20 May 2004

1. Corporate governance post-PenroseMichael CulliganPresented at a seminar of the Society of Actuaries in Ireland“Life Assurance – A brave new world” 20 May 2004

2. Penrose Report • Penrose Report into Equitable Life • Commissioned in August 2001 • To investigate and report into Equitable Life and identify any wider lessons for conduct/regulation of life assurance • Report delivered in March 2004 • Quite a wait…but well-received when eventually published • Critical of • management & directors • regulators • actuarial profession • 800 pages long!

3. Corporate governance (1) • System by which companies are directed and controlled • Boards of directors are responsible for the governance of their companies. • Shareholders’ role is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place • Responsibilities of the Board include • setting the company’s strategic aims • providing the leadership to put them into effect • supervising the management of the business; and, • reporting to shareholders on their stewardship. • The Board’s actions are subject to laws, regulations and the shareholders in general meeting.

4. Corporate governance (2) • So, it’s about how corporations are governed • “Does exactly what it say on the tin”! • Clear that the Board is placed squarely at the centre of things • This applies to all companies • But, life assurance companies are “special” • bring their own issues • can prove tricky to accommodate within generic framework • True of mutuals in particular • don’t intend to consider mutuals • Penrose absolutely scathing on their structures • UK Treasury has launched independent review • Will focus on shareholder-owned companies

5. Agenda • Current corporate governance structures • Issues raised by Penrose • Recent UK regulatory changes • Possible implications for the Irish regulatory regime • Conclusions

6. Irish corporate governance (1) • Every company has a Board of Directors • No rules re size (other than min. 2 people) • No rules re qualifications • No single statement of directors’ responsibilities • Normally, a mix of execs and non-execs • No distinction in law • No law governing the mix (but code for listed companies) • Clear rationale for appointing non-execs • Can make a valuable contribution to decision making process • Can help to formulate strategy • Most importantly, bring an element of independence and objectivity

7. Irish corporate governance (2) • For life offices, IFSRA have power of veto over Board appointments • Board nominations subject to IFSRA approval • “Fit and proper” test • For new companies, approval of initial Board is part of overall approval process • Subsequent nominations subject to approval as above • Allows IFSRA to influence: • make-up of Board • skills, knowledge and experience of Board as a whole • balance between execs and non-execs • Influence may be more theoretical than practical

8. Irish corporate governance (3) • Generally held that Board is responsible for all aspects of the company’s business • IAIS core principle on corporate governance: • “…the board is the focal point…” • ”…it is ultimately accountable and responsible…” • IFSRA also clear about role of the Board: • “…ultimate responsibility lies with the Board and senior management”

9. Irish corporate governance (4) • Position complicated by the statutory Appointed Actuary role • Appointed Actuary has Board as his/her principal • but also has a duty to IFSRA and to policyholders • Appointed Actuary’s annual investigation not subject to Board sign-off • Also, not subject to audit • Means that almost all of the liabilities side of the balance sheet (in IFSRA Returns) is dictated by one individual

10. Agenda • Current corporate governance structures • Issues raised by Penrose • Recent UK regulatory changes • Possible implications for the Irish regulatory regime • Conclusions

11. Penrose – introduction • UK arrangements were broadly similar to those outlined for Ireland • formed backdrop to Penrose’s report • Will examine his conclusions in relation to corporate governance • His report dealt with one company, but many findings have more general application • Report covered a range of governance issues • role of directors • role of audit committee • role of actuaries etc • Will concentrate on role of directors

12. Penrose – on directors (1) • Composition of Equitable Board • gradual shift from non-execs to execs • Penrose clearly viewed strongnon-exec presence as desirable • Also clearly viewed Board’s as having ultimate responsibility for all matters • However, problems with this in practice • skills and experience of actuarial matters? • able to make independent judgements on actuarial issues?

13. Penrose – on directors (2) Penrose saw four main problems: • non-execs “ill-equipped to manage a life office by training or expertise” • directors “totally dependent on actuarial advice” • directors unable to “assess the advice…and challenge the actuaries” • actuaries on the Board inhibited by professional guidance • Criticisms cover Board’s oversight of all actuarial work

14. Penrose – on directors (3) • Not everyone agreed with his conclusions • representations from some non-execs • felt that his criticisms set unrealistic standards for non-execs • But, Penrose did not accept this • difference between ability to do technical actuarial calculations and ability to understand the results of actuarial work • Also, further representations from some non-execs • “absurd” to expect non-execs to challenge actuaries when auditors and regulators had not • Penrose’s response: • to accept this line of argument would have profound significance for the governance of life offices

15. Summary of current position In summary: • Regulators want to emphasise primacy of Board • But, practical problems with ability of Boards to oversee the actuarial function independently • And, non-executives may feel it unreasonablefor them to understand and take responsibilityfor actuarial matters • How do we square this circle?

