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The Actuary The magazine of the Institute & Faculty of Actuaries
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John Greenway MP

A collective responsibility

» If the Northern Rock crisis tells us anything, it’s that the different elements that make up a major institution can’t work in professional silos «

I used to think that the role of the actuary was a pretty thankless task; though always well paid. If the firm makes losses, it’s the fault of the actuaries for getting their sums wrong when setting premiums or assessing risk. Success and profits on the other hand are always entirely due to the brilliance of the folk in sales and marketing.

If the Northern Rock crisis tells us anything, it’s that the different elements that make up a major financial institution can’t work in professional silos. What matters is that each area of expertise contributes towards a collective responsibility for the management and supervision of the business. In this respect, the people who ‘crunch the numbers’ need to be given equal, if not greater prominence in determining a firm’s direction than the people in the front office, who are gungho for new business at any price.

It’s often said that hindsight is a wonderful thing. If only we’d known, we would have done things so differently. That’s how it is with Northern Rock. It was just the same with Equitable Life and it will be the same again in the future if much greater importance is not given to profiling the potential risks and shocks faced by major financial institutions. As with Northern Rock, it will almost certainly be the shareholders who lose their money if things go wrong.

I’m sure the marketing gurus in Northern Rock were preening themselves over their achievement of securing 20% of new mortgage business market share for the first six months of 2007. We would all have felt the same way but I can’t help thinking that somebody within the organisation must have known that the well from which the new lending was sourced might one day run dry.

On top of this, the entire banking sector has known for ages that some substantial losses in the sub-prime mortgage market in the US were inevitable. Only the scale of loss was in doubt. It’s suggested that Northern Rock undertook stresstesting of the inter-bank market up to a 75% reduction in liquidity. I bet that they now wish they had stress-tested to 100%. Other mortgage lenders should recognise their own potential vulnerability in this respect.

Actuaries themselves know that the ability to stress-test to a level that would equate to complete disaster is within their competence and skill. If we want to avoid these kinds of shocks in the future then we must empower the actuaries to ensure that all boards of directors are fully acquainted with the doomsday scenario that could be around the corner. At least then marketing plans would be based on all the facts and possibilities and not merely a partial assessment.

It’s also asking far too much to expect nonexecutive directors, however well qualified, to anticipate disaster on the scale of Northern Rock, though increasingly they should insist that firms are forced to think the unthinkable and plan accordingly. To achieve this, however, will require a substantial change in culture within major financial institutions. Actuaries should not be afraid to speak their minds about the risks being taken within the boardroom. On the contrary, they should be encouraged to make sure that directors are fully aware of the entire risk profile of the business.

The Actuarial Profession has a role to play here. It should first press the argument for total stress-testing. Secondly, it should seek to protect its members from criticism for having the temerity to query the viability of the marketing and growth plans of the financial institutions who employ them. Hopefully, sooner rather than later, the current financial crisis will abate and market conditions improve. It’s then that the waters will be at their most dangerous. There will be both boardroom and shareholder pressure to recoup quickly the lost business resulting from the current credit squeeze.

The only way to ensure that any gains are not short-lived is to strengthen stress-testing and build effective risk management plans. Actuaries have the skills, experience and expertise to fulfil this critical role. Better that shareholders rather than regulators insist that this is done.

John Greenway MP is President of the Institute of Insurance Brokers and Chairman of the Parliamentary All Party Insurance & Financial Services Group