experience of Europe and especially the United States is a guide – that the sector will continue to grow in both size and diversity.”

If we are instead asking whether a corporation that espouses a set of values, instils those values in its staff, supports all business decisions which adhere to those values (no matter the cost), and disciplines those who deviate, will ultimately benefit financially, then the answer is much less clear cut (as Booth, we think, would agree). Part of the problem is that principles of ethics like honesty, promise-keeping, loyalty, fairness and respect for others may be seen to constrain and hinder business opportunities as the discussion in the previous section attested. While Carr (1968) acknowledges the importance of values in business in most circumstances, he does imply that business people are generally morally weak:

“To be a winner, a man must play to win. This does not mean that he must be ruthless, cruel, harsh, or treacherous. On the contrary, the better the reputation for integrity, honesty, and decency, the better his chances of victory will be in the long run. But from time to time every businessman, like every poker player, is offered a choice between certain loss or bluffing within the legal rules of the game. If he is not resigned to losing, if he wants to rise in the company and industry, then in such a crisis he will bluff – and bluff hard.”

In fact, Bhide & Stevenson (1990) go further in commenting that

“cases that apparently demonstrate the awful consequences of abusing trust turn out too few and weak, while evidence that treachery can pay seems compelling.”

Ironically, this argument, while depressing in its message, actually weakens Friedman’s argument because it seems to suggest that the marketplace does not work to weed out wrong doers.

Even so, lapses in business ethics can lead to significant financial damage as the following press report noted:

“Japanese consumers showed this year they are willing to punish companies over corporate ethics when they pulled ¥50 billion out of Dai-Ichi Kangyo Bank after it was revealed the bank had made ¥30 billion in illegal payments to corporate sokaiya Ryuichi Koike.” (Boyd 1997) 101

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Business ethics therefore can become a major social issue when ethical obligations are disregarded in the pursuit of financial gain. Business and ethics, while having separate and distinct “bottom lines”, are inseparably bound into a double helix.

Even the appearance of a lapse in ethics has the potential to tarnish reputations or destroy brand names as the managing director of WMC Ltd, Mr Morgan, seemed only too aware during the controversy surrounding the Reserve Bank’s sale of $2.4 billion in gold:

“In his statement, Mr Morgan strongly denied using any information obtained while on the RBA board to the benefit of himself or his company. ‘I have followed this principal (sic) because it is ethically correct and because it conforms with the legal and secrecy provisions I agreed to when I joined the Reserve Bank Board.’” (Dwyer & Howarth 1997)

Where does an organisation incorporate its values into its strategic and financial plans and objectives? How do they sit alongside profit objectives? These are important questions and, while somewhat outside the scope of this paper, have been briefly considered in Appendix B.

Given the arguments of Carr and the evidence put forward by Bhide & Stevenson, we might expect breaches of trust to be rampant. In fact the reality is that most business people do try to keep their own word most of the time. The reason Bhide & Stevenson discovered in interviews was that business people value their reputations, not for some nebulous financial gain but because they took pride in their good names. Their conclusion was that we keep promises because we believe it is right to do so, not because of good business.

Carmichael maintains that there are many examples where ethical behaviour can feed through to the bottom line in terms of relationship building. Likewise, she contends that costs can follow from lapses in ethical conduct. In practice it probably depends upon the type of ethical behaviour one has in mind. The stakeholders and the general public will be the final arbiters. She quotes a survey that suggested that only 15% of the public broadly trusted multinational business to be honest and fair. Another survey suggested that 67% disagree with the proposition that business generally tries to strike a balance between profits and the public interest.

In order to regain trust, Carmichael argues that the most important ethical value for business is ‘openness’ which was referred to earlier. 102

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APPENDIX D

WHISTLEBLOWING

Common Objections to Whistleblowing

The following objections (which will vary in strength depending upon the circumstances) have been made of whistleblowing and the informant should be prepared to respond to each of them before proceeding:

„ It is informing, perhaps on professional colleagues, peers and mates, destroying trust and friendships in the workplace and profession; „ It involves disclosure of private corporate information without authorisation; „ It might unjustifiably destroy the organisation and the jobs of colleagues; „ The person might not be in the best position to judge if the public interest will be served by disclosure „ It breaks an employee contract with the employer or adviser contract with client; and „ An employee has a duty only to report concerns to superiors, not to rectify the problem personally.

In regards to the possibility of retribution Grace & Cohen (1995) suggest, inter alia, that

“ideally there should be procedures and mechanisms for dealing with genuine concerns within an organisation, so as to minimise the need for heroism with its attendant risks and disincentives.”

Seymour (1988) suggests organisations usually react in one of two ways: respond to the message and ignore the messenger, or to avoid the message and, instead, shoot the messenger. Both reactions are wrong.

“Channels of communication are very important. … Whistleblowers perceive themselves as going out on a limb – the worst thing to do is to cut them off.”

The organisation may also put the employee under immense psychological pressure, particularly if it has something to hide. The sheer struggle to have the truth recognised and accepted in the face of official denials can make them obsessive or appear to be so.

Whistleblowing Criteria

The action of whistleblowing should meet each of the following criteria: 103

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„ The matter has to be serious - the informant should have good evidence of potential harm to public interest; - the evidence should be documented; - the potential harm should be imminent and specific;

„ The information has to be of public benefit; - the public must have the right to know; - the information should not be mischievous or malicious;

„ Less damaging avenues for rectifying the problem - are not available; - have been fully explored; and

„ Blowing the whistle is likely to remedy the problem - good probability that going public will bring about change for the better.

The criteria are based on the twin notions that the public interest is threatened by the organisation’s policy or procedure and the employee has tried to rectify through normal lines of responsibility and management.

If these criteria are met then the employee is considered by Grace & Cohen to have the right to blow the whistle. Some argue that the employee has an obligation to do so but one must recognise the real possibility of resultant personal hardship to the employee, including retribution (but as we noted earlier, ethical decisions usually involve a personal sacrifice). In any event, the means used should be proportional to the end to be achieved.

“Whistleblowing is, on the whole, a grey area. It is important to be aware of the conditions of its justification, but it is equally important not to be beguiled into believing that the term names a clear, identifiable type of conduct which can be used as a template for resolving moral conflicts in the workplace. … The good to be achieved by whistleblowing should be in proportion to the gravity of the act.”

Some Cautions are Warranted

Nonetheless, the following cautions are offered by Grace & Cohen (in turn citing Ross Weber, ‘Whistleblowing’, Executive Excellence, July 1990):

1. Verify your evidence. Is it sufficient? 2. Are you objecting to illegal or immoral conduct? If the conduct is morally objectionable but legal, you might not have a future in the industry. Illegal conduct is not as likely to damage your career. 3. Discuss your proposed action with close stakeholders, namely, your family. They will be affected by what you do. 104

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4. Exhaust organisational procedures for dealing with complaints and objections. 5. Consider whether it is better to act publicly or anonymously. 6. Document every action you take. 7. Don’t spread your heat: keep the objection confined to those who need to deal with it, and be civil to those handling it. 8. If you are fired you may resort to publicity, but recognise that your right to free public discussion might be limited. 9. Consider a lawsuit. 10. Appreciate that your hands will get dirty whatever you do about unethical conduct.

Grace & Cohen offer the additional general caution that:

“Apart from the personal risks involved, it amounts to placing an individual judgement above that of the organisation, and forsaking the duty (sometimes a fiduciary duty) which an employee owes to an organisation.”

The employee should also understand whether the imperative to blow the whistle is for moral reasons or perhaps revenge (particularly if triggered after being sacked), not because the latter imperative is not legitimate (subject to criteria above being met), but because the employee’s credibility may be affected.

Loyalty to colleagues should not override serious issues of immoral conduct – the question to be asked then is whether the silence of others can be excused. Loyalty should be seen as an emotion issue, not as a moral issue. 105

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APPENDIX E

THE FIFTY-NINE-STOREY CRISIS (A Lesson in Professional Behaviour) [Copyright 1995-97 WWW Ethics Center]

William LeMessurier, one of the America’s most distinguished structural engineers, served as design and construction consultant on the innovative Citicorp headquarters tower, which was completed in 1977 in New York. The next year, after a college student studying the tower design had called him to point out a possible deficiency, LeMessurier discovered that the building was indeed structurally deficient. LeMessurier faced a complex and difficult problem of professional responsibility in which he had to alert a broad group of people to the structural deficiency and enlist their cooperation in repairing the deficiency before a hurricane brought the building down38.

The conclusion to the story is the most interesting part and provides a valuable lesson for professionals who may confronted with a serious ethical dilemma:

LeMessurier feared for his career but did not allow any worries or self-protective impulses to sidetrack his attention from carrying out the repairs. In the middle of September, when repairs were almost complete, Citicorp notified LeMessurier and his partner that it expected to be reimbursed for the cost of the repairs.

The estimated total cost for the building's repair ranged between a high of $8 million for the structual work alone, given by one of the construction companies involved, to $4 million, which, according to LeMessurier, was the Citicorp estimate (Citicorp did not make public its estimate).

LeMessurier's liability insurance company had agreed to pay $2 million, and LeMessurier brought that figure to the negotiating table. The Citicorp officials eventually agreed to accept the $2 million, to find no fault with LeMessurier's firm, and to close the entire matter.

A relieved LeMessurier nevertheless expected his insurance company to raise the premiums on his liability insurance. He would, he reasoned, appear as an engineer who had bungled an expensive job and brought about a large cash settlement.

At a meeting with officials from the insurance company, LeMessurier's secretary was able to convince them that LeMessurier had “prevented one of the worst insurance disasters of all time!” Far from behaving in an incompetent or devious manner, LeMessurier had acted in a commendable way: he had discovered an unforeseen problem, acted immediately, appropriately, and efficiently to solve it, and solved it. 106

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LeMessurier's handling of the Citicorp situation increased his reputation as an exceptionally competent, forthright structural engineer. It also prompted his liability insurers to lower his premium. 107

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APPENDIX F

THE TROOPER’S DILEMMA [[[TThhiiisss cccaaassseee ssstttuuddyy hhaaasss bbeeeeeenn eeexxtttrrraaacccttteeedd fffrrroomm KKiiiddddeeerrr (((11999955))) pppp116644---116666 (((wwiiittthh sssllliiigghhttt mmooddiiifffiiicccaaatttiiioonn))) bbyy ppeeerrrmmiiissssssiiioonn oofff TThheee IIInnssstttiiitttuuttteee fffoorrr GGllloobbaaalll EEttthhiiicccsss PPOO BBooxx 556633 CCaaammddeeenn MMEE 0044884433... IIIttt ssseeeeeemmsss tttoo bbeee aaa tttrrruueee ssstttoorrryy...]]]

The case concerned an auto mechanic called to the scene of a wreck on a state highway in Ohio.

Arriving at the isolated, wooded spot, he could see immediately what had happened: A large flatbed truck had gone off the highway and hit a tree head-on. On impact, its load of steel had torn loose and slid forward through the back of the cab, pinning the driver helplessly inside. The cab was on fire, in danger of exploding at any minute.

