Contact David Rush at davidrush@pfsconsulting.com.au to find out more.

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By Jules Gribble, Principal

Introduction

All investment products, superannuation and otherwise, require the attribution of value to investors.  Generally, the changes in value to be attributed at specific points in time (daily, weekly, monthly, …) reflect changes in value of underlying assets.

There are essentially two ways to attribute value.  A unit pricing approach, in which an investor purchases a specified number of units in a transaction and over time the value of these units changes.  Then the value attribution flows through the change in the unit prices.  A crediting rate approach, on the other hand, attributes value through the addition of units to the investors account with the classic example being interest earned on a bank account.  It is perhaps worth noting that while it is generally accepted that unit prices may move up or down depending on the aggregate movement of value of the underlying assets, it is less common to have negative rates of interest applied.  We note that if crediting rates cannot fall below 0.0% then this is a form of investment guarantee to investors.

Investment managers, super funds, trustees and all responsible for the attribution of value to investors in their products clearly have an important obligation to have their value attribution processes work as intended (and promised) and to be equitable and fair to all investors – entering, ongoing and exiting.  Managers need frameworks to assess their businesses and for value attribution to investors in their investment products, the set of principles below gives them such a framework.  For clarity, we note that if there are multiple investment options available in a given product, these principles apply at the investment option level, not at any higher aggregated level.

Management based on these principles must then also be set within an appropriate overarching corporate governance framework.  We do not pursue this overarching framework here but do emphasise its importance all the way up to the senior management and board levels.

The joint APRA/ASIC publication ‘Unit Pricing – Guide to Good Practice’ (the Guide), was initially published in 2005 and updated in 2008.  It is available from both the APRA and ASIC (RG094) websites.  That this document has not required any substantive review of update since then is testimony to its quality and durability).  The Guide is a very useful document and its basis for ‘good practice’ effectively gives the current minimum expected standards of practice for industry.  The Guide is also endorsed by the Financial Services Council of Australia in some of its Standards.

A couple of reality checks

We also suggest it is probably unrealistic to presume that value attribution errors do not occur (perhaps in some contrast to them being discovered).  There are a vast number of transactions done involving value attribution, in bank accounts, credit cards, investment options and superannuation funds every day.  There is real and ongoing challenge to generate assurance that these transactions are being done as properly intended and equitably.  When this is not the case, then the need for remediation and restoration of lost value to adversely impacted investors needs to be considered.

The gulf between setting expectations and their implementation and assessment can be wide.  We call this gulf between theory and implementation ‘Application Risk’: the risk of ‘knowing what to do’ (in theory) in contrast to ‘doing it properly’ (in practice).  To emphasise this distinction, most people can appreciate the theory of building a house, but few can actually execute it.  In the financial services, the investors validly expect a good house to have been built.  In our view, theory may be 5% of the game while implementation is the remaining 95% (think of ‘genius is 1% inspiration and 99% perspiration’).  Application Risk also explains the ongoing litany of major spreadsheet errors.

Generally applicable principles

We consider that the principles given here are consistent with the Guide and apply in both a ‘business as usual’ context, in error compensation exercises, and in situations of stress for unit pricing.

These principles are fully applicable in a crediting rate environment for the attribution of value to investors.

• Principle 1: Proper Financial Position.  Investors receive the appropriate value for their investments at all times.

Considering unit pricing errors, the need is to return investors, having regard to the materiality of the error(s), to materially the same financial position as they would have been in had the error not occurred.  Practical constraints and considerations need to be recognised.  Investors include active and exited investors.

We highlight the focus on value as opposed to either number of units or unit prices separately.  This is obvious in the sense that value is the product of units and unit prices.

• Principle 2:   The unit pricing methodology delivers equitable value attribution to all investors.

Considering unit pricing errors, applying equity considerations should take into account the nature of the errors, the data available and the practicalities of the situation.  Equity should also be maintained between active and exited investors.  In practice, equity can be difficult to assess and apply and appropriate materiality considerations need to be reflected.

• Principle 3: Reflect Unit Pricing Basis.  The unit pricing basis, as disclosed in the relevant PDSs and any other relevant governance requirements, is adhered to.  All relevant constraints and governance requirements applicable by, or on behalf of, the product provider should be met at all times.

Considering unit pricing errors, the compensation outcomes must be consistent with the unit pricing and administrative bases the investor would have expected to have been employed at the time the error occurred. Put another way, the basis for compensation is ‘to redo the processes as they would have been done at the time with identified errors corrected’.   Historic processes, except for those processes or data items identified as being in error (and being corrected), remain accepted.  In the context of evolving practices and industry standards, it is important to ensure that judgements are made in the context of the environment at the time of the error, and not seek to impose current standards on historic situations.

• Principle 4:   Consistency with External Industry and Regulatory Guidance.  Unit price calculations should be carried out in accordance with relevant industry and regulatory standards and guidelines on unit pricing.

