Address to New Fellows, November 1998
Michael A. Walters
Of all the talented people who started down the path of actuarial exams, you made it to the finish line. The determination and judgment you have already demonstrated will come in handy in meeting the challenges ahead. Let's face it, the syllabus for our exams is still quite a formidable barrier to master completely. You had to exercise considerable judgment in finding the essence of those readings and deducing the likely exam questions.
One area that has not been tested in the actuarial exams is supervisory management skillor the art of getting things done through others. Actuaries do not come by this skill naturally, because their first instinct is to solve problems themselves, instead of letting others do it.
Some time ago, when the CAS and SOA were discussing the possibility of expanding the core of common exams, the SOA was contemplating adding management courses to the syllabus, because new FSAs were struggling initially as managers. It seems that large life companies were placing their new FSAs immediately into management positions, without any supervisory experience. The CAS response was not to put management on the actuarial exams. Instead, exhort companies to include supervisory management in the actuaries' training before promoting them.
Actually, in the future, supervisory management may be less critical, although still important. In the new information age, corporations don't need vast spans of control and complex organizational structures. These are being replaced by knowledge workers with vastly improved communication access. This lessens the need for supervisory apprenticeship, with more emphasis on conceptual and communication skills to go along with technical skills that actuaries have in abundance.
The casualty actuarial profession has enjoyed phenomenal growth over the past two decades meeting demands for their skills. But will this growth continue in the future? Will the casualty actuaries experience some of the problems our life brethren now face, wherein the demand for traditional service from 10,000 life actuaries may have peaked? Hence, life actuaries are reaching for new applications for their skills.
First, we won't reach 10,000 in number for a decade or two. Second, the demand for casualty skills doesn't seem to be slowing down. About ten years and 1,500 actuaries ago, we interviewed selected CEOs of major insurers to gauge future casualty actuarial demand. We focused on companies where the CEOs either were actuaries or hired a lot of actuariesBill Bailey of Aetna, Ed Budd of Travelers, Jack Byrne of Fireman's Fund, and Warren Buffett of Berkshire Hathaway.
Warren Buffett was actually a surprise interviewee, as Jack Byrne on his own had lined him up for a teleconference with us in the middle of his scheduled interview. In fact, we were told we could get him only for a short time, and so were limited to a few questions.
With our questions rationed, the first one we crafted was "What are the keys to success in the casualty insurance business." Buffett hesitated at first, asking what we meant. We improvised by observing that in some industries, the keys to success were "brains and guts." He thought for a moment and replied: "The keys to success in casualty insurance are brains and no guts."
He also offered a suggestion regarding the newly emerging requirements for every insurer to have an actuarial opinion on loss reserves. Taking a page out of Jack Byrne's perennial message that insurers need a disciplined balance sheet, he exhorted the appointed actuaries to have more courage in standing up to their company's reserve committee in needed IBNR.
In fact, he recommended a unique reserve runoff test, which has surprisingly not yet been adopted by our profession. He said: "Compare the five year run-off results of all the appointed actuaries. Then take the actuary with the worst record of under-reserving and shoot him." He added, "You don't have to actually pull the trigger. You could whisk him off to a South Sea island, just so no one finds out you haven't actually eradicated him." This message of the need for more accountability for loss reserve opinions was passed along to the appropriate committees, including the discipline committee.
The other CEOs interviewed all concluded that casualty actuarial skill would continue to be in great demand, and even a fourfold increase would not be enough. A much greater supply would allow some of those trained as actuaries to become underwritersperhaps an even more difficult job than an actuary.
Of course, this group could not have known then that two of their companies would later merge, and that consolidation of many insurers could threaten to curtail the number of actuarial positions available.
