Actuarial accounting is a statistics based accounting method primarily used in the insurance industry, and for that reason is often referred to as insurance accounting. Actuarial accounting methods are also commonly used in the management of government regulated pension plans, the creation of financial products and the assessment of the risks associated with financial investments.
Actuarial accountants are statisticians who use formulas applied to statistical information in accordance with statutory and generally accepted accounting principals to assess the probability of a specific risk event taking place within a given time period. Essentially, actuarial accountants gather and analyze data factors, including financial and social data, and make recommendations that will allow a corporation, government entity or insurance agency to maintain a solid financial standing.
Actuarial Accounting in the Insurance Industry
Actuarial findings are used by the insurance industry for two primary purposes: To set the cost of insurance policy premiums and to ensure that insurance companies maintain adequate loss reserves with which to pay benefits.
When setting the price of policy premiums, actuarial accounting is crucial to the underwriting process. When drivers purchase car insurance policies, the insurance company will examine a number of factors to determine the rate drivers will pay for their policies. Among these factors are vehicle type, age, years the driver has been licensed, place of residence, average daily commuting distance, driving record, etc. Although by themselves, these factors don’t mean much, taken together they paint a statistical picture of an individual driver. Risk level is assessed based on the total statistical average taken from this data to determine the likelihood of theft or accident in determining the cost of a person’s insurance premium. Each one of these factors implies a certain level of risk based on statistical averages. In this way, actuarial accounting gives a statistical illustration of how a young driver who has just been licensed and drives a powerful car is much more likely to be issued tickets for moving violations or become involved in accidents than is an experienced, middle-aged mini-van driver.
Insurance companies are required to set aside a certain amount of money in loss reserves to be available to policyholders or beneficiaries to cover liabilities in the event that benefits need to be paid. Federal regulations require these loss reserves to be maintained at an adequate level to be sure policyholders or beneficiaries will have funds available to them when benefits are due. These regulations also see to it that insurance companies remain fully solvent. Rather than tying up huge sums of operating cash flow through gross overestimates, insurance companies use their actuaries to help arrive at an accurate estimate of what their yearly liabilities are likely to be. Using the same data that is collected in determining the level of risk for individual policyholders, actuaries can arrive at an accumulative total dollar amount likely to be paid out in benefits each year, which allows them to maintain an adequate loss reserve to cover these liabilities.
Actuarial Accounting in Pension Plans
The purpose of a pension plan to is set aside funds that appreciate over time and provide the plan holder with a moderate to substantial compensation package that can be accessed upon retirement. The federal Social Security program works in the same way. The goal of an actuarial accountant is to determine how much funding these programs will need to ensure the plans have enough funds to cover their future liabilities as they become due.
Recently, we have heard of pension plan failures at large corporations such as United Airlines and Delta Airways. Many analysts are predicting that other major corporate entities, such as General Motors, have pension plans in place that are not sustainable. Currently, GM pays out $1,600 in ‘legacy costs’ on each vehicle they produce to pay for their employee pension plan program. There is also speculation among actuaries that the U.S. Social Security program will not be able to continue paying out benefits under the current compensation model. As more baby boomers retire, the ratio of liabilities to current funds will become grossly disproportionate.
Actuarial Accounting in Financial Service Industry Risk Assessment
Actuarial accountants also play an important role in the financial services industry by assessing the risks involved with investments and financial products. Actuarial accountants use statistical information and actuarial tables to estimate the potential rate of return on an investment. Some investments carry a high rate of risk, such as stocks and securities, but also carry a high return potential. Other investments such as government-backed bonds are considered to be less risky, but also offer a lower potential return on investment. An actuarial accountant works to determine the potential risk involved with a specific financial product or investment, and whether the company can absorb that risk.
The importance of actuarial analysis was highlighted during the 2005 financial scandal that involved the American International Group (AIG). In 2005, the Securities and Exchange Commission (SEC), the New York Attorney General’s Office and the U.S. Department of Justice began investigating the insurance giant based on suspicion of fraudulent financial activity.
The crux of the scandal involved leveraging risk well beyond adequate loss reserves. The corporation had been using alternative accounting procedures to evaluate their financial portfolio despite their external auditing firm’s recommendations. The actual level of risk that the company exposed themselves to may have been revealed through the use of statutory accounting practices (SAP) had an actuarial analysis of risk been performed with all the data necessary to arrive at a fully informed conclusion.
The investigation concluded with several of the corporation’s officers and executives resigning or being removed from their positions, including the company’s CEO, Hank Greenberg. Several executives were indicted and ultimately convicted of criminal charges and the corporation was fined $1.6 billion dollars.
Actuarial tables are tools comprised of statistical data that is frequently updated. There are many different types of actuarial tables that serve different purposes, from ascertaining the value of annuities each year, to determining the number of deaths within a given sample. An insurance company selling products that include life insurance policies uses a type of actuarial table called a mortality table.
The mortality table below is provided as a simple illustration of one of the many different types of actuarial tables used. This table includes factors that illustrate the number of deaths per million for men and women respectively based on age. This table illustrates that when looking at a sample of one million 91 year old men, statistically 179,849 will die before reaching age 92.
There are a number of regulatory agencies that actuaries are familiar with, as they establish the regulations and policies that affect the insurance industry and other business organizations.