Considering unit pricing errors, assessments should be against guidance in effect at the time of the error.  As with principle 3, we note the importance of not applying current views in a historical context.  Unless applied on an industry wide basis, applying current views may imply different standards in compensation exercises than would have applied to other investors not subject to a compensation exercise.

• Principle 5: Best Estimate at the Time.  This principle explicitly underlies much discussion in the Guide: ‘The calculation of each element of the unit price should be the “best estimate calculation at the time”’.

This principle is equally applicable in a compensation context.  When reviewing past methodology and its implementation, the issue is not one of whether a ‘best estimate’ was made but rather of whether the estimate historically made can be shown to be inappropriate, either by methodology or implementation, and so unable to be accepted as reasonable.   As with the above principles, breaching this one potentially results in attempting to apply ‘wisdom of hindsight’ to the compensation process.   This raises the spectre of implying that all ongoing business unit pricing processes which cannot meet a ‘wisdom of hindsight’ level of accuracy test sometime in the future will potentially become transformed into errors.

• Principle 6: Simplicity and Robustness.  The unit pricing process needs to be robust and capable of withstanding stressful conditions, such as market movements of 20% or 30% in a day.

Considering unit pricing errors, the compensation methodology should be as simple as possible while retaining the necessary degree of accuracy and thoroughness to ensure equity.   The methodology should address all the relevant issues, without getting bogged down with immaterial issues.  In practice it is also essential that a compensation methodology can be implemented and be demonstrated to have been implemented.

• Principle 7: Group – Long Term Interest of Fund.  Investors elect to join a group by joining the fund.  They expect advantages from the group membership, such as better performance and access to more investment options.  However, a consequence of group membership may be, in some particular cases, specific individuals will not be treated identically when compared to their being independent and individual investors.  This ‘group’ principle is fundamental to the existence of collective investment products. 

Considering unit pricing errors, the long term and ongoing interests of the Fund need be considered.  It is inequitable to seek to impose a compensation process which in the longer run leads to current or future investors of the fund being disadvantaged.

• Principle 8: Independence of Investor Intentions. The assumed behaviour of investors needs to reflect their independence from other members in the group of investors. 

Offsetting and averaging arguments reflect summaries of aggregate behaviour from the perspective of the fund and do not necessarily reflect the perspective of the individual members of the group.  The fundamental conceptual flaw of historic unit pricing illustrates the need for this principle.

• Principle 9: Independent Reviews.  Product providers need demonstrable evidence as to the appropriateness and validity of the inputs and outputs of unit pricing processes (together with all the steps in between) to be able to provide assurance to stakeholders of the appropriateness of the value changes attributed to investors. 

The Guide specifically endorses this principle.  Considering unit pricing errors, the importance of independent expert review is heightened.

• Principle 10: Primacy of Investor Interests.  There are typically various stakeholders involved in providing a unitised product and they may have differing perspectives on issues.  This principle reinforces the equity principle by clarifying that the investor is the primary stakeholder.

Considering unit pricing errors, differing parties, such as administrators, trustees and others, may have differing interests that need be recognised, managed and balanced but the primacy of the interests of the investor always remains.

Additional principles for compensation exercises

Some additional principles apply for compensation exercises.  We leave aside the sometimes contentious question of what constitutes a compensatable error.

• Principle 11: Inclusion of All Identified Issues.  To restore an investor’s financial position, all errors identified during an investigation should be addressed in the compensation, whether or not individually they may be judged to be compensatable.

Errors may arise from methodology, parameters, data or implementation issues.  A compensation exercise may therefore need to reflect the correction of multiple errors that have been identified during the data review process.

• Principle 12: Compensation at Transaction Level.  The basic building block for determining compensation is to determine the impact of the compensatable error (or errors) for each transaction.

A transaction is the lowest level of data on which the compensation calculations can be based.  So, once adequate data integrity is established, the corrected reprocessing of transactions provides an accurate and focussed approach.  It minimises the risk of generating compensation where it may not be due.

• Principle 13: Dollar Value of Historic Transactions.  The dollar values of investor transactions are generally established historical facts that should be preserved (barring specifically identified errors).

This is important in assuring adequacy and integrity of data for the purposes of compensation.  It is also important as adjusting transactions requires assumptions that are inherently judgemental and so can be subject to dispute.

Conclusion

The Guide raises many issues, perhaps not surprisingly as it is over 100 pages long and goes into considerable detail.  However, we believe the ‘technical’ aspects of unit pricing can be addressed by applying the principles set out above.

Further information and contact details 

For further information on these principles and their application, please contact Jules Gribble, Principal

Jules can be contacted on:

Email:               julesgribble@pfsconsulting.com.au

Mobile:             +61 (0) 456 801 401

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The Actuaries’ Institute Council recently established a Continuing Professional Development (CPD) Committee to review professional development activities and their delivery to members.  CPD is an expression of the professional curiosity and purpose inherent in our roles and obligation to provide high quality professional services. CPD should therefore be embraced and enjoyed as an integral part of our careers. This committee is reviewing how CPD can become more relevant to members and better support them to manage and progress their own learning. We seek a wide range of inputs to get a balanced perspective and better understand member’s CPD needs, particularly in an environment where there is a vast range of CPD material available from the Institute and other providers.