As he arrived, so did a state police car. And as the trooper ran to the open cab window, the mechanic could hear the driver inside screaming, “Shoot me! Shoot me!” It was obvious that the trooper could not lift off that load of steel and free the driver. So, with the flames growing in intensity, the trooper slowly removed his service revolver from his holster. Then he paused, reconsidered, and slid the revolver back into his holster. And then, amid the driver’s screams, he removed it a second time, paused and put it back again.

The dilemma facing the trooper, it appears, is primarily of the short-term-long-term variety. On the one hand, it is right to relieve suffering in the short term – a position arguing for him to shoot the driver. On the other hand, it is right to preserve life in the long term – a stand that urges him never to kill another person, no matter what the circumstances. Seen this way, the dilemma also fits the justice-mercy paradigm, with mercy urging him to put the driver out of his misery and justice requiring strict adherence to the laws prohibiting murder. Either way, the trooper has a tough choice to make – because he holds deeply felt core values that are directly in conflict.

We know that in the heat of the moment (sic) the trooper had no time to reflect on our three resolution principles. How, if we had been there (author: and had the luxury of time), might we have advised him to act? That depends, in large part, on which of the principles seemed the most compelling.

If we look at these circumstances from the ends-based, utilitarian point of view, we’ll ask what’s the greatest good for the greatest number. At first blush, there don’t seem to be many numbers here: It’s just the trooper and the driver on an isolated stretch of highway. So the “greatest number” may strike us as one – the driver alone. After all, the ends-based thinker will ask, what are his prospects for survival? The cab is on fire and could blow up at any moment. And even if the trooper has the tools to extricate the driver, to try to do so would endanger his own life as well – raising the probability that the “greatest number” could suddenly become two, not one. If, then, the greatest number is indeed two, what is the 108

ETHICS, ACTUARIES (AND ROBOTS) greatest benefit? To save one is better than losing both. And to reduce the misery of the one who is probably going to be lost in any case is better than to prolong his agony. Utilitarianism, then, may well argue for shooting him – although the case could be made that the “greatest number” here is society at large, which will benefit in the long run by a “rule utilitarianism” that upholds the “never kill” dictum even though somebody (namely, the driver) has to suffer mightily for it.

To all of which the Kantian thinker strongly objects – on the grounds that the above arguments are pure consequentialism. Predicated on speculation, they assume as fact what can only be guessed – that the cab will indeed blow up, and that the driver must inevitably be killed. Since the trooper can never be certain of that (or any other) outcome, the rule- based thinker insists that he stick by the largest and safest precept he can – the one he would want every trooper, from now to eternity, to follow in such a situation. That precept may well be “Don’t kill.”

Such a position probably seems absurdly rigid and theoretical to the ends-based thinker, who feels so deeply the suffering of the driver. He understands that real situations have real results. “You want the trooper just to stand there,” queries the utilitarian, “and watch the guy suffer the consequences?”

“Consequences!” retorts the Kantian. “Let me tell you about consequences. You’ve told the trooper to shoot him, and he’s done so. And now, with the smoke still lingering in the gun-barrel and the sound of the shot still reverberating in the trees, he hears another sound: a siren. Within half a minute a fire truck has pulled up beside the wreck – how it got there he has no idea. In another half minute the fire is out. And there lies the driver dead, because the trooper shot him. So much for your silly little efforts of trying to foresee all possible consequences!”

These two guidelines, then, may well give us different answers. What guidance do we get from the Golden Rule? Here, the “other” is clearly the driver. If you were caught in the cab, what would you want a trooper to do to you? If you were pleading for him to shoot you, wouldn’t that be pretty powerful evidence of what you want? Shouldn’t the trooper respect your wishes?

Well, yes and no. Usually, such a request is fair evidence of one’s deepest wishes. But this is clearly an extreme circumstance. Is the driver capable of thinking clearly? His plea, after all, has a strong streak of consequentialism about it: He cries out for this particular solution because, in his fear, he can see only one horrible outcome ahead. But should his plea be honoured? Lifeguards understand that drowning swimmers will often strike out and attack their rescuers. Should lifeguards, therefore, interpret that behaviour as a clear signal whose meaning is “Please leave me alone: I prefer to drown”? Hardly. They’re taught to knock such persons out, if necessary, and drag them ashore against what seems to be their will. 109

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Should the trooper here assume that “Shoot me!” means what it says? And is that the interpretation he would most want another to put on his words if the situation were reversed?

It was at that point in this agonised struggle that the mechanic saw the officer do a remarkable thing. Running back to his cruiser, he grabbed a small carbon tetrachloride fire extinguisher. It was hardly enough to quell the fire. But it was large enough to spray in the driver’s face and put him to sleep, which is what he did.

Shortly afterward, the cab exploded.

Copyright © 1995 by Rushworth M. Kidder

This story is particularly interesting for three reasons:

„ Out of the seemingly intractable dilemma it poses, a trilemma – a third way forward, a middle ground evolved. It thinking process of the trooper possibly (and subconsciously) turned on translating the plea of “kill me” to “put me out of my misery”. As Kidder says, “dilemmas do not always resolve themselves this way. They often leave us with no option but to choose one or the other side. … The role of the resolution process then is not always to determine which of two courses to take. It is sometimes to let the mind work long enough to uncover a third.” Badaracco (1997) refers to this as finding ‘wiggle room’ in order to uncover creative and imaginative resolutions.

„ In a legal sense, the officer probably had no choice but to refuse to kill the driver. Ethics, as we noted earlier, goes well beyond the law and into “obedience to the unenforceable”.

„ It illustrates by way of the notions of “greatest number” and “greatest good” that, for professionals particularly, there may be no easy answer to the questions: “Who is your client?”, “Who are you really serving?”, “How do you define the public and their interests?” 110

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APPENDIX G

MODELS FOR ETHICAL DECISION MAKING

Kidder Model 1. Recognise that there is a moral issue. Identify all issues needing attention. Confirm that the issue is not one of manners, social conventions, economics etc. 2. Determine the actor(s). Determine who is responsible, ie morally obligated and empowered to do something. There may be more than one and interactions can be important. (Avoid consideration of stakeholders at this point, ie those potentially affected, as this implies a strong bias to solely an ends-based outcome.) Refer Appendix H. 3. Gather the relevant facts. Find out the way events unfolded, what finally happened, what else might have happened, who said what to whom, who may have suppressed information, or who was culpably ignorant or innocently unaware. Who has rights? Who has duties? Also consider future potential. Don’t jump to conclusions and avoid superfluous (and time-wasting) accuracy. 4. Test for right vs wrong issues. Does the case involve wrong doing? Apply the legal test – if obviously yes, then the issue is a legal rather than a moral matter. If not sure, try the litmus tests (in section 2.3) If the answer is ‘yes’ to any of these, then stop at this point and make the decision you know you have to. 5. Test for right-vs-right paradigms. Truth vs loyalty, self vs community, short-term vs long-term, justice vs mercy. This step confirms that core values are being pitted against each other and that it is a genuine dilemma. 6. Apply the resolution principles. Apply the ends-based, rule-based, and care-based principles to discern the most relevant and persuasive to the issue at hand. Caution: Take care not to apply them blindly or place over-reliance on them. 7. Investigate the ‘trilemma’ options. Is there a third, up-till-now-unthought-of way through this dilemma. Perhaps a compromise is required. 8. Make the decision. This is where the moral courage may be required and is often the hardest part, despite the care taken over the previous steps. Important: Ask “How do I feel?” This is referred to as the ‘sleep test’ and is a critical check on the decision made. 9. Revisit and reflect on the decision. The feedback loop. Seek out lessons after the tumult has died down in order to adjust the moral compass.

(Refer Kidder (1996). Includes some slight modification to partially address Badaracco’s (1997) concerns.) 111

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Michael Rion Model

Stage 1 – be bothered 1. Why is this bothering me? Is it really an issue? Am I genuinely perplexed, or am I afraid to do what I know is right? 2. Who else matters? Who are the stakeholders who may be affected by my decisions?

Stage 2 – form a personal view 3. Is it my problem? Have I caused the problem or has someone else? How far should I go in resolving the issue? (Refer Appendix H) 4. What is the ethical concern? Legal obligation, fairness, promise keeping, honesty, doing good, avoiding harm?

Stage 3 – test view 5. What do others think? Can I learn from those who disagree with my judgement? 6. Am I being true to myself? What kind of person or company would do what I am contemplating? Could I share my decision ‘in good conscience’ with my family? With colleagues? With public officials?

(from Rion 1989) 112

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APPENDIX H

ETHICAL RESPONSIBILITIES [Based on Rion (1990) ©]

Corrective Proactive Responsive Voluntary

Did I hurt someone? How can I respect Should I help? Are there good others? deeds I could do How can I What principles are What if I don’t help? Do I have an compensate? involved? opportunity to make a difference? - Apologise - Promise keeping - Need - Volunteer - Repair - Fairness - Proximity - Pro bono work - Repay - Honesty - Capability - Corporate - Reconcile - Avoiding harm to - Last resort philanthropy others - Legal compliance

OBLIGATIONS CHOICES 113

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APPENDIX I

SLEEP-TEST ETHICS

Badaracco (1997) offers a framework of phrases and questions to help resolve the ethical dilemmas and which are based on the “sleep-test” concept – refer section 7.6.

For situations where a decision must be made in which the decision maker is at the centre of the problem, the questions are:

1. How do my feelings and instincts define the dilemma? 2. Which of the responsibilities and values in conflict have the deepest roots in my life and in (moral) communities I care about? 3. Looking to the future, what is my way? 4. How can expediency and shrewdness, along with imagination and boldness, move me toward the goals I care about most strongly?

The four questions help to devise an action plan. They are all important as they balance each other, limiting the risks that each one, considered alone, might create.

When the decision maker must decide on a matter which directly impacts others within the organisation, the four questions are:

1. What are the other strong, persuasive, competing interpretations of the situation or problem that I hope to use as a defining moment for my organisation? 2. What is the ‘cash value’ of this situation and of my ideas for the people whose support I need? 3. Have I orchestrated a process that can make the values I care about become the truth for my organisation? 4. Am I playing to win?

Finally, Badaracco offers these questions for situations where the decision maker must decide on a matter which impacts both inside and outside the organisation––these are usually the most complex because there are usually many stakeholders.

