Ian Laughlin

Two actuaries have developed a skill and capability checklist to help Australian bank and insurance companies appoint Directors with the right qualifications to prevent misconduct uncovered by the Hayne Royal Commission.

Barry Rafe, a former Actuaries Institute President and experienced director and board advisor, and Ian Laughlin, a former APRA deputy chair, said their Dialogue^[1] paper, The Special Needs of Financial Services Boards, provides a practical toolkit for Board appointments, specifically aimed at bank and insurance companies.

The Hayne Royal Commission revealed misconduct in the sector that resulted in the resignation of chief executives, Board members and Chairs, along with about $10 billion in payments to right wrongs. It highlighted acute failures. The Dialogue paper asks whether Directors enabled that behaviour because they failed to understand their businesses.

Financial service businesses are extremely complex, with long-term contractual obligations to customers, significant information asymmetry, short-term profit pressures and frequently, a third party intermediary between the business and customer. Customers often have a large financial exposure to these institutions.

And while there has been substantial change in the membership of financial services company Boards since Royal Commissioner Kenneth Hayne handed down his findings in February 2019, there is evidence that the misconduct identified reflects Directors’ lack of knowledge, “clearly reflecting systemic gaps between the essential Board skills and capabilities, and Board appointments”, the paper states.

Identifying those gaps is essential to ensuring mistakes are not repeated. The Dialogue provides an aid to help financial services Boards recruit the correct mix of Directors. It states that assessment for a new Board member should be considered within a set of clearly defined criteria, and “if not, why not?”

Using the aid would likely lead to a Board with at least three Directors with deep operational experience, earned working in the financial services sector. These Directors should have handson experience to help guide them through the trade-offs management routinely make when running a bank or insurance company.

Boards should include Directors from other sectors; the Chair should be a former CEO; and those with ‘golden’ or unblemished careers may not be as valuable to the Board as those who have survived an insolvency or major crisis.

“Risk aversion to Director selection may result in Boards lacking Directors with foresight for emerging challenges and a lack of experience to be able to effectively recognise and manage them,” the paper states.

Directors must understand broader community expectations and provide ethical leadership.

Mr Rafe said Boards are not made overnight. “They evolve over time, as Directors come and go.” To continue to remain effective, “Boards therefore need to have a long-term plan involving Director assessment and skills/capabilities matching for the changing needs of the organisation.”

Financial services profits come from leveraging other people’s money, remuneration is high and linked to profits, and issues may take years to emerge clearly. Therefore, the Board must closely consider management priorities, decisions, behaviour, and culture.

“Boards are obliged to act in the best interests of the company but in financial services there are other legal and moral obligations to protect the interests of customers,” Mr Laughlin said. “The skills and capabilities of the Board and individual Directors can have profound implications for conduct and culture.” Key capabilities include understanding customer outcomes. Boards must be collegial within a high-trust environment that allows individuals to contest key information. Risk appetite and management must be well understood from the customer’s perspective.

Elayne Grace, Actuaries Institute Chief Executive, said a growing number of actuaries sit on Australian and international company Boards. They bring skills that include objectivity, independence, and good governance, which are part of the profession’s rigorous training.

President Jefferson Gibbs noted that actuaries have strong analytical training and bring those skills to Boards and senior executive ranks. “As businesses become more complex, which is a given, actuarial skills and highly ethical behaviour must come to the fore in managing some of our biggest and most complex corporations.”

Read The Special Needs of Financial Services Boards.

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[1] The Dialogue is a series of papers written by actuaries and published by the Actuaries Institute. The papers aim to stimulate discussion on important, emerging issues. Opinions expressed in this publication are the opinions of the paper’s author and do not necessarily represent those of either the Institute of Actuaries of Australia (the ‘Institute’), its members, directors, officers, employees, agents, or that of the employers of the authors.

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Elayne Grace

Australian company directors should be doing more to ensure their executives stick to the ethical values espoused at Board level if they want to avoid a repeat of the poor behaviours exposed at the Hayne Royal Commission.

In a Dialogue paper^[1], published by the Actuaries Institute but representing the views of the author, Barry Rafe identifies a serious flaw in Board governance practices in large complex organisations.

“Boards need to espouse values that are realistic, can be put into practice, and be monitored by directors, but as important, Boards need to be aware of the potentially different values which drive the daily and strategic activities of their executive teams,” Mr Rafe said.

Mr Rafe is a former President of the Actuaries Institute and an expert on governance. His paper, CEOs Say One Thing and Do Another: An insight Provided by a Royal Commission, can be accessed here.

“The Hayne Royal Commission, which investigated misconduct at the most senior levels in the Australian financial services sector, provided important insights into the justifications made for decisions which organisations themselves admitted breached required standards and conduct which certainly fell short of community standards and expectations,” Mr Rafe said.

“A key finding of my research is that while Boards of directors appear to act ethically, routine actions of CEOs and other executives may not reflect their organisation’s espoused values,” he said.

“This finding is important because it appears that Board engagement in espoused values is a necessary but not sufficient condition to prevent organisational misbehaviour.”

In his study, which focussed on two case studies from the Royal Commission dealing with activities at Westpac and Commonwealth Bank, Mr Rafe said there was a disconnect between the values of the organisation and the routine actions taken by the CEOs and the senior executive team.

He said misconduct and poor behaviour could not be blamed on ‘weak’ Boards, but on the CEO and executive team’s focus on ‘maximising profit within the bounds of the law’.

Among his recommendations, Mr Rafe said Boards need to:

• establish espoused values that can be operationalised by the senior executive team;
• routinely review decisions made by the senior executive team and determine if they align with espoused values; plus
• design remuneration systems that penalise senior executives for practising values that do not align with the organisation’s values.