In fact, industry contraction has been a major, and not surprisingly parochial, concern of actuaries recently. A few years ago, the CAS began an annual survey of actuarial leaders to identify the top ten actuarial stories of the year. For two years running, the lead story was industry consolidation first by primary insurers, and then by reinsurers. For years there weren't enough casualty actuaries to put even one in each company. Lately, the ratio is up to three per company. Not a cause for alarm just yet, but if the number of insurers drops below 50, there may be a need to speed up the nontraditional applications of actuarial science.
Appropriately, the top story of the past year was the growth of risk securitization. Talk about re-energizing actuarial need, pushed to an extreme, every separate book of business by subline within a traditional insurer could potentially require an actuarial opinion on its expected value for a transaction from a risk originator to a risk bearer. The latter may not even be an insurance company.
A third top ten story was the emergence of enterprise risk management another nontraditional actuarial venture. Why not take the tried and true precepts of risk managementrisk identification, risk assessment, risk control and risk financingand translate them into the rest of corporate risk management? Even if some of those business risks are classically uninsurable, the expertise of actuaries can surely be applied to some of those ventures.
For example, the year 2000 problem lends itself to enterprise risk management. In fact, there is even a way to buy insurance for that computer risk. It may have liberal doses of risk control in it, but some risk transfer is still possible.
But the greatest potential expansion of actuarial demanddynamic financial analysis (DFA)did not even appear as a top ten story probably because of the way that list was compiled. Only external news stories were used, which had some actuarial implications. No internal CAS research or committee work was considered. This was to keep an external focus for potential long-range planning purposes, and to avoid commenting on internal works in progress.
For almost eight years, the CAS has been actively working to nurture the DFA concept, which has the potential of becoming a major practice area for actuaries in the future, on a scale with ratemaking or loss reserving. It builds on ratemaking and reserving skills by adding a new dimension on the asset side of the ledger and its interaction with liabilities. It also adds a fourth dimension by measuring the risk or variability of results and its effect on capital needs.
DFA requires new skills not now in the repertory of most actuaries but that can be acquired. The CAS Syllabus 2000 will be adding these new financial topics. And there is a mushrooming set of continuing education guidelines to give some of our existing members the skills and techniques needed to practice in this area. What might also be needed is some marketing prowess, as this concept still has some hurdles to overcome before it is readily accepted by CEOs and CFOs.
Lastly, if these new opportunities don't generate enough jobs for actuaries, there are even more nontraditional possibilities. For example, last year Mavis [Walters] and I were returning from a golf outing, and stopped at Romanelli's pizzeria to pick up the order my wife had phoned in. Much to my surprise, there were two pizzas in my namea small pepperoni and a medium cheese. This did not look like a very good deal, because Romanelli's new jumbo pizza, with half pepperoni and half cheese, had a much lower price and appeared to provide about the same amount of pizza.
So I started quizzing the cashier. How big is the jumbo pizza? Answer: 18 inches. Is that radius or diameter? Ahh…around. That can't be the circumference; it must be the diameter. Then I started some quick calculations, out loud, to assess the relative areas. Let's see. A small pie is 12 inches diameter and eight dollars. At pi r squared, that's 36 pi. A medium is 14 inches at ten dollars; pi r squared makes it 49 pi; and a jumbo is 18 inches at twelve dollars; pi r squared makes it 81pior almost the same size as the two smaller pies but at a third less cost. So why didn't you suggest a jumbo pie when my wife called in? To which the English-as-second-language cashier replied: "Pies are not square; pies are round."
Meanwhile, I was attracting a crowd of interested parties, including the owner who asked if I was a mathematician? No, an actuary. He then asked if I was available to help him price his pizzas, since his view of the situation now was that he might be underpricing the new jumbo pies. My response was that we had to consider the fixed cost of pie preparationnot just the size. Also, from the hungry customer's viewpoint, there may be some adverse selection against the seller. We left it that I would have to get back to him when I was no longer hungry.
Never went back. The lesson learned? Every pricing problem is an actuarial problem; we just have to understand the environment a little better. And when banks and investment firms get into the insurance risk transfer business, we'll just have to get into their business at the same time.