1. Have I done all I can to secure my position and the strength and stability of the organisation? 2. Have I thought creatively and imaginatively about my organisation’s role in society and its relationship to its stakeholders? 3. Should I play the lion or the fox? “The lion cannot defend himself against snares and the fox cannot defend himself against wolves.” 114

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Baradacco provides a detailed discussion of the basis for these questions but also in the conclusion to his book, emphasises the importance of creating time for reflection in order to apply them effectively. 115

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APPENDIX J

CATEGORIES OF ISSUES IN PROFESSIONAL ETHICS FOR ACTUARIES [Developed by Lindon Cole, Managing Director, Society of Actuaries 1997]

I. THE ACTUARY’S OWN WORK A. Inadequate resources – asked to do a job (or sign a report) without adequate time, data, budget etc B. Asked to change an answer • By your boss • By your client C. Questionable request – asked to do something that seems questionable to you (or even illegal) • By your boss • By your client • By your colleague D. Unsavoury client – asked to work for someone who probably runs their business in questionable ways • As their employee • As their consultant E. Responsibility to “secondary” clients – does the actuary’s responsibility extend beyond the person paying the fee (or the salary)? • Duty of confidentiality to primary client vs duty to disclose to protect the interests of “secondary” clients affected by your work • Other situations where your work affects more people than those paying for the work F. Error disclosure – Should a discovered error you made be corrected and disclosed, or should it be buried? • Recent error • Old error G. Aggressive interpretation – of standards, regulations, etc. • Exploiting loopholes • Stretching the literal meaning of words to cover what you want to do

II. R ELATIONSHIPS WITH OTHER ACTUARIES A. Whistleblowing B. Error disclosure – Should a discovered error another actuary made be corrected and disclosed, or should it be buried? • Recent error • Old error 116

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C. Second guessing – When should an actuary challenge another actuary’s work (assuming neither reports to the other)? • Same employer • Same consulting firm • Rival consulting firm D. Confidentiality – Must an actuary keep client information from colleagues who could help other clients if they knew about it?

III. P ROFESSIONAL ISSUES A. Conflict of interest B. Use of inside information C. The nature of the professional opinion D. Can an actuary audit her/his own work? E. Competence - Accept a job only when competent to do so F. Reliance on the work of others G. Materiality

IV. GENERAL ISSUES A. Is it alright to cheat a little, if it leads to a good result, and no one is hurt (very much)? B. Isn’t what someone does with my work product their responsibility alone?

NOTES: There is obviously some overlap between the last two sections and the first two. This is not to be considered a complete list. If you have a topic or an idea that you feel should be included in this list, please contact Linden Cole at the Society of Actuaries office (e-mail: [email protected]). 117

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APPENDIX K

ETHICS CENTRES AND LEARNING

„ The St James Ethics Centre – founded in 1989 by St James Anglican Church and incorporated in 1990. It is an independent non-profit, non-political organisation that provides a forum for the promotion of business and professional ethics.

It provides consultancy services (for example, assistance in drafting a code of conduct), a free counselling service for people who encounter an ethical dilemma and seek assistance for its resolution, other support to individual professionals, learning programmes for current and future leaders, as well as awards to people who have demonstrated leadership and moral courage. Worth noting is that the Centre has representatives on a number of corporate and professional ethics or disciplinary committees.

Street Address: Level 2, 140 Sussex Street, Sydney NSW 2000 Postal Address: GPO Box 3599 Sydney NSW 1044 Telephone: (02) 9299 9566 Facsimile: (02) 9299 9477

„ Australian Association for Professional and Applied Ethics – formed 1993 out of a conference of academics and professionals from many different backgrounds. Its aims are to encourage awareness of applied ethics as a significant area of concern, to foster discussion of issues in applied ethics, and to foster and maintain lines with special interest groups. Each year it holds a conference.

It can be found in the Internet at http://www.arts.unsw.edu.au/aapae/

The author is aware that ethics is taught at the Graduate School of Business at the University of Sydney and The University of New South Wales (and no doubt at other universities and colleges).

The latter in fact offers the course Graduate Diploma in Professional Ethics which can be completed in one or two years of evening or distance learning. Details can be found at http://www.arts.unsw.edu.au/philosophy/pg.htm 118

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APPENDIX L

ETHICS WITH SACRIFICE [Sourced from Grace & Cohen (1995) and Sir Adrian Cadbury, Chairman of Cadbury Schweppes, ‘Ethical managers make their own rules’, Harvard Business Review, September-October 1987]

Sir Adrian’s grandfather was a strong opponent of the Boer War. His views lead him into two ethical dilemmas which he had to resolve to maintain his principles:

1. In 1900, Queen Victoria sent a decorative tin with a bar of chocolate inside to all of her soldiers who were serving in South Africa. At the time, he owned and ran the second-largest chocolate company in Britain, so he was trying harder and the order meant additional work for the factory.

He resolved the dilemma by accepting the order, but carrying it out at cost. He therefore made no profit, his employees benefited from the additional work, and the soldiers received their royal present.

2. He bought the only British newspaper which shared his views so that he could reach a wider audience. But he was also opposed to gambling, and removed all references to horse-racing from his paper. The circulation of the paper fell accordingly and defeated the point of buying it in the first place. An ethical choice had to be made: report on horse-racing and acquire a large audience for moral arguments against the war, or stick to principle, allow no help to gambling, and lose an anti-war voice.

He decided that opposition to the war was more important than offering some small encouragement to gambling, and the reporting of horse-racing was resumed.

The important point to note here is that even though he made a decision to be ethical, it was not ethically cost-free. He had to sacrifice a principle. The cynic might suggest that the second decision was easy it being also profitable, but note that he bought the paper in the first place with an ethical motive, not a profit motive. 119

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Endnotes

1 It has been suggested that it is rare in practice to be confronted with a genuine ethical dilemma (that is one that seems intractable by normal problem solving techniques), but rather ethical problems are more the norm. This is no doubt correct but we will use the term ethical dilemma in this paper without attempting such a distinction.

2 According to a citation by Grayson (1995), when Harvard Business School offered the first course in business ethics in 1915, there were few takers and most students were bewildered about what the class was supposed to teach them. Now more than 90% of all business schools in the U.S. offer ethics courses, and they are strong in demand. But the big surge in enthusiasm has come only recently.

3 A similar word in Latin is mos from which we derive moral, mores, and morale. We make no distinction between the use of the terms ‘ethics’ and ‘morals’ (although some writers do) but it is worth distinguishing bad ‘manners’ which Kidder (1995) describes as certain unpleasant behaviours which, while not necessarily immoral, may offend the canons of good taste.

4 Of course, the reference here is more to criminal, corporate, civil and common laws as distinct from say tax laws (although tax cheating itself is unethical).

5 For example, Sharp (1996) states that murder, when considered by governments or revolutionaries to be in the national interest, is not only tolerated but actually encouraged and required although it is, naturally enough, not labelled with that name.

6 The stench test is rule-based; the front-page test is ends-based; the mum test is care-based.

7 McCoy (1997) has observed that younger persons usually see ethical dilemmas as black-and-white (the “right” choice is obvious) whereas older persons tend to see more of the shades of grey.

8 Full details of the circumstance of this story and the ethical issues are covered in English (1997).

9 Some actuaries might!

10 The debate has been recently taken up in The Actuary – refer Sharp (1997b), Booth (1997), Grenham letter September 1997, and Sharp’s response November 1997.

11 For example the abortion and euthanasia debates seem to be about values in highly charged conflict when in reality both camps uphold the sanctity of life. The abortion debate is, at its root, about the definition of the beginning of life, a scientific question which cannot ever be resolved so it becomes a moral question. The euthanasia debate is, at its root, about the rights of people to choose when they die, about whether doctors should be legally able to assist that right, and about the efficient use of scarce and expensive medical resources to maintain a life when things look hopeless. The creationist vs evolutionist debate is another example: Should a society built on scientific evidence tolerate a religious teaching in schools which seems to be at odds with it? One answer might be that a modern society such as Australia has been built just as much on religious teachings as scientific theory so why should it not accommodate such teachings.

12 The term “business” is used to refer to business in all its corporate forms, from sole trader to multi-national corporation. A corporation is nothing more than a grouping of people that can achieve something more efficiently and effectively than if they tried individually.

13 In the US, according to Carmichael, guidelines have been developed over a period of years for assessing the culpability of a corporation before sentencing. The effect is to reward companies for good behaviour, rather than to penalise them for bad behaviour. If a company is convicted of any offence, the fines are normally two or three 120

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times the assessed damage caused by the company’s action. But if the company can prove that it has an effective ethics program in place, the fines can be mitigated by as much as 95%.

14 The author recommends this as useful background reading for anyone wishing to do business in foreign countries. In the end though, nothing will replace experience and local guidance.

15 Refer Leeuwen (1998) and Macken (1998)

16 Note that it is not being suggested that professionals are intrinsically more ethical than, say, greengrocers or real estate agents, but that certain values come into more prominence because of the particular relationship with the client.

17 This section is based largely upon Grace & Cohen (1995, Chp 8). They are of general application to all employees. The special circumstances of actuaries with their professional obligations and appointed actuaries with their statutory obligations will be considered in Part B.

18 The NSW Whistleblowers Protection Bill of 1992 failed and then the NSW Protected Disclosure Bill 1994. For a full dissertation on the legal aspects of whistleblowing, refer to the Submission to the Senate Select Committee prepared by Dr Simon Longstaff., 1994.

19 quoted from J.McMillan ‘Legal Protection of Whistleblowers’ published in Corruption and Reform, University of Queensland Press, 1990, p205

20 It is merely noted here that criticisms have been levelled at codes of conduct such as (a) they are designed to protect the exclusivity of the professions; or (b) they are rarely enforced, or that if they are, it is against those who might challenge the traditional elite. Cody & Bloch provides a full review of these types of issues as well as the general criticisms directed at the existence of professions per se.

21 citing Sharon Beder, ‘Engineers, ethics and etiquette’, New Scientist, 25 September 1993, pp.36-41

22 Gioia provides a fascinating account of the celebrated case in 1973 of the recall of Pinto cars due to them being potential fire hazards, of the self-analysis that followed, and of his personal ethics in a business situation being severely tested. The notion of internalising scripts for enacting one’s personal values during decision making is discussed.

23 Actuaries have resigned over this type of dilemma, as the Code of Conduct impels them in the last resort.

24 Both rule-based and ends-based thinking have become the dominant way of looking at ethics since the Enlightenment (which had so much to do with looking at things rationally).

25 Kant gained many of his philosophical insights from the Protestant reformer Martin Luther.

26 He gives this hypothetical in support of his contention: You are standing in front of a burning building. You have a choice of saving one child at one end of the building or three at the other end but you cannot save all. There is no risk to you. The principles seem to point unambiguously to saving the three children. But what if you then realise the one child alone is your own child? How useful are the principles then?

27 This has now been stopped by changes to SIS and the IAA Guidance Notes, restricting uninsured death benefits for small funds.

28 An extract of the results was published by The St James Ethics Centre in “City Ethics” Issue 30, Summer 1998. The notes that follow were derived from that extract. 121

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29 It is important to note that any comparison of PI rates is fraught with problems due to differences in regulatory environments, socio-economic factors, amounts of cover purchased, amounts of excess applicable etc

30 Interestingly, the accounting survey conducted in 1991 achieved an almost identical response rate out of the 7,000 sampled from an accounting population of over 60,000.

