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Monday, September 29, 2014

What is actuarial malpractice?

-OBKCG Web Site-

--I have been stressing this for years and I still cannot stress it enough. Learn what your pension board and your employer are doing with YOUR money. It is boring to read about. Some of it will need explaining from someone. But in the long run you will be much more prepared for any instance that comes your way.--

Legal Insights for Pension Boards (Spring 2014)

by Meganne Trela

Actuaries play an important role in the lives of public pension funds. Actuaries are responsible for reviewing the demographic and financial data and information for a pension funds to determine a suggested yearly funding amount based on future forecasts and predictions. Technically, the information actuaries provide to pension funds about future funding needs is a highly educated guess. Just like any other type of future prediction, calculated predictions made by an actuary may not always be exactly right. However, in some cases, those calculated predictions may be drastically wrong. In those cases, a claim for actuarial malpractice may be lurking under the surface.

Actuarial malpractice claims are fairly recent phenomenon. These claims generally look like malpractice claims against accountants. Claims for actuarial malpractice can be made by a variety of sources: individual clients, persons an actuary knows will rely on his or her work, persons an actuary knows may rely on his or her work, and unknown parties who an actuary should reasonably foresee will rely on his or her work. Any of these parties can all make claims for actuarial malpractice depending on the egregiousness of the actuary’s conduct. In the world of public pension funds, this means potential claimants include the actual pension fund, pension fund members, the public body contributing to the pension fund, and may even include taxpayers in some limited cases.

Claims for actuarial malpractice can arise from an actuary’s failure to reconcile, adjust, understand, or use appropriate data; unreasonable assumptions that conflict with or ignore experience; use of improper methodologies; carelessness in calculations; or professional ignorance. Professional ignorance includes a failure to understand and consider applicable law. Two of the most common types of actuarial malpractice claims in a pension fund setting stem from an actuary’s use of unreasonable assumptions or from professional ignorance.

For example, making unreasonable assumptions can consist of an actuary’s failure to account for future salary increases in calculating a suggested funding amount. In Gallagher Corp. v. Massachusetts Mutual Life Insurance Co., 105 F.Supp.2d 889 (N.D.Ill. 2000), the federal court for the Northern District of Illinois found that a pension fund actuary who assumed no salary increases in calculating benefits was liable for malpractice because the assumption was unreasonable on its face. In that case, the actuary should have reviewed salary increase trends and accounted for those increases when he was calculating future benefits.

Professional ignorance can happen when an actuary fails to consider current law. For example, In Horton v. CIGNA Individual Financial Services Co., 825 F.Supp. 852 (N.D. Ill. 1993), an actuary advised an owner that a change in the law required an amendment to its pension plan. As a result of the amendments, the plan became underfunded. Because the amendment was actually unnecessary under the law, the actuary was sued for actuarial malpractice.

There are two ways a claim for actuarial malpractice can be asserted: 1) as a contract claim; or 2) as a tort claim. Funds or individuals bringing claims under a contract theory are generally limited in their recovery to compensatory damages (damages awarded to make parties whole) and cannot recover punitive damages. Punitive damages go beyond compensatory damages and are awarded to punish or deter a defendant. Under a tort theory, however, claimants can recover compensatory damages and may also be entitled to punitive damages.

To bring an actuarial malpractice claim under contract some sort of privity between the parties must exist. Privity requires a formal relationship between the parties. For example, a written contract for actuarial services between a public pension fund and actuary would create privity. Where privity exists, actuaries owe a specific duty of care to their client. This duty generally consists of providing actuary services with the degree of skill and competence reasonably expected of persons in the actuarial community.

In addition, most actuaries owe some sort of fiduciary duty to their clients. Thus, an actuary’s failure to use generally accepted actuarial principles while providing actuarial services may subject the actuary to legal liability. However, in Chua v. Shippee, 2013 U.S. Dist. LEXIS 128634 (N.D. Ill. 2013), the federal court for the Northern District of Illinois recently dismissed a claim for breach of fiduciary duties under ERISA, concluding that the plaintiff (trustees and plan participants of a private defined benefit plan) had failed to properly allege that the defendant actuary and attorney were engaged in fiduciary acts for the plan when giving advice to the plan. This is in contrast to other court decisions which have held that actuaries could be fiduciaries and could be held liable for both breach of fiduciary duty, as well as aiding and abetting breach of fiduciary duty by others. (See, for example, N.Y. State Workers’ Compensation Board v. SG Risk, LLC, 2014 NY Slip OP. 2373 (N.Y. App. Div., April 3, 2014))

Under a tort theory, privity between the parties is not required; however, the actuary must owe some sort of duty of care to the individual or entity bringing the claim. For instance, a member of a pension fund may not have a contractual relationship with an actuary; however, the actuary may owe the pension fund member a duty of care because the actuary’s calculations impact the pension member.

The law in this realm is evolving; however, be prepared to see an increase in actuarial malpractice claims because of suspected underfunding issues. With the state of public pension systems in Illinois, there will likely be more claims for actuarial malpractice related to those underfunding issues.