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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Jefferson Gibbs

Risk management is a significant area of growth for Australia’s actuaries as the private and government sectors, the economy and jobs market recover from the impact of COVID-19, incoming Actuaries Institute President Jefferson Gibbs said.

Mr Gibbs, who takes over from Hoa Bui, said actuaries will increasingly expand their remit, taking on greater and more diverse roles in managing risk.

“We must continue to lead in areas of public policy where we have the insight to create real change,” Mr Gibbs told actuaries in his Presidential speech, delivered on 22 February. He said those areas include post-COVID economic recovery, retirement, climate, and intergenerational equity.

“We need to continue to strengthen relationships with governments, regulators, like ASIC and APRA, and we need to repeat that success with a wider-ranging set of organisations,” he said.

He reflected on a call from John Lonsdale, Deputy Chair of APRA, for actuaries to “have the courage to speak up” to help CEOs prudently manage risk.

In the year ahead, the Institute will update its important work on intergenerational equity and the Australian Actuaries Climate Index, and it will begin new work on the aged care sector. It will also expand its education program, including data analytics principles.

Mr Gibbs said student actuaries bring great talent and diversity of thought to the profession. Offering a strong education platform, that attracts those with strong maths skills and purpose, will result in a broader and stronger profession, both within financial services and outside it, benefitting clients, the community, and actuaries themselves.

Mr Gibbs is a senior partner at KPMG specialising in general insurance. He has been an Appointed Actuary, and worked with governments, not-for-profits, and private sector clients in Australia, New Zealand, the UK and around the globe, over almost 30 years. His work spans strategy, policy, audit support, reserving and valuation domains.

Actuaries Institute Chief Executive, Elayne Grace welcomed Mr Gibbs’ appointment as President.

“Jefferson champions the ability of actuaries across all fields,” Ms Grace said. “The experience he brings to the role of President includes being able to look at issues from a high level, but also understand the fine details.

“Jefferson is passionate about broadening the opportunities for the profession and areas where they can contribute, recognising that young actuaries have strong interests in climate change, government and data analytics, alongside traditional work in superannuation and insurance.”

Mr Gibbs said 2020 was a year of crisis that affected every business. He urged the Institute’s members to reflect on the changes and the work they can do now to provide help and insight and to focus on future opportunities during and beyond the disruption.

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Jefferson Gibbs

In a pre-Budget submission to federal Treasury, the Actuaries Institute has urged the Government to simplify Australia’s superannuation regulations, review areas where retirees need extra support and legislate to make the overall objective of the retirement income system clear.

The submission was lodged with the federal Government on 29 January.

The Institute believes Australians should be able to confidently live their retirement with dignity.

The submission states Australians should be able to get good financial advice at an affordable price and funds should be able to confidently develop retirement income products ahead of changes due in 2022. Trustees should develop default retirement products and be required to consider providing longevity protection along with appropriate information that outlines its benefits.

The appropriate superannuation guarantee (SG) rate is likely to be between 9.5% and 12%, but the submission states setting the levy is complex. Some of the complex interactions that need to be considered include the government’s overall objective for the compulsory SG system, its interaction with the Age Pension, rental assistance and other forms of assistance that support older Australians.

In determining adequacy, assumptions around retirement income indexation, broken work patterns and involuntary early retirements also need to be considered.

The linkages with savings in other assets, such as housing, are also important to understand.

The Actuaries Institute submission also says the Government should consider simplifying regulatory requirements, such as merging the asset and income test, potentially including a portion of home ownership. It has also called for a review of rent assistance for retirees who are not home-owners.

“Along with retirement policy, the Pre-Budget submission addresses climate change and the need for measures to help Australians develop greater resilience to extreme weather; intergenerational inequity, which is wider now than it has been at any time in the previous two decades; and the rise of gig workers as a significant part of Australia’s economy,” said Jefferson Gibbs, President of the Actuaries Institute.

He said measures can be taken to limit the impact of climate change on Australia’s communities.

The Institute publishes the Australian Actuaries Climate Index each quarter, which is a measure of extreme weather and sea levels. It shows temperatures are warming, sea levels are rising, and extreme dry conditions are more frequent. Funding mitigation works and strengthening building codes, where cost effective, could lessen the devastation caused among communities, businesses and the economy.

Climate change risks can be physical, as a storm or tidal surge ruins homes and infrastructure; a transition risk, as businesses change direction to lower their carbon emissions; or a liability risk, which directors and trustees must consider. The Institute urged the Government to consider these risks as it prepares its 2021-22 Budget.

The submission also called on the Government to improve the data it collects on gig workers.

A larger gig workforce, which the Institute estimates grew nine-fold between 2015-2019, capturing $6.3 billion in food delivery and ride share spending alone, has implications for policy, including the diminution of near-universal superannuation, and likely future increased Age Pension costs.

The Government needs better data to gain deeper insight into gig workers’ conditions, and the best policy options, especially for young workers who may spend longer in the gig economy, where insurance, superannuation, holiday and sick pay may be scant or non-existent.

It also pointed to greater inequality between Australia’s generations. The widening gap, shown in the Australian Actuaries Intergenerational Equity Index, shows asset price rises left older Australians 87% better off compared to a 20% increase for those aged 25-34.

Government spending, including the Age Pension and health care, has skewed to older Australians over time. Younger Australians are not buying houses because getting into the market is difficult, but homes are a huge store of wealth for Australians. This highlights the importance of understanding any linkages between savings levels in different types of assets, acknowledging the role that supply-side factors play in the levels of home ownership.

A rise in net government debt is considered a burden on future generations. And changes to the climate, including adverse trends in rainfall and biodiversity, are seen as negative factors for young people who inherit a diminished environment.

“Actuaries have a long tradition of participating in public policy across a wide range of sectors that affect Australians, their communities and private enterprises,” said Actuaries Institute Chief Executive Elayne Grace. “We look forward to actively contributing to the debate where we have relevant experience.”

Read the pre-Budget submission.

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