31 This book was referred to in Duncan Ferguson’s Presidential address to the U.K Institute in 1995 quoting from an SOA meeting

32 Not all in the U.S. agree with this view. A 1996 SOA presidential candidate stated, “I object to the tendency of our profession to carve out a role as guardians of the public trust.” He concludes, “There is a potential for appointed actuaries to get boxed in and be viewed by senior management as whistle blowers and technicians.” Refer to Heacox (1997) for full argument and response.

33 This paper assumes that people can be expected to act in what they believe to be their own self-interest except when principles in a situation are valued more highly. If people never acted in their own self-interest, but instead always acted altruistically, and the altruism is not itself a self-interest mechanism, then there would hardly be a need for the study of ethics. However, that would mean that they are not maximising utility or not acting rationally, fundamental axioms underpinning economics. It would also mean they are populating a world unknown to politicians, academics, or clergy.

34 Interim Report––Tomorrow’s Company: The Role of Business in a Changing World (1993-1995) – a project under the sponsorship of the Royal Society for the encouragement of Arts, Manufactures & Commerce (RSA). Cited by Sharp (1995)

35 According to a 1968 study cited by Sharp (1995), 70% of the US public thought business tried to strike a fair balance between profits and the public interest. By 1976, only 15% answered positively while by 1979, the percentage stood at 19%.

36 The expression ‘ethical behaviour’ can refer to either socially responsible actions, right vs wrong decisions (‘moral temptations’), or right vs right decisions (‘ethical dilemmas’), although ‘ethical/unethical behaviour’ tends to be used in business writings to refer to right vs wrong decisions.

37 In the U.S. during the early 1990’s, unethical and illegal activities were shown to be endemic among large defence contractors so much so that ethical companies were effectively barred from obtaining any business. Consequently, the only survivors were the unethical. Is this an exceptional example? Grayson (1995) quotes from a National Business Ethics Survey which concluded that some 30% of employees have ‘often’ or ‘occasionally’ observed conduct they thought violated company policy or the law.

38 For a complete description of the case (and others), interested readers should refer to http://www.cwru.edu/affil/wwwethics/LeMessurier/lem.html Institute of Actuaries of Australia - Simple Superannuation (Tax Reform) Taskforce

Discussion Paper on Superannuation Tax Reform and Simplification

2 November 1998

NOTE: This Paper has been prepared by a Taskforce comprising members of the Institute of Actuaries of Australia, to promote discussion on tax reform for superannuation. The contents of this paper do not represent Institute policy.

Table of Contents

1 Executive Summary 1

2 The need for superannuation Tax reform & Simplification 3

3 Objectives Of a Superannuation System 7

4 The need for superannuation Tax support 8

5 the Constraints & criteria for superannuation tax 9

6 current proposals 12

7 An Alternative Model 15

8 The need for CAPS & LIMITS 19

9 revenue implications 20

10 integration of public & private retirement savings 21

11 Conclusion 22

12 References 23

1 EXECUTIVE SUMMARY

The Institute of Actuaries of Australia is keen to promote discussion and debate in relation to the simplification of the superannuation system, and in particular reform of the taxation of superannuation. To that end, the Institute established a Simple Superannuation (Tax Reform) Taskforce, comprised of members of the Institute with experience in superannuation.

This Discussion Paper represents the preliminary views of the Taskforce. The contents of this paper do not represent Institute policy. The Discussion Paper has been prepared for initial discussion with Government, the superann-uation industry and other interested parties, to obtain input from a wide range of sources on the overall approach prior to developing more detailed proposals.

Reasons for Superannuation Tax Reform

The Institute believes that fundamental change to the taxation of superannuation is required to:

§ retain the effectiveness of long-term superannuation savings and encourage voluntary superannuation saving in the context of the Government’s broader tax reform proposals; and

§ considerably reduce the significant complexities, anomalies and inefficiencies of the current superannuation taxation system.

This will result in improved confidence in the superannuation system and a more stable and sustainable retirement incomes policy.

The preliminary framework of one possible model for superannuation tax reform that has been developed by the Taskforce is briefly outlined below.

Key Features of the Taskforce Framework for Tax Reform

§ the taxation of superannuation will be based on an expenditure tax model, however some level of tax on investment income will be retained to maintain Government revenue in the shorter term;

§ there will be no tax on superannuation contributions, removing both the basic 15% tax on deductible contributions and the 15% surcharge tax;

§ all superannuation contributions up to an annual limit will be either deductible or receive a rebate (the limit is yet to be specified but is required, in some instances, to be at a higher level than the current deductible contribution limits);

§ superannuation benefits accruing after the “tax changeover date” will be taxed at marginal income tax rates when the benefit is paid – although some level of tax- free threshold will be retained;

§ an upper limit on the maximum benefits available (at a level similar to the current pension RBL) may be required to limit the total tax deferral available (possibly by

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applying penalty tax rates on benefits above this level);

§ transitional benefit tax provisions – the “big bang” approach – will be used to protect the tax position of benefits accrued prior to the tax changeover date. This will involve a one-off benefit tax calculation under the current rules as at the tax changeover date. The dollar value of the pre-changeover benefit (indexed) and an overall tax rate on this benefit would be retained and used to calculate the tax payable on this component of the final benefit at the date of payment.

Advantages of the Proposed Framework for Tax Reform

§ the overall tax system will be significantly simpler than the current system;

§ there will continue to be tax incentives for voluntary superannuation savings;

§ the complexity and anomalies of the current different tax treatment of different types of contributions for funded/unfunded arrangements, employees/employers/self-employed, pre-tax/post-tax contributions etc would be removed or reduced;

§ the “big bang” approach allows the 13 current different benefit tax components to be reduced to two – pre and post changeover – while protecting (to a large degree) accrued entitlements;

§ application of marginal tax on all benefits (i.e. lump sums and income streams) should encourage more individuals to take their entitlements as income streams;

§ it will also provide a growing source of tax revenue as the new tax system matures, during the same period as other revenue falls because of the aging of the population;

§ the caps on contributions and benefits will be more flexible than at present, catering for varying work patterns and contribution periods, particularly women (and others) with broken work/contribution patterns; and

§ importantly, the proposed model should allow transition from the current superannuation tax system to the new system without an unacceptable impact on Government tax revenue, or on individuals currently in the superannuation system and those in or near retirement.

Issues that will need to be considered in relation to the proposed framework for super- annuation tax reform, and where more detailed modelling work is still required; include:

§ the extent of the likely shortfall in total tax revenue in the short term as a result of removing contribution taxes – it will take some years for the increased benefit taxes to kick in and so the level of investment tax retained will need to be set at a level such that this shortfall is acceptable to the Government; and

§ there may be some individuals disadvantaged by the “big bang” approach proposed for dealing with the change to the taxation of benefits – further work is therefore required to identify those likely to be affected and minimise the potential impact. 2

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2 THE NEED FOR SUPERANNUATION TAX REFORM AND SIMPLIFICATION

Superannuation savings are critical to the Government’s retirement income policy objectives of providing “encouragement for individuals to achieve a higher standard of living than would be possible from the Age Pension alone” and of “encouraging people who are able to save for their retirement to do so”.

The Government is planning major taxation reform that will have a significant impact on the attractiveness of superannuation as a savings vehicle, and hence on the achievement of these retirement income policy objectives.

Further, it is widely accepted that the aging of Australia’s population will place increasing pressures on the social security system in the next century. Funding of Australia’s (increasing) age pension liabilities will not be fiscally sustainable without increased self-provision for retirement. It is also recognised that the level of compulsory superannuation (even when it reaches 9% of salary) will be inadequate to have a significant effect on the demand for age pensions, reinforcing the need to maintain the attractiveness of voluntary superannuation savings.

Finally, the existing superannuation system (and in particular the taxation of superannuation) is extremely complicated and inefficient. This complexity undermines public understanding of, and confidence in, the superannuation system and so again impacts on the achievement of the Government’s retirement income policy objectives.

A comprehensive review of the taxation of superannuation now, with a view to achieving significant reform and simplification, provides the opportunity to tackle these important issues within the context of the Government’s broader taxation reform and the implementation of a coherent retirement incomes policy.

The key reasons for a comprehensive review of the taxation of superannuation touched on above fall broadly into 2 areas – encouraging increased private saving, and removing complexities and inefficiencies, to restore confidence in the superannuation system.

Encouraging Increased Private Saving

§ The Government’s proposed changes to marginal income tax rates will reduce (or remove) the tax-effectiveness of superannuation savings, particularly for low and middle-income earners, unless changes are also made to the taxation of superannuation.

§ The overall tax on superannuation currently ranges from 29% to 41.5%, taking into account the tax on contributions and benefits (for employer-provided benefits above the tax-free threshold). The rate varies depending on the age at which the benefit is received and whether or not surcharge applies.

The table below summarises the variation in effective tax rate (excluding investment tax) in different circumstances.

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EFFective tax rate on superannuation versus Income

Taxable Salary Marginal Tax Rate Effective Tax Rate Tax Advantage of $ % on Superannuation Superannuation % % 5,400 – 20,700 21.5 29.0 -7.5

20,701 – 38,000 35.5 29.0 6.5

38,001 – 50,000 44.5 29.0 15.5

50,000+(no 48.5 29.0 19.5 surcharge) 50,000+ (surcharge) 48.5 41.5 7.0

(Note: the calculations assume that the final benefit received is less than the RBL and accrued post-1983, and ignores the tax-free threshold.)

§ The (incorrect) public perception is that the combined tax rate on superannuation benefits above the tax-free threshold is between 31.5% and 46.5%. However this simply adds the 15% contribution tax, 15% surcharge contribution tax (if it applies) and the 16.5% benefits tax. It ignores the multiplicative effect of the contribution and benefit taxes. It also ignores the tax on investment income (as does the analysis in the table above), and in particular the timing differences inherent in the three different types of tax.

It is difficult to simply determine an effective tax rate that also includes the effect of investment tax, as this will vary with the age and the period over which the benefit is accumulated. The effect of investment tax is best assessed by comparing the net amount accumulated in superannuation versus alternative investments.

§ Even at the lowest overall tax rate of 29% in the above table, superannuation is not a tax effective investment option for those currently earning $20,700 or less (for whom the marginal income tax rate (MTR) is 21.5%). It provides only marginal tax benefits for those earning up to $38,000 (with a MTR of 35.5%).

§ Under the Government’s tax reform proposals, 81% of individual taxpayers would have a marginal income tax rate of 31.5% or less. There would therefore be insufficient incentive for this group to save in the restricted access environment of superannuation. As the remaining 19% of higher income earners are likely to save anyway, it is these 81% of taxpayers that represent the lower and middle- income earners who need to be provided with the greatest encouragement to save.

