Actuarial

One of the challenges actuaries regularly face come from management or customers who seek an answer – not just any answer, mind you, but The One True and Infallible Answer, a particular number that one’s hat can be hung on.

That sort of demand makes it a good thing that recent developments in computing technology and modeling algorithms make it possible to generate a number, with quite a bit of impressive-looking analysis and number-crunching behind it.

There is a problem, however.  The One True Answer is rarely just a number.   It’s a range, couched in caveats on potential sources of uncertainty, and subject to the chance that assumptions made in modeling and number-crunching could be wrong.

That uncertainty doesn’t necessarily damn the model’s output, mind you.   However, it’s important to remember that the model provides just one piece of information.  The possible other outcomes need to be considered.  And, when conventional wisdom or common sense contradict model output, there’s a healthy opportunity to review what we know, what the shortcomings of limited knowledge might be.

Sometimes it’s OK to discount, or even discard, the output of the black box when there’s reason to believe it’s not quite right.  Just document the phenomenon, periodically review the deviations to ensure they’re honest and not a reflection of bias, and attempt to retrain the tool given what we’ve learned about its shortcomings.

Sadly, in management’s quest for The One True Answer, such deviation and retraining can be forgotten.  Managers like their firm, seemingly infallible numbers.

A taste of that phenomenon appeared yesterday in a Wall Street Journal article discussing criticism of property/casualty catastrophe modeling (subscriber link):

Perhaps the most prominent critic to surface is Karen Clark, an economist who founded one of the first cat-modeling firms two decades ago. Today, she warns about the programs’ misapplication.

After Katrina, she attended insurance-company meetings to discuss "what went wrong" and concluded that there were more problems with how insurers were using the models than with the models themselves.

Companies that rely too heavily on cat-model data "are subjecting their businesses and their customers to the volatility of computer models," says Ms. Clark, who now runs a Boston cat-model consulting business. "The models are being used as if they produce definitive answers rather than uncertain estimates." Ms. Clark says she advises clients to use them in conjunction with other factors, such as broad historical data.

To be sure, insurers themselves are facing higher rates from the reinsurance companies that backstop their claims. The reinsurers, and the financial ratings agencies that assess the health of carriers, are also using the controversial newer models.

It’s thinking about debates like this which makes my job fun. 

And, before anyone thinks otherwise…no, this doesn’t mean Florida politicians are correct.   Providing cat wind cover in Florida is risky and expensive even before model outputs are grossed up for possible short-term climate phenomena and regardless of anyone’s overreliance on the models.

I wrote earlier that the wackiest Democratic Presidential contender, Dennis Kucinich, introduced a House resolution calling for impeachment of the President.

A Moment of Truth has posted a copy of Kucinich’s resolution, and I couldn’t help but notice part of the reason he’s calling for Bush’s impeachment:

A Medicare Actuary who possessed information regarding the true cost of the plan, $539 billion, was instructed by the Medicare Administrator to deny Congressional requests for it. The Actuary was threatened with sanctions if the information was disclosed to Congress, which, unaware of the information, approved the bill. Despite the fact that official cost estimates far exceeded $400  billion, President Bush offered assurances to Congress that the cost was $400 billion, when his office had information to the contrary. In the House of Representatives, the bill passed by a single vote and the Conference Report passed by only 5 votes. The White House knew the actual cost of the drug benefit was high enough to prevent its passage. Yet the White House concealed the truth and impeded an investigation into its culpability.

In all of these actions and decisions, President George W. Bush has acted in a manner contrary to his  trust as President, and subversive of constitutional government, to the prejudice of the cause of law and justice and to the manifest injury of the people of the United States. Wherefore, President George W. Bush, by such conduct, is guilty of an impeachable offense warranting removal from office.

Man, I did not expect to see an actuarial reference in that document.

Seriously, the document is interesting enough to merit a quick skim-through.  I seriously doubt that many of the points Kucinich raises really rise to the impeachment threshold of “high crimes and misdemeanors”, but the recitation is a decent, if somewhat biased, reminder of the antics that have transpired over the past 7½ years.

In case you haven’t seen it elsewhere, a little math-geek humor for the holiday weekend:

It’s good to be loved.

Seen in the New York Times:

By firing its actuarial consultant last week, the New York State Legislature shone a light on one of the public sector’s deepest secrets: All across the country, states and local governments are promising benefits to public workers on the basis of numbers that make little economic sense.