National Association of Insurance Commissioners: This regulatory organization works to assist insurance regulators in each state by providing guidance and other tools to help them oversee insurance companies. This organization is also responsible for publishing the Accounting Practices and Procedures Manual, which outlines specific rules, regulations, and statutory accounting principles with which all insurance companies must comply.
Governmental Accounting Standards Board (GASB): This is an independent organization that establishes accounting standards, procedures and financial reporting requirements for state and local governments. The Financial Accounting Standards Board (FASB) governs this organization. They are also responsible for establishing the generally accepted accounting principles (GAAP) that are used universally within accounting.
Although this organization does not have the power to enforce these accounting standards on their own, some states have enacted laws requiring the use of such accounting principles by state agencies. GAAP principles would most likely affect pension plans and other employee benefit plans, which are governed by the Employee Retirement Income Security Act (ERISA). ERISA is a federal law, which sets forth specific procedures and standards for pension plans and employee benefits offered in the private sector.
Federal Accounting Standards Advisory Board: This organization establishes accounting standards for federal government agencies. It is similar to the GASB with the exception that it deals with federal level agencies as opposed to state and local government.
There are several actuarial certification options offered through a number of different certifying bodies, many of which are highly specialized and specific to particular industries. Despite the variation in certificate type, they often fall within two distinct tiers:
Associateship Designations are considered to be the base level designation in the actuarial profession. In order to achieve associateship, candidates must complete a series of preliminary exams on probabilities, financial mathematics, financial economics, life contingencies, and construction and evaluation of actuarial models. Candidates for associateship designations must also successfully complete college level coursework in economics, corporate finance, and applied statistical methods. Two major organizations offer specialized associate level designations:
- Actuaries who specialize in property and casualty insurance would pursue the Associate of the Casualty Actuary Society (ACAS) certification through the Casualty Actuarial Society.
- Actuaries specializing in life, health, pensions, finance or investments would pursue the Associate of the Society of Actuaries (ASA) credential through the Society of Actuaries.
Fellowship Designation tracks are pursued after an actuary has had a few years of work experience. This designation allows candidates to choose highly specialized credentials based on their experience specific to group health plans, pensions, life insurance, annuities, corporate finance or investments. In order to obtain fellowship designations candidates are required take seminar courses in their selected field of specialization and successfully pass a series of exams. Each specialty track has its own specific course and testing requirements. Fellowship designations are offered by three major certifying agencies:
- Fellow of the Casualty Actuarial Society (FCAS) is conferred through the Casualty Actuarial Society
- Fellow of the Society of Actuaries (FSA) is conferred through the Society of Actuaries
- Fellow of the Society of Pension Actuaries (FSPA) is conferred through the American Society of Pension Professionals Actuaries
IRS Enrolled Actuary | Employee Retirement Income Security Act (ERISA)
The Internal Revenue Service offers the enrolled actuary designation to highly qualified applicants. Enrolled actuaries hold the unique distinction of being associated with a federal body that requires them to perform actuarial services in accordance with the federal Employee Retirement Income Security Act of 1974 (ERISA). ERISA is a federal law that sets forth specific requirements and procedures for handling employee pension plans so as to safeguard retirement benefits against mismanagement.
The process for becoming an enrolled actuary involves holding a bachelor’s degree specific to actuarial mathematics or statistics from an accredited institution as well as satisfying experiential requirements of no less than 36 months of pension plan experience, or 60 months total actuarial experience including 18 months of pension plan experience. Candidates for the enrolled actuary designation must also demonstrate knowledge of actuarial mathematics and methodology through the completion of the Joint Board exam administered by the Society of Actuaries
Education and Degree Options
According to the United States Department of Labor, Bureau of Labor Statistics, most jobs in the area of insurance and actuarial accounting generally call for a bachelor’s degree plus professional certification through one of the major professional actuary organizations. The following are the degrees and supporting certification typically held by actuaries:
- Bachelor’s degree in accounting, mathematics, statistics, actuarial science, business, finance or economics, followed by a professional actuarial certification
- MBA or master’s in mathematics, statistics, actuarial science, accounting, finance economics followed by a professional actuarial certification
Individuals seeking a career in actuarial accounting may also wish to consider becoming a Certified Public Accountant in addition to their associateship or fellowship designation. While obtaining a CPA is not a requirement for obtaining employment in the field of actuarial accounting, it continues to be the best recognized and most well respected credential in accounting.
As of 2020, there were approximately 27,700 actuarial accountants employed throughout the United States, according to the U.S. Department of Labor, Bureau of Labor Statistics. Approximately 71 percent of them worked in the insurance and finance industry, while the other 30 percent were either self-employed or on the payrolls with financial, consulting and government organizations.
The 2020 BLS report shows actuarial accountants earning a median salary of $111,030, while the top ten percent earned more than $196,010.
Interestingly, the highest salaries that year were among actuaries working in business, professional, labor and political organizations where they earned an average of $173,070. Nest were those working in credit intermediation earning an average of $154,250, followed by computer systems design firms at $149,140 and financial services at $139,100. Just behind private industry were Federally employed actuaries in the executive branch earning an average of $136,140.
May 2020 U.S. Bureau of Labor Statistics salary and labor market information for Actuaries is based on national data, not school-specific information. Conditions in your area may vary. Data accessed April 2021.