In My Opinion: Answering The Big Question

by Paul E. Lacko, AR Managing Editor

In this issue we are proud to publish another perceptive article from Victoria Stachowski, an American FCAS currently living and working in Europe. Victoria will bring you periodic news and views from "the Continent," joining Kendra Felisky-Watson, who does such an excellent job serving as our London bureau chief reporting on events in the U.K. International actuarial affairs are on the front burner right now, and this issue of The Actuarial Review will help you get up to speed.

Steve Lehmann and Mary Frances Miller paint the big picture for you in their articles. Kendra highlights a recent discussion between U.K. actuaries and North American actuaries, and Victoria has compiled some information about the education and training of European actuaries in countries besides the U.K. Like us, they are high-level professionals. Like us, they have to satisfy demanding requirements to earn their credibility. Unlike us, they find that actuaries can be trained effectively without requiring of them a series of ten passing grades (ten, nine, whatever) on post-collegiate examinations that concentrate on property/casualty insurance. What would it take to make European actuaries as "qualified" as North American P/C actuaries to provide actuarial services to North American clients? For that matter, what would it take to make North American P/C actuaries as "qualified" as European actuaries to provide actuarial services to clients in European countries?

As the CAS explores these questions and others, I can't help but think that The Big Question is knocking on our door again, this time speaking with an accent that sounds foreign to our ears: What is an actuary? Victoria chose this question as the title for her article, and it is The Big Question. No matter how hard we try to answer it, no matter how much we strain and perspire, it's never satisfied. It always comes back for more.

The Society of Actuaries is wrestling with The Big Question, again, these days. The Big Question seems to be winning. Some members of the SOA are now thinking that maybe an actuary is anyone who applies mathematical and statistical methods to business problems. Sounds like the old "give it everything it wants and maybe it will go away" approach to negotiation.

Sholom Feldblum, one of our favorite contributors to The Actuarial Review, also touches on The Big Question in his article in these pages. Indeed, if you look back at the opinion pieces we've published in The Actuarial Review (you do keep the old issues, don't you?) I believe you'll find The Big Question in each and every piece. As I said, it's everywhere.

Sholom's current article identifies at least three important issues that bear on The Big Question. First, the problems that traditionally have been classed as "actuarial" in nature require that the Law of Large Numbers holds. In other words, we assume that we can define a population, analyze samples drawn from the population, and then use that analysis to make valid inferences about the population.

Second, actuaries have come to realize that the Law of Large Numbers does not always lead to an acceptable solution to the problem at hand. We keep our faith in the Law of Large Numbers, but we look for other approaches to solving the problem of, for example, pricing the risk of property damage due to an earthquake. Dynamic financial analysis applies the Law of Large Numbers to help us analyze the financial impacts of various investment strategies given a set of scenarios about the future investment performance of various asset classes. The Law of Large Numbers has not, however, provided a solution to the difficult problems of accurately forecasting the movements in interest rates and stock market returns that result from very large numbers of market transactions every day.

The label "nontraditional actuarial model" is often attached to the new approaches. They are "nontraditional" because they are not based on the Law of Large Numbers. Maybe we need models that go even beyond "nontraditional," models such as the ones described in the book Fractal Market Analysis: Applying Chaos Theory to Investment and Economics , written by Edgar E. Peters and published in 1994 by John Wiley & Sons. (This book has an interesting discussion about the Law of Large Numbers, come to think of it.) You can check out some truly "extreme models" in At Home in the Universe: The Search for the Laws of Self-Organization and Complexity, written by Stuart Kauffman and published in 1995 in paperback by Oxford University Press. (Don't expect to see any continuous, closed-form functions here.)

Third, an actuary is sometimes required to act contrary to the actuary's best judgment. Such requirements are set by policy makers who understand that actuarial models do aim in the right direction and almost never produce a direct hit exactly on the bull's eye. But they are concerned that actuaries may sometimes miss not only the bull's eye, but the target, as well. In other words, how soon can we recognize a mistake, and how can we minimize and repair any collateral damage? This is not a question of improving our models. No model is ever likely to duplicate the workings of the real world, so there is some chance that any model, no matter how good, will fail unpredictably at least some of the time. What becomes of an actuary when the actuarial models fail?

It's difficult for people to trust what they don't understand, and most people don't understand actuaries. Can we blame them? What can you say when someone asks, "Well, OK, tell me, what is an actuary, anyway?" Can all the actuaries in the world answer that question? Not yet. But stay tuned.