Exams in Real Life: Exam 7

by Dan Watt, FCAS

The purpose of the “Exams In Real Life” series is to share how content from CAS exams are used in the workplace today. In essence, we would like to supply a little motivation by answering “Why am I learning this stuff?” and “When am I ever going to use any of it?” If you have not already done so, please take a moment to read our prior articles. (See Exams IRL Archive below this article.)

For this issue, we’re focusing on Exam 7 – Estimation of Policy Liabilities, Insurance Company Valuation, and Enterprise Risk Management. Exam 7 is a deep dive into reserving, expanding on some of the concepts introduced with Exam 5. I love this material! I am a nerd. Exam 7 gets pretty “mathy,” but for your own good. The deeper you understand a process, the better equipped you will be at using them properly, explaining it to others, and visualizing all the moving parts and assumptions. Good stuff!   

An actuary is so much more than a number cruncher! An actuary needs to be an effective business partner, consultant, decision-maker and teacher. Exam 7, along with Exams 8 & 9, will bring deeper understanding to ratemaking and reserving, as well as overviews of enterprise-level concepts, such as risk management and reinsurance. This is vital if you are going to be an impactful partner at the table. You need to see the big picture! You need to understand how all the actuarial concepts fit into the workings of the company.

One of the greatest aspects of Exam 7 is delving deeper into how the variance of typical reserving methods can be used to develop ranges around best estimates. This is incredibly useful in the decision-making process. It is a far better conversation with business partners to have a range of reasonable estimates, rather than just a point estimate. Simply having the difference between booked and indicated is often not enough information to know how much we should be concerned and how to react to the difference. A range of reasonable estimates provides this perspective.

Exam 7 also teaches the tools you need to push the art of prediction forward in reserving. Understanding how models work, the various sources of risk and how to compare models as well as identifying opportunities to improve your predictive methods are vital pieces of knowledge for the profession going forward. We actuaries are constantly reinventing ourselves and the methods we use. As computing power increases and more tools become available to push the envelope of prediction, we will be able to estimate IBNR with better accuracy, which has always been a challenge for longer-tailed lines of business.   

When studying for Exam 7, you get to dig into the good work of Mack, Brosius and Clark. Not only will you better understand how to establish reserve ranges, but you will learn important specialized techniques to evaluate reserves for complex policies used in excess insurance and reinsurance. Layers! Layers! Layers! As soon as limits and deductibles are introduced, things get far more complicated, particularly if you are trying to estimate the reserves for umbrella and/or excess layers without the benefit of ground-up data. Exam 7 teaches you how to handle layered reserving.   

In many aspects of the job, actuaries will need to understand reinsurance. Many of you will and do work for reinsurance carriers or in lines of business that have reinsurance contracts. Exam 7 teaches the base concepts needed to understand reinsurance reserving. This material will be particularly useful when dealing with larger reinsurance contracts, often found for runoff business like asbestos.

How do all our reserving efforts affect the company? Exam 7 delves into this as well. You will learn techniques for the valuation of P&C insurance companies. Thus, you will see how your reserving efforts directly and indirectly affect the value of a company. This knowledge is incredibly helpful as background when working with business partners and presenting results. We do not work in a vacuum! The consultations that actuaries provide to the business are taken very seriously. Thus, we need to contemplate all the impacts of suggested changes to the enterprise level. We need to understand all the moving parts and how one change will impact the rest of the machine.   

The actuary’s role at the enterprise level is vital. For this reason, Exam 7 also introduces the concepts of risk management. Many of the companies you work for have a whole department dedicated to risk management (ERM). Whether you are working as a ratemaking or reserving actuary, it is a necessity to understand how insurance risk is quantified and how it can be managed. Economic capital models and other risk management models help to evaluate the enterprise-wide risk of doing business and are the centerpieces of planning. The leverage ratio outputs of these models directly affect ratemaking. The payment patterns from your reserving work are often used in investment strategy and risk management. Again, we do not work in a vacuum! Understanding these concepts will help you see the big picture, which will make you a better business partner, and thus a more effective actuary.   

As with all actuarial exams, Exam 7 is tough, but the concepts provided are the core to P&C actuarial work. In studying for the exam, I recommend doing so with the frame of mind that every topic you dig into will be useful during the span of your career. The methods learned will be used. The assumptions memorized will become second nature. Exam 7 will make you a more effective business partner. Soak the material up! It is an incredibly helpful exam!