The stated values set by the Board “need to be more than just for ‘branding’ and ‘marketing’ purposes, they need to set the tone for how decisions are made”, the paper states. It adds “Executives need to be rewarded for making decisions in line with espoused values.”

“Senior executives need to assess their own behaviours to see if there is a gap between their values and those practised on a daily basis, with any discrepancies being raised with the Board,” Mr Rafe said.

Elayne Grace, Actuaries Institute Chief Executive, noted the growing number of actuaries in non-executive roles and that this stems from the reputation of actuaries for objectivity, independence, and financial acumen.

Jefferson Gibbs, President of the Actuaries Institute, noted the number of actuaries supporting financial service companies in responding to the findings of the Royal Commission. In his recent address he said, “Risk management is an area of significant growth for actuaries and we see more and more ‘risk actuaries’ taking roles in aspects of governance and compliance.” He noted the timeliness and relevance of Mr Rafe’s paper as the profession does its part to contribute in this important area.

Barry Rafe is Principal, Rafe Consulting, and former President of The Actuaries Institute. He is a Fellow of the Actuaries Institute and a Fellow of the Australian Institute of Company Directors. Barry presents courses on board governance, finance and strategy for the Australian Institute of Company Directors and is available for interview.

Read the report: CEOs Say One Thing and Do Another: An insight Provided by a Royal Commission. This is the first in a series of papers dealing with important issues in governance, targeted particularly at non-executive directors and C-suite executives.

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[1] The Dialogue is a series of papers written by actuaries and published by the Actuaries Institute. The papers aim to stimulate discussion on important, emerging issues. Opinions expressed in this publication are the opinions of the paper’s author and do not necessarily represent those of either the Institute of Actuaries of Australia (the ‘Institute’), its members, directors, officers, employees, agents, or that of the employers of the authors.

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Tim Andrews

The Actuaries Institute has launched a climate index, an objective measure of extreme weather conditions and changes to sea levels, to help policymakers and Australia’s businesses assess how the frequency of weather extremes is changing over time.

The Australian Actuaries Climate Index, which includes a number of sub-indices, tracks changes in the frequency of extreme high and low temperatures, heavy precipitation, dry days, strong wind and changes in sea level, mainly concentrating on the 99th percentile of observations. The components of the index were chosen due to their link to risk, an area of expertise for actuaries, and because extremes have the greatest potential impact on people and, often, the largest cost to the economy.

The index is the culmination of an extensive research and implementation process. It is the result of consultation with Australia’s Bureau of Meteorology, Commonwealth Scientific and Industrial Research Organisation (CSIRO), leading insurance and natural hazard scientists and regulators.

“The index is designed to help us understand how extreme weather, and hence risk levels, may be shifting as a result of climate change,” said Tim Andrews, a Principal at Finity Consulting. Mr Andrews, who has 30-years of actuarial experience, collated the index, using data from the Bureau of Meteorology’s extensive network of weather stations and tide gauge facilities. The data was collected nationally and grouped into 12 climatically similar regions.

“This index is a very important piece of work for the Actuaries Institute,” said Institute President Barry Rafe. “Actuaries are skilled at summarising and presenting complex data, and the assessment and management of the financial consequences of risks.”

“This project aims to help big and small corporations better understand the changes in weather extremes across Australia. It is one way to bring science and business together.”

Actuaries Institute Chief Executive Elayne Grace said: “This work will assist businesses to assess and report risks from climate change, and Australians more generally will be able to look at the data and see what’s going on.”

Australian financial institutions can reference the index to help them meet their commitments to adopt international risk reporting measures, Ms Grace said. The Financial Stability Board’s Taskforce on Climate-Related Financial Disclosures in 2017 wrote recommendations for a single international cross-industry standard for disclosing those risks.

The Australian Prudential Regulation Authority (APRA), which last year warned that the risks of climate change were “foreseeable, material and actionable now”, has welcomed the new index.

APRA Executive Board Member Geoff Summerhayes said: “APRA has a longstanding working relationship with the Actuaries Institute, collaborating on financial risk metrics and standards. We believe this initiative is a positive step towards helping regulated entities to understand and manage the potential impact of climate risk on their businesses.”

Chief Executive Officer of the Investor Group on Climate Change, Emma Herd, said: “The effects of climate change are here and now, and getting worse.”

“Australian investors are looking for the tools they need to better assess and mitigate physical risks for their investments. The Australian Actuaries Climate Index is a welcome new tool for managing climate risk.”

The IGCC represents Australian and New Zealand institutional investors with around $2 trillion in funds under management, and others in the investment community concerned about the impact of climate change on investments. The very first Australian Actuaries Climate Index report, to be issued November 12, which covers the period 1981 to 2018, shows the frequency of extreme conditions in Autumn 2018 was higher than the historical extremes for Autumns in the baseline period from 1981-2010.

In fact, the frequency in the baseline period has been exceeded in every season but one since 2010. The results are compared to a 30-year reference period, mostly focusing on the 99th percentile of observations. The index will be updated each quarter.

The Australian index was built following the establishment of a similar tool in the United States and Canada that tracks different components to measure risk and climate change. That index, published quarterly, measures the frequency of extreme weather and the extent of sea level change. The US/Canada index is supported by a number of actuarial groups, including the American Academy of Actuaries and the Society of Actuaries.

The Actuaries Institute plans to develop more explicit measures of risk and the climate index represents the first phase of that work.

“This is a first step,” Ms Grace said. “We hope to build on this index by attaching risk data, such as damage to property and health statistics, in order to understand the relationship between weather extremes and risk, enabling more explicit risk indices to be developed.”

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