§ A significant increase in private retirement savings is required to ensure the publicly funded age pension safety net is financially sustainable. The unfunded pension liability for the current group of age pensioners has been estimated at $172 billion as at June 1997. This is in addition to the unfunded superannuation liabilities (for public servants) of $111 billion. By comparison, Australia’s national debt was $202 billion as at the same date. (Rice 1)

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The ABS projects that the number of people over age 65 will increase from 2.25 million to 4 million within 25 years and the Treasury’s Retirement Income Modelling projections show that the ratio of persons aged over 65 to persons of working age will double by mid-next century. (Rothman2). Hence, without a significant increase in the level of private retirement savings, publicly funded age pensions will at some stage in the future have to be severely restricted or reduced, putting at risk the concept of the age pension as a publicly funded safety net.

§ Compulsory superannuation alone, even with contributions rising to 9%, will not be sufficient to have a significant effect on the demand for publicly funded age pensions (Rothman2). Therefore, voluntary superannuation savings in addition to the SG will be essential. However, since the 1970’s, the household savings ratio has reduced from 10% to below 5% (ASFA3). Further, poor integration between the superannuation system and the publicly funded age pension system only makes it less likely for lower to middle income Australia to see any benefit in saving for retirement.

Removing Complexities and Inefficiencies

§ The existing taxation system is too complicated, is inefficient and is poorly understood. Further, the existing system has been subjected to ad-hoc changes over many years, adding to rather than reducing complexity and contributing to lack of confidence in the superannuation system. More ad-hoc changes are clearly undesirable – rather, a comprehensive review with bipartisan support and a commitment to future stability of the system is required to restore community confidence in superannuation as a vehicle for retirement savings.

§ Not only are we the only country to impose tax on all three stages of superannuation savings – contributions, investment income and benefits - but the structure of these taxes (particularly the taxes on contributions and benefits) are also unbelievably complicated. For example:

Taxes on Contributions: § 3 different taxing systems for contributions made by employees, employers and the self employed; § 2 different types of contribution taxes on employer contributions – the basic 15% tax and the 15% surcharge; § different contribution tax rates for funded and unfunded (public sector) superannuation schemes; § 3 different types of tax rebates for individuals;

Taxes on Investment Income: § 2 different taxation rates for accumulating assets versus pension assets;

Taxes on Benefits: § 13 different tax rates depending on whether the benefit is pre 83 or post 83; funded or unfunded; concessional; paid before or after age 55; under or over the tax-free threshold; under or over the RBLs; a lump sum or a pension or a death benefit.

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§ Only some of the 13 tax rates are related to marginal income tax rates (the tax on pensions and on lump sum benefits in excess of the RBL) so any changes to marginal income tax rates immediately changes the relativities of superannuation taxes versus personal tax rates.

In addition, the rules regarding the taxation of superannuation contributions and benefits have been subject to constant change over the past 10 years.

§ The complexity of superannuation taxes results in significant inefficiencies in the superannuation system, leading to higher administration costs for funds, members (through the need for financial planning advice) and Government agencies such as the ATO. This in turn impacts adversely on private and public savings.

The constantly changing regulatory and taxation system have already eroded the community’s confidence in superannuation. If the superannuation system is to be changed again, it should only occur after a comprehensive review, and only if the changes proposed achieve a simpler, better system. .

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3 OBJECTIVES OF A SUPERANNUATION SYSTEM

The desired objectives for reforming the superannuation system should be to ensure that the superannuation system:

§ enables implementation of a coherent retirement incomes policy under which there is better integration of private (superannuation) savings and the age pension system;

§ ensures a sustainable (affordable) age pension safety net, when expressed as a % of GDP;

§ increases community understanding of the superannuation system, trust (or confidence) in the stability of the system and awareness of the advantages/desirability of deferring income for retirement;

§ encourages greater use of income streams rather than lump sums;

§ encourages private retirement savings of sufficient level to provide reasonable retirement incomes, with tax concessions targeted at those who can afford to save but who otherwise would be reluctant savers eg middle income Australia, whilst limiting the concessions for those who would save anyway;

§ creates a more efficient system, that minimises administration and compliance costs.

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4 THE NEED FOR SUPERANNUATION TAX SUPPORT

The tax system should be structured so that there are no distortions or disincentives to save. People cannot be expected to voluntarily defer income until retirement unless there is a benefit in doing so. Money in hand is less risky than money deferred, so there has to be an additional return provided to compensate for the risk of deferring payment.

As indicated above, the incentives required to encourage people to defer income for retirement should be targeted to those who would not otherwise save. There is a need to assist individuals to maintain their pre-retirement standard of living and dignity in retirement by providing a saving environment and culture where this is attractive.

The existing tax on superannuation contributions and investment income is effectively bringing forward future tax revenue (from taxes on end benefits and reductions in age pension payments). The costs of the tax incentives provided to superannuation must therefore not be counted in isolation. Account must be taken of the expected reduction in the present value of the growing unfunded age pension costs. This link is often overlooked in assessing the value of taxation support provided to superannuation.

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5 THE CONSTRAINTS & CRITERIA FOR SUPERANNUATION TAX

Any tax system should generally satisfy the following basic criteria:

1. Efficiency:

The tax system should encourage savings behaviour across a wide range of income levels.

2. Equity:

Similar taxpayers should be treated similarly and lower income earners should have a lighter tax burden than higher income earners.

3. Simplicity:

Taxes should be simple enough to be readily understood and administered without creating an unnecessary drain on private and/or public savings.

4. Flexible:

The tax system should have some flexibility to deal with changes. For example, if superannuation taxes were integrated with marginal tax rates, any changes in marginal tax rates would automatically flow through to the taxation of superannuation, maintaining the same relativities.

Simplification of the superannuation taxation system will be subject to additional constraints such as the following:

1. Any proposed changes to superannuation taxation should not adversely affect those people currently in the system: whether “savers” or self funded retirees.

2. In practice it is unlikely that Government would accept any significant short-term reduction in tax revenues from the superannuation system.

3. Any changes to taxation must simplify the current system. Therefore, any changes that increase administration requirements or create further confusion in the community are not acceptable. This means that changes that would require complicated grandfathering rules or phasing in arrangements would not be considered appropriate.

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Features of Different Types of Superannuation Taxes

Currently tax applies at all three stages of the superannuation cycle: contributions going into the superannuation system, investment earnings in the accumulation stage and benefits when subsequently taken. Each of these different taxes has different implications in terms of administrative burden, level of consumer understanding and the level and timing of revenue collection.

For example, the taxing of contributions, investments and benefits creates different administration burdens, some of which are far easier to handle than others. The greater the administrative complexity, the more likely that people will not understand or trust the system. Different taxes also result in different revenue streams to Government, which have to be taken into account when considering any changes in the mix of taxes.

Each of the three taxes: contribution, investment and benefit taxes are considered below in terms of ease of administration, consumer understanding and revenue implications for Government.

Contributions tax:

Advantage:

§ Provides higher immediate revenues for the Government.

Disadvantages:

§ Creates most of the administration complexities/problems currently in the superannuation system (due to the different tax treatment of different types of contributions). § A flat rate of contribution tax also creates equity problems in that it disadvantages lower income earners relative to higher income earners.

Contribution tax creates two main administrative problems.

1. The first relates to the difference between funded (private sector) and unfunded (public sector) superannuation schemes. Unfunded schemes are not fully funded by contributions, and so a contribution tax requires a different system of taxes on end benefits for funded and unfunded schemes. This is so that the lack of a contribution tax in unfunded schemes can be compensated for by higher taxes on the end benefits paid from unfunded arrangements.

This difference creates considerable complexity in the taxes applying to benefits. The taxes vary depending on the degree to which benefits were accumulated in funded versus unfunded arrangements. This impacts on people transferring between the public and private sectors. Having two sets of rules for public sector and private sector superannuation creates considerable confusion in the community.

2. The second problem is that being encountered with the surcharge tax. In many superannuation arrangements, it is not a straightforward matter to assess the actual contribution counted towards each individual’s benefit each year. This 10

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applies to defined benefit schemes and also to partially vested accumulation schemes and creates equity problems.

Investment Tax:

Advantages:

§ Provides higher immediate revenues for the Government and is a growing tax base. § Administratively a simpler tax as there are well established systems in place for the payment of this type of tax.

Disadvantages:

§ A flat rate of investment tax also creates equity problems in that it disadvantages lower income earners compared to higher income earners.

Benefits Taxes:

Advantages:

§ Can be an administratively simple tax as it falls within the established PAYE system, particularly if tax rates are tied to marginal income tax rates; § Provides a source of growth in revenue to the Government in the longer term as the superannuation system grows and matures. § It is easier to be “fairer” under taxes on benefits because the tax is paid at the time the benefit is received and can be adjusted to reflect the level of benefit received.

Disadvantage:

§ A shift in tax mix from contribution taxes to benefit taxes would result in a potentially significant reduction in tax revenues to the Government in the short term and therefore may be unacceptable to Government.

From an administration viewpoint, the taxation of contributions (particularly under the current tax system) creates the greatest administrative complexity and consumer confusion. Investment and benefit taxes are far simpler to administer and understand.

While administration considerations should not override other considerations (such as equity), it is a key issue for the superannuation industry. Further, reductions in administrative complexity are consistent with the focus of superannuation taxation reform on reducing complexity, improve understanding and restoring consumer and community confidence.

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6 CURRENT PROPOSALS

A number of proposals regarding superannuation taxes have recently been put forward for consideration. Almost all proposals prefer a system based on the expenditure tax model rather than the income tax model. Under an “expenditure tax model”, taxes are paid at the benefits stage only and are based on marginal income tax rates. This is the true deferred income model where income deferred is allowed to accumulate in a non-taxed environment and then taxed at marginal tax rates when eventually consumed.

By comparison, under an “income tax model”, the tax is applied at the point of saving and on any earnings generated, with the subsequent benefits being tax-free. This model is perceived to be biased against savings, as savings are seen to be taxed twice - once when first saved and again on earnings.

Many industry groups, including ASFA, IFSA, and the Sydney Institute, support a superannuation taxation system based on the expenditure tax model. It is also the most widely used system for retirement savings in other countries.

The income tax model was adopted by New Zealand and is viewed as not having been successful in generating long-term savings.

The Taskforce also believes that the expenditure based tax model is the preferred tax model for long term savings. However it is recognised that there are two major problems inherent in any proposal to vary the existing superannuation tax system to one based on an expenditure tax model. These are:

§ Firstly, any change in tax mix from contributions to benefits, as required in a move to an expenditure based tax model, would result in short term loss of revenue to the Government;

§ Secondly, any increase in tax on benefits would result in a retrospective increase in tax for all those with superannuation benefits already accumulated under the existing rules, unless suitable transitional arrangements can be developed.

Some proposals recognise the potential loss of revenue inherent in moving to an expenditure based tax model by suggesting that some form of contributions tax (sometimes referred to as a withholding tax) be retained. While this approach does address the problem of the reduction in short-term revenue, in practice retaining any form of contribution tax will also retain the significant administrative burden and complexity described above. Therefore, in our view this type of system does not achieve sufficient simplification.

Finally, none of the current proposals address what we believe to be the major problem that would need to be solved. That is, there must be a transition path from the current system to the new system that ensures existing people in the system are not significantly disadvantaged by the change. Equally importantly, the transition path must not add to the existing complexity nor create yet another grandfathering rule, or else we have failed the task of simplification.