The numbers are off-base for a variety of reasons. Sometimes there is a glaring conflict of interest, as there was in Albany, where the consultant was being paid by the workers seeking richer benefits. More often, there is subtle pressure on the actuary to come up with projections that make the pension fund look good.

Most of all, public pension actuaries use old methods that have fallen far out of sync with the economic mainstream. That does not necessarily mean their figures are wrong, but it does make them vulnerable to distortion, misunderstanding and abuse.[...]

The article provides a few examples, in which the Times, to its credit, does note that the actuaries involved opined in a manner that likely didn’t quite register with their audiences.   For example, regarding New Jersey’s pension mess:

Two years later, a state senate committee called back the actuary, Robert D. Baus, for questioning, to make sure all was well. Senator Peter A. Inverso noted that a $4 billion deficit had appeared in the pension fund. “That frightens me,” he said. But Mr. Baus said that while the deficit had grown, “it does not change the fact that the system is funded.” He said New Jersey would have to close the shortfall at some point, but in the meantime, “it does not mean that there is not enough money to cover the liabilities right now. There is more than enough.”

No one asked exactly when the shortfall would have to be closed. Instead, legislators kept withholding pension contributions, even as they increased benefits again and again. Over the years the imbalances in the fund finally snowballed.

Now the fund is so deep in the red that Governor Jon S. Corzine’s administration cannot find the cash to catch back up. The Securities and Exchange Commission is investigating.

One other comment which caught my eye:

Actuaries worry their profession cannot withstand too many large lawsuits. The board that writes actuarial standards has been working on revisions in how to make economic assumptions.

But change is coming at a creep. There are still a large number of actuaries for public plans who vigorously defend current methods.

If you’d like to see a little discussion within the actuarial community about the article, you might be interested in this thread at the Actuarial Outpost.

I’m not a pension actuary, so I’m perhaps not the best person to comment on the specifics in that article.

However, I can note that as a profession, we actuaries are frequently lacking when it comes to communication skills (the NYT article has a “muted warnings” comment in one example).  And, while we are comfortable with the language of risk and the concept of potentially widely varying outcomes, it’s all too easy to remember that our customers and the general public aren’t as well traveled in the land of randomness.

Mere non-actuarial mortals want a point estimate.  A number.  The One True Answer Fixed and Unchanging For Evermore™.

That’s a problem.  An honest answer in our line of work is rarely just A Number.   It’s a range of values, along with a discussion of what influences might impact where the outcome might be, and perhaps a few words around how to monitor the chaos to get a better indication of the final outcome as the situation evolves.

A lot of folks, sadly, aren’t equipped to handle that.

Thus, we have the real challenge of our profession — how to phrase our opinions in a way that educates our customers…or at least minimizes the potential harm from misuse of our opinions.

One thing’s for certain: the rule of thumb we were taught in the session of the CAS’s professionalism class I attended years ago — how would this look if it appeared on the front page of the New York Times? — seems very appropriate right about now. 

Aside from trying to cover the internet bill, one of the main reasons I carry ads on this site is just pure, geeky curiosity — a desire to dabble a little bit with the optimization techniques professional ‘net types do, as well as wondering what sorts of ads would appear given my eclectic range of interests.

I have to say that the nature of some of the ads that have popped up have been somewhat disturbing.    I’d expect a few questionable items to leak through, despite Google’s efforts to the contrary…but an ad I saw on my front page is disturbing…especially considering the source:

It takes a little more than just a degree to qualify as an actuary, folks.  And while I’ve been rather vocal in the past in transitioning the actuarial exam process away from self-study exams into something more interactive, taking advantage of distance-learning techniques…. I’m pretty sure this isn’t that.

But what troubles me…it’s a Washington Post-sponsored ad?  Come on now!

I’ve put in a filter to keep that ad from appearing again.  On the off chance anyone was deceived by it, I apologize….and I am extremely disappointed in WaPo for associating with such a scam.

Found via an Actuarial Outpost thread:

Surely, this can’t help the actuarial branding campaign going on. 

Seen in the Australian Financial Standard:

Actuaries will play a more central part of the banking and financial services sector as a result of the US sub-prime mortgage crisis, according to Greg Martin, Institute of Actuaries of Australia president.