Effective CPD should be tailored to your individual needs and have a definitive, outcomes focused purpose. The Lowther and MacMillan papers referenced below point out a few ways to make CPD authentic. Having good structures enables actuaries to be deliberate and strategic in the personal development. We intend to build on the current CPD processes to make them supportive and user friendly, to better organise material to make them easier to navigate and expand access to new material (including from other providers). We also want to expand the range of delivery options to support better access and utilisation. All this should support your changing needs as your career develops. We need your input and views to do this effectively, so encourage you to participate in an upcoming survey on how our CPD programs can be improved.

The CPD review takes a broad view, considering both technical and professional skills. Professional skills include the range of skills needed to enable translation of the technical skills into recommendations to support decision makers and drive actions and outcomes.

These include skills such as communication, networking, influencing, critical problem solving and reasoning, people management, negotiating, commercial awareness, constructive decision making and ethical behaviour. Many of these skills are not specific to actuaries and so could conceivably be sourced from broader corporate CPD offerings.

In Australia, as globally, we are seeing major shifts in the business environment and in community expectations.  The impact of the February 2018 Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (the Hayne Report) will drive significant changes in expectations of appropriate professional behaviours. This is already being seen in increased supervisory activity from both APRA and ASIC. A benefit of these changes is the opportunity for actuaries to improve their profile as thought leaders and add real value to the community. The recently developed Climate Index shows how actuaries can demonstrate this added value.

The Institute recognises the need for an increased focus on the professional skills of actuaries and wants to understand how this can be further enhanced. This should create shared benefits; for individuals it will develop their capability and careers; for businesses, they should see improved contributions to business outcomes; and for the profession we want to see continued growth and increased recognition of the value the profession can add in traditional and emerging practice areas.

The actuarial profession has always been held in high regard in terms of professionalism, ethics, quality and integrity. Effective CPD protects the profession, actively supports it maintaining its reputation, and supports its members developing along their career paths.

To ensure the profession’s ongoing relevance in a rapidly changing professional world, we believe that now is a good time to review and enhance CPD approaches, delivery and content.

All members will soon be asked to participate in a CPD survey to provide input on how the review of CPD may progress. We encourage you to respond and share your views. The papers referred to and other material that provide more background can be found on the Actuarial Society of South Africa’s website.

To learn more about the work that PFS Consulting does please contact Jules Gribble.

Background: This paper is based on the article by Jules Gribble, Lesley Traverso and Caroline Stevenson published in Actuaries Digital in February 2020. Jules chairs the current Institute Council’s Continuing Professional Devlopment Committee.

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In a nutshell, actuarial consultants analyse the financial implications of future risk and uncertainty, assess the potential costs and potential returns, and advise on the best path forward.

Actuaries do this using financial math, statistics, and educated judgement to evaluate the likelihood and financial implications of possible future events. Using those evaluations, actuarial consultants then help organisations develop strategies to better manage risk.

There are three specific areas of strategic value an actuarial consultant can add to any organisation.

Strategic value an actuarial consultant can bring to your business

Data and decision making

The term “big data” has become a buzz word in recent years. Data analysts and scientists have proliferated globally to support the many different decisions organisations need to make. Hard on their heels artificial intelligence and machine learning are rapidly emerging to analyse diverse data sets.

Many organisations work towards having rich, complete data sets on which to base decisions. However, even where they do have good data, it is often not directly relevant to the issues on which decisions are needed. The reality is that many business decisions have to be made based on very little data.

Actuaries excel at using imperfect data, and small data sets, to create useful insights which improve strategic decision-making for the future.

Future perspectives

Historical data is often used as a basis for forecasting. That is undoubtedly helpful, but to be really useful any projection needs a future focused perspective brought to bear on insights gleaned from the past.

Actuaries use insights gained from analysing historical data, however imperfect, together with an understanding of the context in which past events occurred and broad industry knowledge, to create useful, prospectively focused, models as a basis for decision making. Actuarial consultants specialise in delivering future focused perspectives.

Judgement around uncertainty

Every organisation faces uncertainty of some kind, and many use models to help them navigate that uncertainty. However once a model is in place organisations often tend to fall into too slavishly following the output of the model, no matter what. But the model may not – in fact almost certainly will not – deal with all the uncertainty. Models have limitations which can impair the decision-making process if not properly taken into account in the way the model is used, and interpreted.

Actuarial consultants who have substantial business experience are expert in working with uncertainty. They are skilled at applying judgment to build, use, and interpret models as tools to inform decision making.

What to look for when hiring an actuary

The right actuarial consultant can help your organisation unlock its potential. As a partner to your business, an actuary will help you better understand risk and navigate uncertainty to make the best possible decisions for your organisation.

When you look to engage an actuary, be mindful to understand the detail of their experience and track record of helping businesses achieve their goals.

For more information about the actuarial consulting profession or to explore how an actuary may be able to help achieve your business objectives contact us.

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