Brief comments on several major taxation proposals currently being promoted are presented below. 12

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ASFA – Expenditure Model

ASFA supports the move to an expenditure based tax system. Contributions would be fully deductible, with no contribution limits and no tax on investment earnings. Benefits accumulated up to a 1.5 x AWE income level would be taxed at marginal income tax rates. Benefits beyond this level would be taxed at higher tax rates to recoup the value of the tax concessions provided during the accumulation phase.

The main issues arising from this model are:

§ the transitional problems which would have to be solved prior to shifting from the current taxation system to this proposed system to avoid disadvantaging those people currently in the system; § the short term loss of revenue to the Government due to removal of both contributions and investment tax; and § the lack of any limits on contributions receiving a full tax deduction. This could potentially lead to abuse from those individuals able to contribute very large annual amounts and claim the full tax deduction. Although higher taxes would apply at the end, the significant tax deferral available would be perceived by many as preferable to tax paid now.

The Sydney Institute recommended a very similar proposal to that of ASFA.

IFSA – Withholding tax model

IFSA believes that the superannuation taxation system should be reviewed as part of a more comprehensive review of savings. IFSA also believes that the superannuation taxation system should be closer to the expenditure tax model than presently is the case and that there are merits in including a withholding tax on contributions offset by the tax on end benefits. IFSA recommends the reduction or elimination of investment tax.

The major problem we see with this proposal is the proposed (withholding) tax on contributions. As indicated above, of all the types of taxes, a contribution tax generates the greatest administrative complexity and confusion. For example, the distinction between funded and unfunded arrangements would need to be retained, with the associated anomalies and complexities that this creates. The approach to applying a withholding tax to defined benefit funds also requires further consideration – for example, whether it would be based on actual contributions (which raises issue for funds in surplus) or notional contributions (which creates difficulties of measurement as has been the case with the surcharge).

We would also suggest that there might be a public confidence issue to be overcome with this type of model. Individuals may well be sceptical as to whether the offset to the benefit tax payable when they receive a benefit for the withholding tax paid during the accumulation phase will actually be received. The superannuation system has been changed so frequently that there is likely to be little public confidence that it won’t be changed again between when they pay the withholding tax and when they receive their benefits.

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FPA – Compulsory versus Voluntary System

The FPA proposes a retention of taxes on all three stages, namely contributions, investments and benefits, and also a different system of tax for compulsory versus voluntary contributions. For example they recommend a 20% contributions tax on compulsory contributions, with different taxes applicable to the benefits arising from compulsory versus voluntary contributions.

The major problem with this model is its administrative complexity. By retaining taxes on all components - contributions, investments and benefits, the existing level of complexity is retained. Introducing different taxes on compulsory versus voluntary superannuation benefits actually results in greater complexity than exists at present. For example, segregating each superannuation benefit into a compulsory versus voluntary component would create a significant administrative problem in itself.

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7 AN ALTERNATIVE SUPERANNUATION TAXATION MODEL

An alternative taxation model being considered by the Taskforce is also based on the expenditure tax model. However it retains an investment tax in order to maintain Government revenues in the short term. An investment tax is chosen in preference to a contributions or withholding tax because it is administratively simpler.

Other features of the model proposed by the Taskforce are as follows:

§ Annual contributions up to a set limit (probably higher than the current age-based limits at younger ages) would be either deductible or receive a rebate.

§ A low rate of tax would apply to investment earnings in the accumulation stage.

§ All benefits, both lump sums and income streams, would be taxed at marginal tax rates, with a tax-free threshold retained (possibly equal to the current tax-free threshold of $93,711).

§ There would be a one-off tax calculation as at the “tax changeover date” to protect benefits accrued under the current tax system.

§ There may also need to be an overall cap on the maximum level of benefit (perhaps similar to the current pension RBL).

Advantages of Proposed Model

1. This model reduces the distinctions between contributions by employees, the self-employed and employers. This reduces the number of benefit components subject to different taxes. If the deduction or rebate were structured so that the tax effect was close to the company tax rate then the model could remove the distinction between the different types of contributions. As an example, contributions could be deductible at the lesser of marginal tax rates and the company tax rate.

2. The model does not distinguish between funded private sector superannuation and unfunded public sector superannuation, removing further complexity.

3. A transition path from the current taxation system to the new system is catered for by the one-off tax calculation, which incorporates all existing taxes on the many different benefit components. This allows benefits accumulated under the new system to be taxed at marginal tax rates, simplifying the whole system of benefit taxes.

4. The taxation benefits provided as a result of being able to defer income until retirement are limited by the annual deductible contribution limit. This focuses the taxation benefits on low and middle income Australia, and reduces the opportunity for higher income earners to abuse the system of tax deductions and tax deferrals.

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5. There will be increased flexibility, for example to cater for broken work patterns, and superannuation splitting between couples could be facilitated.

6. The new tax system would be considerably simpler, making it easier to understand. Income deferred up to a certain amount each year results in a tax deduction (or rebate). Savings accumulate at tax advantaged earning rates and when benefits are subsequently taken on retirement, the amount above the tax- free threshold is taxed at normal marginal tax rates.

Further details of the proposed model are set out below.

Contributions:

1. No taxes would be payable on superannuation contributions. That is, both the basic 15% contribution tax and the 15% surcharge tax for higher income earners would be removed. All superannuation contributions up to a specified annual limit would be either deductible or receive a rebate. The structure of the deduction or rebate should be such that the distinctions between contributions by employees, employers and the self-employed are reduced or removed.

2. There would be no work test to satisfy in order to contribute to superannuation however an age test of 70 would apply to deductible contributions. As contributions are deductible or receive a rebate, money is more likely to flow into superannuation from income earning individuals. If, however, a member chooses to contribute in reduced or nil income earnings years then there is no reason to prohibit this.

3. After the tax changeover date, there would be no further need to segregate benefits into undeducted contributions, pre 83, post 83, funded and unfunded components.

4. Contributions may be able to be made by the income earner into either their own superannuation or into their spouse’s superannuation, where that spouse is low/non-income earning, and still be eligible for the tax deduction or rebate. (This would replace the existing spouse rebate and recognises that one income earner is often at least partially supporting another person. It would be preferable to encourage the splitting of superannuation in the accumulation stage rather than at the benefits stage in the event of a divorce.)

Investments:

1. Tax on investment income would be retained, ideally with the tax rate set at no more than the current 15% rate. 2. The existing preferential tax treatment provided to pension assets would be retained as an encouragement to take income streams over lump sums.

Benefit Taxes:

1. Superannuation benefits (both lump sums and income streams) accruing after the “tax changeover date” would be taxed at marginal rates of tax when the benefit is paid to the member. This provides an automatic and strong incentive to take pension benefits rather than lump sum benefits.

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2. A tax-free threshold, perhaps equal to the current threshold of $93,711, would be retained to allow individuals flexibility to take out a relatively small lump sum for one-off retirement needs. This threshold provides some compensation, particularly for lower income earners, for the investment tax applied on their savings during the accumulation phase.

3. To limit the overall level of tax benefit (or tax deferral) available from the superannuation system there may need to be some upper cap on benefits. For example, penalty tax rates in excess of marginal tax rates could be applied to superannuation benefits in excess of a set limit (such as the current pension RBL).

4. Death benefits to spouses and dependants would remain tax-free.

5. A transitional tax calculation will be used to protect benefits accumulated under the existing tax rules prior to the tax changeover date.

Transitional Benefits Tax Rule

To provide a transition path from the current tax system to one based on an expenditure tax model there are two possible options. The first involves a gradual increase in tax on end benefits. The second involves a single “big bang” tax clean up.

A gradual increase in tax on end benefits will still disadvantage people who have accrued benefits in the current tax system, because an increasingly higher benefits tax will be payable on their current entitlements when they subsequently take their benefit. This is because they would have already paid tax on past contributions at between 15%-30%. Also, a gradual change in tax rates will not reduce as quickly the high levels of confusion in the community regarding superannuation taxes, nor the administrative complexity.

The “big bang” tax clean up option, on the other hand, would incorporate all previous tax rules and grandfathering provisions into a single tax calculation undertaken as at the tax changeover date.

This calculation of tax at the tax changeover date would be based on the current tax rules in operation prior to the changeover date and would be based on the greater of the resignation and retrenchment benefit as at that date. This calculation would therefore automatically allow for any existing pre-83, post-83, undeducted, funded and unfunded benefit components as at the tax changeover date.

The current tax-free threshold would be ignored in the changeover date tax calculations, as it will be incorporated in calculating the tax applying to benefits accrued after the tax changeover date. This also simplifies the one-off tax calculation at the changeover date, as no adjustments will be required for members of multiple funds to ensure the threshold is only counted once.

The tax calculation at the tax changeover date would provide the following information, to be retained in the superannuation system until benefits are subsequently paid out:

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§ the dollar value of the pre changeover benefit to be quarantined, which would be indexed to the date of benefit payment; and § the overall tax rate applicable to this pre changeover benefit, which becomes the future tax rate for the quarantined benefit component.

The quarantined benefit and tax rate would flow through into the calculation of tax on pensions as well as lump sum benefit payments.

Superannuation systems are already well established for calculating the tax payable on a benefit. The two items of information to be retained until the benefit is subsequently paid out involve far less onerous administration record keeping then the information that currently has to be retained on all the different benefit components.

The same rules as above would apply to any superannuation benefits within the system as at the changeover date. At this stage we envisage that pensions commenced prior to the changeover date would continue to be run under the current tax rules but that pensions commuted post tax changeover date would be converted at the date of commutation to the new tax system.

Our preliminary modelling indicates that the tax payable on pre-changeover benefits after the tax changeover date may be higher for some individuals in some circumstances than may have applied under the current tax system. This is due to the fact that growth above the level of indexation of the pre changeover quarantined benefit would be taxed at marginal tax rates. Clearly this raises issues that would need to be addressed, as any perceived retrospective change to taxation is likely to be difficult to get accepted politically and by the community at large.

However the Taskforce is of the view that such a one-off “big bang” approach may be workable and that further modelling work (to identify and minimise groups or individuals that may be disadvantaged) would be worthwhile given the considerable simplification that could be achieved.

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8 THE NEED FOR CAPS & LIMITS

It is generally recognised that the current age-based annual deductible contribution limits are not sufficiently flexible to deal adequately with varying work/contribution patterns, particularly women (and others) with broken work patterns. This is particularly the case at younger ages, where the limits are relatively low. Nevertheless, where superannuation contributions are deductible or a rebate applies, it is widely accepted that there is a need for some cap on the amount of annual contribution to superannuation to prevent significant tax deferral by higher income earners.

An annual deductible contribution limit of 1.5 – 2 times AWE would provide sufficient flexibility for those people with broken work patterns to be able to provide for their retirement during their years of income. It would also prevent significant abuse or tax deferral. It would also be possible to allow for the annual contribution limit to be cumulative for people such as farmers who are allowed to average their income over a number of years. For example, they could be allowed to contribute 5 years’ contributions from one good income year.