“We are seeing enterprise risk management (ERM) roles proliferate across the financial services sector particularly where recent volatility and repricing has highlighted the need for ERM related skills and disciplines. Actuaries are playing an increasing role in this trend,” said Martin.

I realize that from my vantage point in the P&C side of the American insurance industry, it was tempting to question the SOA’s creation of the Chartered Enterprise Risk Analyst (CERA) designation last year.

However, it is interesting to see an Aussie grasp on such an expansion of / shift in actuarial focus as a way to expand the profession into other industries.

Also, the quote above conjured the image of Superactuary, traveling faster than a speeding bullet to save mild-mannered economists from the dungeon of Evil Credit Crunch Guy….an image which amuses me far more than it should.

I have been remiss in not noting that we’re into actuarial exam season.  (To those whose brains are about to fry / have fried, I salute you!)

This morning, I had the opportunity to be an exam proctor for the first time.

I have to say that it’s quite a different experience from the other side of the table.  Aside from the distinctly lower stress level, it was kind of cool being able to watch the different behaviors of the exam candidates — the different strategies of organizing exam material; the different piles of supplies folks brought (e.g., one candidate brought three calculators; another had essentially a small pantry of food and snacks to tide him through the 4 hour, 15 minute ordeal…surprisingly, no Red Bull was in sight)…even the different ways that folks would exhibit that they were lost in thought (looking up; quietly banking the heel of a hand on the forehead; ticking off list items on fingers….)

That was a fascinating experience.

Seen at Institutional Investor:

The Faculty of Actuaries is ready to begin discussing a possible merger with the Institute of Actuaries, Professional Pensions reports.

Unsurprisingly Scottish actuaries are a little concerned with the potential that the British actuarial profession could become a bit too London-centric if such a merger were to occur.

The Courant ran an article on the trials and tribulations of coastal Connecticut homeowners seeking or renewing their property insurance.

The bulk of the story isn’t particularly surprising.  For the past couple of years, insurers have been faced with some hefty reinsurance bills, have started paying more attention to their aggregations of exposure, and have been forced to face the likelihood that a major hurricane in the northeast, though extremely unlikely, would also be incredibly catastrophic.

Bob Hunter provides one of the consumer advocate opinions for the article…and part of it expresses a sentiment I agree with:

J. Robert Hunter, director of insurance for the Consumer Federation of America, [...] noted that reinsurance rates are coming down, so “I think the insurance commissioner has to look hard” at insurers’ rate increases and ask whether they can be lowered by getting a better reinsurance deal.

Speaking from first- and second-hand knowledge, in the past couple of years, getting a better  reinsurance deal has been tricky.  When challenged with some seeming irrationalities in treaty pricing, the feedback has been essentially, “we’re charging this because the market will bear it”.  It’s an annoying answer, true, but it’s a necessary artifact of a free market.  As a result, insurers have been forced to give some real thought to the risk loading in their rates and the economics and risk theory associated with purchasing cat cover.

However, reading between the lines in Bob’s comment, you can see an implicit criticism that could be made about insurers’ ratemaking processes.  At many companies, ratemaking and reinsurance buying are discrete, mostly unlinked procedures.  Because of timing issues (mismatch of implementation of rate changes versus the timing of treaty negotiations and the lag time in preparing rates, getting them approved, and getting them implemented), reinsurance costs are not always as tightly linked in insurance rates as they could be.   In some cases, an insurer could be finally realizing increased treaty costs 9, 10, or 11 months after the treaty price was finally set.

That’s a problem given the expectation of some volatility in treaty costs.

I have the pleasure of working with one business whose products are mostly unregulated.  Essentially, once we know what the new treaty costs are, I can plug in the updated figures into a set of spreadsheets, and generate all-new rates reflecting that revised expense assumption.  The organization is flat enough that I can discuss the marketing/sales impacts of those proposed changes very quickly with the relevant parties.  There are no rate filings to speak of…and so we can usually get revised rates in place at about the same time as the new treaty takes effect.

That’s a handy ability to have in environments when reinsurance costs are rising rapidly, as they were until recently, or when they start to ease, as should happen in a year or two if we continue to be lucky.

You’d think that insurance regulators in cat-prone areas would see the value of such responsiveness, and would work to streamline the rate approval process and encourage insurers to quickly act upon such revised assumptions as quickly as possible.