How PEOs Should Use Actuaries

As touched upon in a previous claims article, the actuarial function is one of the least visible or straightforward to understand. And yet within this space are some of the most impactful connections to a PEO’s direct costs and thus sales competitiveness. This article will attempt to explain the following:

• What an actuary is
• How the actuary performs his/her analysis
• How the actuary’s work product is tied to sales
• How to utilize an actuary
• How to find an actuary

What is an “actuary”?

An actuary is someone who is trained in mathematics, statistics, economics, finance, legal, and other fields in order to quantify risk. Actuaries are split along major industry lines, such as property & casualty, health & life, and retirement. There are two major credentialing bodies that cover different industries –the Casualty Actuarial Society (CAS) for property and casualty (P&C) and the Society of Actuaries (SOA) for the remaining three industries. Because of the different needs of each industry, the CAS and SOA have different educational requirements. Both associations have a gauntlet of exams from which actuarial candidates must pass in order to be credentialed, and those exams differ in content, number, and form. It takes on average seven years for an actuary to be credentialed.

Actuarial Analysis

Actuaries are usually involved in helping estimate future costs for risks that have uncertain outcomes. For a PEO, the main areas in which actuaries are involved are with workers’ compensation and health benefits insurance.

The approach to estimate both workers’ compensation liabilities and health benefits claims costs are theoretically similar. In both, the actuary examines the claims experience to date, compares the claims experience to an underlying exposure base to help normalize volume growth, estimates future development according to historical experience (where available), and incorporates other judgmental impacts like internal and external changes and trends. While the actuary learns about rocket science-level concepts in his/her credentialing process, the analysis of workers’ compensation and health benefits claims mainly utilizes good ol’ fashioned arithmetic and skilled judgments.

While this type of analysis is helpful for policies that are already active, it is even more so for prospective years, whereby an actuary’s forecast can serve as a benchmark for both the PEO and an insurance carrier assuming risk to begin premium and coverage negotiations. The well-prepared PEO will perform their own analysis to determine their own target figure, with some even employing in-house actuaries to assist in such calculations. Assuming a $20M premium, the potential to negotiate 5%-10% savings is well worth the expense of consulting fees and internal employee time.

Actuaries Connection to Sales

It is this hypothetical 10% delta that serves to illustrate the connection to sales. It is not uncommon for the insurer’s premium request to parallel the actuarial estimate in both direction and magnitude. Should the actuary determine that the upcoming year’s costs will be 10% higher than the current in-force year, the insurer may seek a 10% increase in premium. If the industry is seeing an overall 5% increase in premiums, your firm is at a 5% price disadvantage before one salesperson gets in front of a prospect. On the flip side, if the actuary determines that the next year’s costs will be largely flat from the current year, and the industry is seeing a 5% increase in premiums, then your firm will be at a 5% price advantage. Obviously, the sales process and closing a prospective sale is much more complicated than what I’ve just described, but the platform for success (or failure) can still be significantly affected by the actuarial analysis.

How to Utilize an Actuary

While 10% might seem far-fetched, it’s not unheard of. Can you imagine negotiating the insurance coverage thinking everything was good, only to find out years later that you overpaid premiums by 10%? More than likely, you passed some of that overpayment on your sales prospects and existing client base. How might you feel if you realize that insurance coverage resulted in materially lower sales volume and/or materially lower client retention?

This naturally presents one of the first ways to utilize an actuary – to perform the direct analysis of estimating future claims costs. PEOs commonly engage an actuary within a consulting firm to perform this type of analysis.

Another way to utilize an actuary is to support the primary actuary performing the analysis. Because the analysis can be extremely complicated, two similarly experienced actuaries may come to materially different conclusions. It can be extremely helpful for a PEO to either engage another consulting firm or hire an actuary internally to review the primary actuary’s work.

Last but not least, a PEO can utilize actuaries for their variety of other skill sets that are well suited for PEO business issues. This includes sales strategy, M&A due diligence, predictive modeling and analytics, financial forecasting, and more.

How to Find an Actuary

With as many services as exist for an actuary to provide a PEO, the question arises as to how to find and select an actuary. Below are a few high level suggestions, looking first at the individual and panning out to the organization employing the individual.

Credentials — Both of the CAS and the SOA have two levels of credentialing for their actuaries – the first is the Associate, which shows the actuary has passed most but not all of the exams, and the second is Fellow, which shows the passing of all exams. The exams just for future Fellows are often specific to particular industries and potentially most useful for a PEO. All else equal, lean to a Fellow over an Associate.

PEO Experience — For credentialed actuaries, the next most important – and arguably the most important overall – is for the actuary to understand PEOs. Note that this is not necessarily the same thing as utilizing an actuarial consulting firm that is heavily involved in the industry. Each consulting firm has many consultants, each of whom has varying depth and experience with PEOs. It is imperative that the consultant you select understands what a PEO is, what your goals are, what your value proposition is, and how that differentiates you not only from other PEOs but also other non-PEO clients. I have heard from multiple PEO CEOs and executives that they have to continually remind their consultants what a PEO is and why they differ from the consultant’s other workers’ compensation or health benefits clients.

Unlike a credential, understanding is not as easily discerned. I recommend having conversations with prospective actuaries, and ask questions about how they perform their analysis and how you being a PEO might impact those judgments and methods. If they give you wishy-washy consultant-speak that suggests the understanding is not there, look elsewhere. Request case studies and/or references (where permissible) that can give greater comfort that the consultant is not overstating his/her PEO experience.

Task Experience — Just as you would want to send your sick child to see a pediatrician, so should you engage an actuary that is experienced and trained to perform the tasks you so desire. Even beyond industry delineations, actuaries are often separated by more granular specializations. Do not assume that the same actuary who is performing your reserving work is also the best actuary (or actuarial firm) to revise your pricing strategy.

Firm Support — Whether it is to support your actuary in discussing challenging situations, providing technical and peer reviews, or providing further breadth of services should your particular actuary not be broadly experienced enough, the firm that employs your actuary is very important. While looking for brand names (as much as they exist in the actuarial community) is helpful, look more at the individuals who will support your actuary. Request their names and their experiences, and don’t settle for broad claims. Request references that show they have collaborated as a firm to effectively serve various needs.  Demand expertise in each area that you want to use your actuary.

Wrap Up

The actuarial function, as somewhat murky and mysterious as it is, has a major role in multiple areas of a PEO’s operations. While actuaries differ by industry and expertise, finding the right actuary for your PEO can be made much easier with some simple conversations and your own due diligence.

Take-Away Questions 

1. Does your actuary make an attempt to help leadership understand its analysis?
2. Have you ever had to explain to a consultant what a PEO is after an engagement had begun?
3. How did your company decide to engage your current actuary and actuarial firm?