There may be some need for an overall cap on benefits, to limit tax deferral by higher income earners who are able to contribute at the annual contribution limit every year. Generally, retirement incomes in the order of 50% to 60% of pre-retirement incomes for a single person (more for a couple), capped to around 2.0 times AWE, would be considered a reasonable retirement saving target.

To achieve this level of annual retirement income, the accumulated benefit at retirement would need to be of the order of 25 to 30 times AWE. At current levels of AWE, this would equate to a lump sum benefit of around $1 million – which is similar to the current pension RBL. It seems reasonable to focus tax concessions on the provision of benefits to this level, but not beyond.

In considering the appropriate level of any annual contribution limit it should be noted that the contribution rate required to provide this target level of retirement savings is of the order of 15% (net of tax) per annum over a 30 to 40 year period.

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9 REVENUE IMPLICATIONS

In any change to the tax system, the impact on Government revenue is clearly a consideration. However, a broader view of the impact on revenue needs to be taken than is often the case.

Superannuation taxation needs to be viewed in the context of responsible long-term retirement incomes policy. The aging population will place increasing pressure on public finances. A move to an expenditure tax model, with higher taxes on end benefits, will lead to collection of increasing tax revenue as it is needed to fund these increasing costs for the aged.

Governments often focus on immediate revenue impacts of policy decisions and not on the overall impact on accrued assets and liabilities. This can lead to decision making that is less than optimal, for example where the improvement in the short- term financial position causes much greater losses in the long term. Government decision making should ideally be based on financial information similar in fashion to a "whole of government" balance sheet (i.e. an accrual accounting approach rather than a cash accounting approach).

This approach has been utilised by several state governments and was encouraged by the Commission of Audit report in 1996. It would also be consistent with the Charter of Budget Honesty's objective of providing a more informative financial picture of the Government's overall financial position.

If an accrual accounting basis is used in relation to superannuation taxation, and hence the effect of changes in taxation on overall Government (public sector) assets and liabilities recognised, then immediate cash flow effects of any change to superannuation taxation should be less critical.

The Government does not need to actually receive the tax payments from the superann- uation fund before it takes credit for them in its own books. It could record as an asset (ie a deferred tax benefit) all the taxation that relates to benefits already accrued, even if the tax was not payable to the Government until the benefit was payable.

The immediate impact on Government finances would be to increase borrowing requirements compared to the current situation. Provided the "deferred tax benefits" in superannuation funds increases faster than the cost of borrowing (which should be expected over time from balanced portfolios), the Government will receive revenues with a higher present value than if it received them immediately.

Under the tax model proposed, the short-term loss of revenue due to removal of contribution taxes will be compensated over time by increasing taxes on benefits and reductions in age pensions liabilities or costs.

Irrespective of the above comments, there will inevitably be some focus on short-term revenue impacts. One possible method to overcome the short term revenue shortfall of the proposed tax model is to replace all the existing taxes on contributions and investment income with a 5-10 year transition levy, commencing in, say, July 2000.

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The Taskforce has not had the facilities or data to undertake the detailed modelling required to assess the overall impact on revenue. This will obviously be required to develop the proposed taxation model further.

10 INTEGRATION OF PUBLIC & PRIVATE RETIREMENT SAVINGS

Although it is unlikely that many lower income earners would be able to save sufficient benefits to fully support their retirement, the system should benefit (rather than disadvantage) those that do manage to save. The only way to achieve this is if there is some ability for private savings to add to any publicly funded pension for people below a certain income level, rather than simply replacing the publicly funded pension.

This is clearly an important issue but is beyond the scope of this paper. Further work as to how better integration could be achieved should be encouraged and the Institute would be happy to contribute to discussions and work in this area.

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11 CONCLUSION

The Institute believes that a comprehensive review of the taxation of superannuation is required and that now is the time to do it. Fundamental change is required to:

§ retain the effectiveness of long-term superannuation savings and encourage voluntary superannuation saving in the context of the Government’s broader tax reform proposals; and

§ considerably reduce the significant complexities, anomalies and inefficiencies of the current superannuation taxation system.

This will result in improved confidence in the superannuation system, and a more stable and sustainable retirement incomes policy into the next century when the pressures of financing Australia’s aging population will increasingly be felt.

The Institute established a Simple Superannuation (Tax Reform) Taskforce, comprised of members of the Institute with experience in superannuation, to develop a Discussion Paper in this area. This Discussion Paper represents the preliminary views of the Taskforce. It has been prepared for initial discussion with Government, the superannuation industry and other interested parties, to obtain input from a wide range of sources on the overall approach prior to developing more detailed proposals. The contents of this Discussion Paper are not Institute policy.

The Discussion paper outlines the broad framework of one possible model for superannuation tax reform that has been developed by the Taskforce. Key features of the proposed model are summarised below.

§ The taxation of superannuation will be based on an expenditure tax model, however some level of tax on investment income will be retained to maintain Government revenue in the shorter term.

§ There will be no tax on superannuation contributions, removing both the basic 15% tax on deductible contributions and the 15% surcharge tax. All superannuation contributions up to an annual limit will be either deductible or receive a rebate.

§ All superannuation benefits accruing after the “tax changeover date” (above a tax-free threshold) will be taxed at marginal income tax rates when the benefit is paid. A transitional tax calculation – the “big bang” approach – will be used to protect the tax position of benefits accrued prior to the tax changeover date.

The main advantages of the proposed model include:

§ the overall tax system will be significantly simpler than the current system;

§ there will continue to be tax incentives for voluntary superannuation savings;

§ the complexity and anomalies of the current different tax treatment of different types of contributions for funded/unfunded, employees/employers/self-employed, pre-tax/post-tax etc will be removed or reduced;

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§ the “big bang” approach allows the 13 current different benefit tax components to be reduced to two – pre and post changeover – while protecting (to a large degree) accrued entitlements;

§ application of marginal tax on all benefits (i.e. lump sums and income streams) should encourage more individuals to take their entitlements as income streams;

§ it will also provide a growing source of tax revenue as the new tax system matures, during the same period as other revenue falls because of the aging of the population;

§ the caps on contributions and benefits will be more flexible than at present, catering for varying work patterns and contribution periods; and

§ importantly, the proposed model should allow transition from the current superannuation tax system to the new system without an unacceptable impact on Government tax revenue, or on individuals currently in the superannuation system.

Further, more detailed, modelling work is required to flesh out aspects of the model, as indicated in the Paper.

The Taskforce looks forward to healthy discussion and debate on the proposals put forward in this Paper.

12 REFERENCES

1. The Age Pension Our Unstable pillar Rice, Michael (1998) Sessional Paper - September 1998 Institute of Actuaries of Australia

2. Projections of Key Aggregates for Australia’s Aged Rothman, George P, (1998) Retirement Income Modelling Unit Sixth Annual Colloquium of Superannuation Researchers – July 1998 University of Melbourne

3. Blue Skies – A Blueprint for a National Retirement Income Policy Association of Superannuation Funds of Australia June 1998

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Expense Apportionment for Life Companies

Some Observations and Potential Profit Impacts

David Hotchkies FIAA, ASIA

1 Introduction

1.1 At present there is no actuarial or accounting standard dealing with the apportionment of expenses within a life insurance company, although the actuarial standards board currently have a draft which has been released for comment.

1.2 The Life Insurance Act regulates the apportionment of expenses, to the extent that it must be equitable and in accordance with generally accepted accounting principles (Section 80). In addition, the Appointed Actuary must provide written advice regarding the appropriateness of the apportionment, and the Approved Auditor must provide a report that the apportionment is equitable and in accordance with generally accepted accounting principles.

1.3 The profitability of the company will depend, inter alia, on how the expenses are apportioned, and then converted into policy liability assumptions.

1.4 In my experience, there is a significant degree of judgement involved in the basis of apportionment, and a relatively wide middle ground which would likely be considered to be equitable and in accordance with accounting principles. As a result, there can be variability in the reported profit of a life insurance entity simply due to the subjectivity of the expense apportionment.

1.5 The purpose of this paper is to explore some of the issues surrounding expense apportionment, particularly those where judgement is required, and discuss the potential profit impact of these outcomes.

1.6 At the time of updating this paper, a new life insurance accounting standard had only just been released, and the potential impacts and differences with the actuarial standard (AS1.01) had not been fully investigated. For the purpose of this paper, comments on profit concentrate on the impact due to AS1.01.

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2 Summary of AS1.01 Requirements

2.1 The requirements of AS1.01 that relate to the apportionment of expenses can be briefly summarised as:

Expenses need to be classified as either Acquisition, Maintenance or Investment Management.

Due to reporting requirements, expenses need to be apportioned at least down to Related Product Group level, but can be taken down further to product level for management purposes.

For use in the calculation of policy liabilities, assumptions are essentially required at policy level, for example $ pa per policy or % of premium.

Acquisition expense assumptions must be the actual acquisition expenses incurred in the reporting year.

Maintenance expenses must be on a `best estimate’ basis, and be sufficient to cover the expected cost of servicing each policy in the following year. Similarly for Investment Management expenses.

In deriving the above three expense assumptions, those expenses considered to be one off in nature, or non recurrent exceptional items, must be excluded. (These will then be a direct experience loss in the year incurred, net of tax.)

2.2 One interesting issue relating to the standard is the definition of Maintenance expenses. These are defined to include those expenses not covered by the other two categories, but the definition also states it includes the costs of administering the general operations of the company. Notwithstanding this latter point, there seems to be a general view in the industry that a portion of overhead type expenses can be deemed to be acquisition related, on the basis that a portion of the overheads of the company would effectively be ‘retrenched’ if the company was closed to new business.

2.3 In terms of the Life Insurance Act (Life Act), the apportionment of expenses needs to be equitable at Statutory Fund level, and class of business level (Ordinary versus Superannuation). However, as noted above, the reporting requirements effectively mean that the apportionment needs to take expenses down to Related Product Group level, at least.

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3 Expense Apportionment Bases

3.1 The method used to apportion expenses varies from company to company.

3.2 At one extreme, it might consist of a relatively rough end of year analysis and calculation simply to support Life Act and reporting requirements. At the other extreme, it could be a more sophisticated regular process as part of a larger management information regime, with the aim being to allocate the expenses as accurately as possible to the ultimate source, such as by function and product (and noting the Life Act requirements, to Acquisition, Maintenance and Investment categories). Ideally, it is considered that the latter situation would be the aim of management as part of an expense monitoring and control process.

3.3 In any event there is no correct basis on which to apportion many expenses, simply a number of possible bases that might be considered to produce a reasonable or equitable result. Examples of alternative bases might be policy transactions, weighted policy transactions, number of products, or some form of time survey. Even though each of these bases might be ‘equitable’, they are likely to produce different apportionments.

3.4 Also, the extent of apportionment required is dependent on the administrative structure and internal accounting systems and processes of the company - one with a large number of cost centres, each undertaking a discrete product function, would require less apportionment than one with fewer cost centres that cover a range of functions.

