Actuarial Notes

Materiality: Concepts on Professionalism

By American Academy of Actuaries Task Force on Materiality · American Academy of Actuaries · 2006

Study guides: Exam 6U, Exam GI-302

A discussion paper (June 2006, Professionalism Series No. 8) prepared by the Task Force on Materiality of the American Academy of Actuaries' Council on Professionalism to help actuaries consider the aspects of materiality as they provide professional services to their principals. The paper was not promulgated by the Actuarial Standards Board and is not binding on any actuary; the Code of Professional Conduct governs.

On the syllabus

  • Exam 6U — objective C7; the whole discussion paper (Professionalism Series, 2006, No. 8, June 2006).
  • Exam GI-302 — Outcomes 4a; the discussion paper (Task Force on Materiality, AAA, 2006, No. 8), pp. 1-8, 13-17 and 19-20 (as the syllabus states it)

Preface

  • The paper was developed for discretionary use by actuaries, is intended to stand on its own and be freely interpreted, and yields to the Code of Professional Conduct wherever they conflict.
  • Task Force members represented both the American Academy of Actuaries and the Canadian Institute of Actuaries.

Background

  • Materiality is central to the reporting and interpretation of financial information; it arises in the context of inclusion, of refinement and of disclosure.
  • In the United States no Actuarial Standard of Practice is devoted to materiality; the word "material" is defined in only two ASOPs (No. 5 and No. 17), though the term is used in as many as sixteen.
  • The Actuarial Standards Board considered issuing a separate standard but decided not to, and the Academy's Council on Professionalism established the Task Force to prepare a discussion paper of non-binding guidance.

Purpose and Scope

  • The paper is intended to stimulate thinking and discussion about materiality, extending the discussion that has occurred in property/casualty to practice areas where there is no current U.S. guidance.
  • Its concepts are broadly applicable to all practice areas (life, health, pension and property/casualty) and to all actuarial work.

Defining Materiality

  • The Task Force's generalized description: an omission, understatement or overstatement in a work product is material if it is likely to affect either the intended principal user's decision-making or the intended principal user's reasonable expectations.
  • Materiality is different from the range of reasonable values in an actuarial estimate and from the inherent uncertainty associated with actuarial estimates.
  • The primary guidance for property/casualty actuaries is section 3.4 of ASOP No. 36, effective for statements of actuarial opinion with a valuation date on or after October 15, 2000.

Reflecting Upon Materiality: User is Key

  • The paper does not propose a universal definition of materiality; user perspective is typically the key element, and the definitions in the Appendix collectively send the message "know your user".
  • The framework of ASOP No. 41, Actuarial Communications, helps resolve the difficulty of indirect users: the actuary controls the intended audience, and has no obligation to communicate with anyone outside it.

Applying Judgment About Materiality

  • Materiality tends to be more task-specific than practice-specific, and U.S. actuaries appear to have more experience applying judgment about it in valuation work than in setting rates.
  • The more common practice is the selection of a single materiality standard for a task or assignment; a separate "tolerance level" for the accuracy and completeness of data is a different concept.
  • An actuary would not normally change the materiality standard significantly from year to year, but may reconsider it as an organization approaches a threshold such as risk-based capital action levels.

Accounting Vs. Actuarial Materiality

  • An accountant or auditor would presumably select a materiality standard on similar criteria, so some actuaries argue that the two levels would normally be equal or close; in practice auditors may select a level without first communicating with the actuary.
  • Good communication between actuary and auditor, for which ASOP No. 21 gives guidance, is likely to lead to appropriate levels for both.

Communication and Disclosure

  • It would normally be in the user's interest to know the materiality level the actuary used, so the actuary would usually at least consider some disclosure of it within the work product.
  • Neither ASOP No. 36 nor any other ASOP requires disclosure of the selected level, but the NAIC Instructions for property/casualty Statements of Actuarial Opinion, beginning with 2004, require the materiality standard and its basis to be disclosed in US dollars.

Appendix Helpful Sources for Use in Selecting Materiality Standards

Related readings

  • ASOP 41 - Actuarial Communications — the standard whose intended-audience framework the paper uses

Sources