16. Possible options Two possible options: • regulator ensures that Boards have requisite actuarial skills • regulator makes clear to Boards that they are ultimately responsible and should take necessary actuarial advice • Potentially a third option • regulator bypasses the Board and takes direct responsibility for overseeing actuarial function • not realistic • Regulator unlikely to go for first option • Second option provides potential way forward

17. Agenda • Current corporate governance structures • Issues raised by Penrose • Recent UK regulatory changes • Possible implications for the Irish regulatory regime • Conclusions

18. Developments in the UK (1) • Fundamental overhaul of regulation by FSA • CP167 on governance issues • final proposals published in June 2003 (after consultation) • Driven/influenced by with-profits issues • not going to focus on with-profits issues • focus on issues affecting all insurers • First main change is the removal of the Appointed Actuary role • New role – “Actuarial Function Holder” (AFH) – created instead • AFH’s role is to advise directors on actuarial issues • can be either employee or external consultant • may a director, but not be CEO or Chairman

19. Developments in the UK (2) • Directors are responsible for the methods and assumptions • AFH’s role is an advisory one • Returns to FSA will include a cert. from the Board re value of long-term liabilities • Other major change is extension of audit • long-term liabilities now to be subject to review by actuary advising the auditors (“Reviewing Actuary”) • Peer review of AFH? • In summary, new regime brings fundamental change • Appointed Actuary’s sole responsibility removed

20. UK developments vs. Penrose • How well do these measures address Penrose’s criticisms? • Penrose less concerned with detail of new proposals than with overall result • Key question for him was how to ensure “independent and effective actuarial audit” • New UK system achieves this (through auditors’ Reviewing Actuary) • But, is change from AA to AFH really necessary? • Would peer review of the AFH really addmuch value?

21. Agenda • Current corporate governance structures • Issues raised by Penrose • Recent UK regulatory changes • Possible implications for the Irish regulatory regime • Conclusions

22. Implications for Ireland? • Historically close ties with UK • industry • actuarial profession • Given scale and high-profile nature of UK changes, likely to put it on the agenda in Ireland • Society of Actuaries in Ireland (SAI) conscious of this • Society has developed a set of proposals for discussion with IFSRA • Proposals intended to address criticisms of existing regime • Echo broad thrust of UK changes, but differ in certain key respects

23. SAI’s proposals (1) • Position of Appointed Actuary to be retained • AA to retain responsibility for deciding on methodology and assumptions • AA to continue to sign off as at present • Scope of directors’ certificate to IFSRA to be extended • to include certifying the value of long-term liabilities • Wording of auditors’ certificate to IFSRA to be changed • remove reliance on AA’s certificate • matter for auditors to decide amount and source of actuarial advice they need

24. SAI’s proposals (2) • Proposals have much to recommend them • Clearly extend responsibility for signing off on long-term liabilities to Board and to auditors • But, are not unnecessarily prescriptive about nature or amount of actuarial advice each should take • Directors free to engage independent actuarial advice if desired • Auditors would almost certainly take some advice, but this is left to them to decide • Less prescription is important practical point • UK approach would bring significant extra cost for little extra benefit? • Take example of purely unit-linked office • Proposals form solid base for dialogue withIFSRA

25. Agenda • Current corporate governance structures • Issues raised by Penrose • Recent UK regulatory changes • Possible implications for the Irish regulatory regime • Conclusions

26. Summary and conclusions • Current corporate governance structures increasingly seen as problematic • But, considerable practical difficulties with reconciling primacy of Board with actuarial expertise of directors • Question is how to square this circle • Conclusion is that Boards must be expected to take advice on actuarial matters (whether internally or externally) • UK proposals address this issue • SAI’s proposals also address this issue, but in a slightly different (and less prescriptive) way • Current regime seems destined to change – let’s see what happens!

27. Corporate governance post-PenroseMichael CulliganPresented at a seminar of the Society of Actuaries in Ireland“Life Assurance – A brave new world” 20 May 2004