3.5 Set out below are the main groups of expenses incurred by a life company with discussion of some of the issues involved in the apportionment of these expenses.

3.6 Direct Policy Expenses

3.6.1 These are expenses that are directly incurred at the product level, such as sale commissions, stamp duty, medicals for risk policies, and investment management expenses.

3.6.2 By their nature, these expenses are easily allocated to a product, business function, and acquisition/maintenance categories, and assuming the accounting systems capture the information at the necessary level, do not need apportionment.

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3.7 Expenses of the Sales Process

3.7.1 These expenses might include a salaried sales force, distribution support costs (eg. training, investor strategies, compliance), telemarketing costs, direct mail costs, advertising, and brochures.

3.7.2 The apportionment of the costs of a salaried sales force down to product level can pose some interesting issues, such as whether to treat a portion of the time spent as a maintenance cost (that is maintaining the customer relationship), and if so how much. Usually, the sales force will have some focus on maintaining a client relationship post sale (akin to renewal commission for a commissioned sales force) but quantifying this is difficult. Also, there are likely to be differences in the amount of time spent selling the various products in the range, which ideally would be reflected in the apportionment. In the end these will be judgemental issues with no exact answer.

3.7.3 Distribution support costs are likely to be apportioned in line with commissions or the apportionment of the salaried sales force, although some products may be given a greater weighting in the apportionment basis than others depending on the activity undertaken.

3.7.4 Telemarketing costs would ideally be apportioned based on statistics automatically collected by the telephone system, using say time expended on each product, but the apportionment may need to use a proxy (product sales or rough time estimation) depending on what is available.

3.7.5 Direct mail costs should be able to be readily allocated to a product, assuming the expenditure relates to a targeted product based campaign.

3.7.6 Advertising expenses are unlikely to be straightforward. Some will relate directly to a product campaign (for example print based advertising) and be treated as acquisition, but others might be general brand advertising and therefore will have a maintenance component and also be difficult to break down to product level. Some advertising may also be treated as a one off expense if it was considered over and above normal advertising expenditure, such as sponsorship of a one off event.

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3.8 Policy Issue/Processing Expenses

3.8.1 The type of expenses envisaged here are those incurred in processing the new business of the company, such as the new business part of the customer service section, the related computer costs, the underwriting function, and some accounting time.

3.8.2 The extent of apportionment required for the customer service expenses will depend on the level of detail recorded in the accounting system of the company. It is likely that some form of time surveys or estimates will exist as part of the productivity monitoring of the section, and these can be used to drive the costs down to product level.

3.8.3 The apportionment of computing costs can be a significant item for some companies, particularly those running mainframe systems. Unfortunately the system may not give sufficient detail to allow an accurate apportionment to the drivers of the costs, so some proxies will likely be required. It may even be difficult to ascertain the fixed component versus the variable component of the charges in some cases, making the apportionment a very judgemental exercise.

3.9 Policy Maintenance Expenses

3.9.1 These expenses would include the remainder of the customer service section, again some related computing costs, probably some telemarketing expenses, some accounting time, and a portion of the distribution support costs. The apportionment of these has been discussed above.

3.10 Other Support Expenses

3.10.1 These might be described as general overheads, but consist of expenses related to the supporting functions of the company, such as General Manager, strategic planning, accounting/reporting, actuarial, personnel, company secretariat, compliance and marketing.

3.10.2 Due to the nature of these expenses, they are probably the most difficult to apportion. In many cases there will be no clear basis to relate the expenses to a product. Apportionment bases might be some combination of product statistics, or simply a survey of the relevant cost centre manager.

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3.10.3 In terms of the Life Insurance Act, the apportionment to statutory fund must be equitable. What is considered an `equitable’ apportionment basis for, say, the General Manager of distribution might include number of sales versus dollars of sales versus value added by the sales - each of these would produce a significantly different result.

3.10.4 As noted earlier, some part of these costs is usually considered to be a component of the acquisition activity of the company, however again the relevant component is very subjective.

3.11 For life insurance companies, the portion of the expenses that require apportionment (particularly those related to general overheads) is relatively high compared with other industries, which means the resulting expenses at statutory fund, product or function level is subject to a relatively wide margin of judgement.

4 Profitability Impacts

4.1 There are a number of apportionment outcomes which can have a significant impact on the reported profitability of a life entity or financial services group. Some of these are discussed briefly below.

4.2 Acquisition versus Maintenance Expenses

4.2.1 As noted earlier, there are certain expenses which have an acquisition component, but which are difficult or subjective to determine, such as some overhead type expenses. The acquisition versus maintenance split of expenses is fundamental to the calculation of policy liabilities, and hence the reported profit of the company.

4.2.2 The acquisition component of the expenses, to the extent that there is no fee income received at the outset to meet them, can effectively be spread into the future via the policy liability calculation. That is, they will not be a direct drain on profits at the outset, but will be a gradual drain on profits over time as the business runs off and the deferred expense is effectively written off.

4.2.3 On the other hand, the maintenance component of the expense will be a direct drain on the reported profit of the business in the year incurred.

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4.2.4 The combination of the above means that if more of the expenses for the year can be classified as acquisition as opposed to maintenance, there will be lower maintenance costs in the policy liability calculation, and in a present value sense a lower total expense result, and therefore higher profit margins established. That is, the reported profitability of the company will be higher at the outset.

4.2.5 If, however, over time the true maintenance costs exceed those assumed initially, this will reduce profitability over time. That is, for this scenario, profits will have been released earlier than should otherwise have been the case. Note that unless there are other impacts coming through, ultimate profitability is not impacted by this, rather it is simply a timing issue.

4.3 Apportionment to Participating versus Non Participating Classes

4.3.1 Participating classes typically have an 80/20 profit sharing between policyholders and shareholders, which includes the expenses incurred in the business. This implies that if more of the expenses can be apportioned to the participating business, instead of the non participating business, this will be more advantageous to shareholders and detrimental to participating policyholders, and vice versa.

4.3.2 Note, however, there are obviously constraints in terms of policyholder equity, but given previous comments regarding the room for judgement in the eventual apportionment, there is potential for significant difference between two otherwise identical companies.

4.4 Apportionment to Business in Loss Recognition

4.4.1 For any component of new business in loss recognition, any acquisition and maintenance expenses apportioned to that line will have a negative and direct impact on current year profit, to the extent that the present value of the future expenses exceeds the margins in the product. This can be a significant component of reported profitability, given the multiplier effect on one year of maintenance expenses in the present value calculation.

4.4.2 For existing business on which past losses have been recognised, any increase in expenses apportioned to the line will increase the future maintenance expense assumption. This will cause a direct reduction in current profits equal to the increased annual expense multiplied by a present value factor.

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A similar situation occurs for a reduction in expenses, providing an increase in profits, although the present value impact is limited to the extent of previous loss reversals.

4.5 Expression as Fixed versus Variable Expenses

4.5.1 In deriving assumptions for use in the policy liability calculation, all expenses are effectively viewed as variable. That is, the assumption of a dollar expense per policy inherently assumes the expense base increases or decreases directly with the number of policies. In practice this will not be the case, as there will be a certain component of the expense base which is fixed in nature, and needs to be spread over the larger or smaller number of policies in force.

4.5.2 This will potentially impact the timing of profit release, depending on the growth of the company and the stability of the fixed component of the expense base.

4.6 One-off Expenses under AS1.01

4.6.1 The calculation of policy liabilities under AS1.01 requires the actuary to exclude those expenses, both acquisition and maintenance related, that are considered to be one off in nature. Guidance is given in the attachment to the standard, which describes one off expenses as non recurrent exceptional items, and gives a couple of examples.

4.6.2 Any expenses so determined will be excluded from the policy liability calculation, and will effectively be an experience loss in the year incurred. The profit impact will depend on the tax rate (either a direct product tax rate or the GME rate) and whether any component is apportioned to participating classes of business.

4.7 Apportionment Across Entities

4.7.1 In most financial services groups these days, there are a number of legal entities, one of which might be a life insurance company. The management of the group has a certain amount of scope to allocate expenses around the group differently depending on the overall management aims. Some examples of the possible different aims of management might be to maximise the value added of the group, or to maximise the reported profitability of the group.

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4.7.2 The profit outcome from expenses differs between a life entity and a standard company.

4.7.3 In the latter, all expenses are usually deductible at the company tax rate, currently 36%. The net of tax expense (64%) is then a drain on net profits.

4.7.4 For a life entity, the profit impact will depend on whether the expense is acquisition or maintenance, whether the business is in loss recognition, the portion allocated to participating lines, and whether the expense item is directly deductible at the relevant tax rate for the business or is classed as a General Management Expense and deductible at the average GME rate.

4.7.5 In general, the acquisition component of the expense (the part not covered by an entry fee) can be effectively spread into the future via the policy liability calculation, with the result that it is not a drain on net profits at the outset, but will be a gradual drain on future profits as the business runs off.

4.7.6 The maintenance expense component will have a similar impact to expenses in a standard company, that is a drain on profits in the year incurred, although the tax deductibility will be at a different rate to a standard company.

4.7.7 Any business in loss recognition will result in a larger drain on profit in the year compared with a standard company, due to the need to capitalise future losses through the policy liability. Note, however, that these losses may be able to be reversed in future years if experience improves.

4.7.8 Overall, the net profit impact of the above issues will very much depend on the individual circumstances of the group in question. As an example, assuming some of the expenses are acquisition related, but most of the expenses relate to superannuation business, passing additional expenses through the life entity might provide a boost to current year profits due to the deferral of acquisition costs, but will reduce value over time due to the lower overall deductibility of expenses.

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4.8 Service Company

4.8.1 A service company arrangement is a particular example of the implementation of 4.7 above. That is, the life entity undertakes with another entity to pay certain amounts for certain services. The aim may be to focus part of the group on the control of expenses. Depending on the arrangement this may impact on the nature of the expense in some circumstances (from say a GME to a direct expense), which could change the tax deductibility and therefore impact profits. A service company may also be used to limit the expense losses in the life company, and avoid loss recognition.

5 Conclusion

5.1 The above discussion was aimed at providing some observations of the difficulties involved in the apportionment of expenses, and hopefully highlights the potential for a wide margin of judgement in many items.

5.2 The discussion was also aimed at highlighting the fact that different profit results are possible from a number of key expense apportionment decisions. Although policy liability reserving (of which expense apportionment is a part) only impacts the timing of release of profits, the apportionment of expenses to and within a life entity can also impact the quantum of ultimate profits.

5.3 Life company profitability is now in the spotlight more than ever before, with the life insurance sector of the Australian stock exchange growing and becoming more significant.

5.4 The work currently being done by the LIASB to develop a standard on the subject is a welcome step forward, although it is unlikely that the standard will be very detailed or prescriptive. It should at least indicate to the analysts and others the general framework being applied, and help those parties make informed judgements.

June 1998 Updated January 1999