Oct 6, 2014

Future Role of THE Actuary

To quote a leading Dutch actuary (Jeroen Tuijp):

THE Actuary doesn't Exist!

But what is, or could be the role of an actuary in the next decade?

Perception: What's an actuary?
The answer to the question "What's an Actuary?", strongly depends on who you are asking.

Some examples of possible answers:

  • Accountant: An Actuary helps to estimate and understand discounting the assets and liabilities
  • Board Member: My Actuary is my premium and liability adequacy advisor, he manages risk
  • Risk Manager: Our Actuary helps me to identify hidden risks and estimate embedded options
  • Investment Manager: Our Actuary helps me to define ALM and investment models
  • Administration Officer: I ask our Actuary for advice on how to administrate in an efficient way
  • ICT Manager: The actuary is responsible for defining the equations in our system
  • Marketing Manager: Our actuary is the driving force behind product development
  • Supervisory Board Member: Our Actuary is the lock on the door

The perception of the professional  contribution of an actuary not only depends on the view in the eye of the beholder, but also on the wide variety of roles that actuaries fill in all kind of organisations.

Some examples of the endless list of the many different (actuarial) roles and positions that actuaries fill in:
  1. Certifying Actuary, Advisory Actuary, Valuation Actuary
  2. Pension Actuary, Investment Actuary, General Insurance Actuary, Health Actuary, Life Actuary, Claims Actuary, Public Pension Actuary, Reinsurance Actuary
  3. Risk Manager, Capital & Solvency (II) Manager, 
  4. Marketing Manager, Head Product Development, Head Financial Control

On top of, the actuarial work field comprises a list of detailed professional disciplines, such as:
  • Regulation: Solvency (II) , Basel,
  • Technical Life Topics: Mortality, Longevity, Healthy Life years, 
  • Technical Non-Life Topics: Car & House Insurance, Catastrophe Risk, Health Insurance, 
  • Investment Topics: ALM, Risk Return Policies, Tail Risks, Economic Risks
  • Long list: Compliance, Resilience, Tax, Ethics, Financial Reporting,  Reinsurance, etc...

All of these viewpoints and wide professional manifestations make it hard to classify and compartmentalize actuaries, especially in and around boardrooms. Yet, actuaries are nearly in every field present, often without being identified or recognized as such!

An actuary is what we call 'The Elephant in the Room', or perhaps better formulated:

THE Actuary is the Multi-Perceived Elephant in the Boardroom

Despite of the wide range of positions actuaries can fulfill, it becomes harder and harder for actuaries to follow a career path that leads to a boardroom position as CXX...

Why is it so hard for an actuary to end up as CEO or COO of a company?

The simple answer to this question is:

Thinking in Stereotypes

Because actuaries are good at mathematics, people in general as well as professionals continue to view and stigmatize them as Overspecialized Nerds and Brilliant Autistics. This way of (wrong) stereotype thinking identifies actuaries often as 'problematic communicators' and 'non-managers'. As a consequence, the managerial qualifications of a lot of actuaries are unfortunately overshadowed by their outstanding professional technical skills.

Thinking in stereotypes is a phenomenon that is around us everywhere, as is shown in Herge's comic book "The Valley of the Cobras". In this book the (quixotic) 'Maharajah of Gopel' is vacationing in the french ski-resort of Vargése. Suddenly the Maharajah discovers his pearl necklace has been stolen and he needs a detective to track down his necklace.The rest of the story is shown in the short comic strip below (click to enlarge):

Conclusions and lessons Learned
THE future role of THE Actuary doesn't exist. As an actuary, fill in every professional role that attracts and fits you. Try it out, to discover you can fill in more than one role in the many healthy life years  ahead of you......

Finally some wrap up ground rules to keep in mind:

  1. Never think in stereotypes as an actuary!
  2. If you are an actuary and have the ambition to become a CEO, CFO or CRO of a company: Act, Dress, Speak and Behave accordingly, as other people probably will keep thinking in stereotypes
  3. If you meet other actuaries: Talk and behave like an actuary
  4. Ground Rule Number One: Always Stay Yourself!


Jul 6, 2014

Understanding Confidence Levels in Time

What's the right understanding of the concept of 'confidence level' for a financial institution?

That's not an easy question....

A short (popular) definition of confidence level in terms of Solvency and Basel regulation would be:

The probability that a financial institution doesn't default within a year.

In this blog I'll discuss and compare three more or less accepted confidence levels (CFLs):

  1. Dutch Pension Funds: CFL= 97.5% 
  2. Life Insurers (Solvency II): CFL = 99,5%
  3. Banks (Basel II/III): CFL = 99.9%

Understanding Confidence Level
Before we get into the details, let's first shine a light on a widespread misunderstanding regarding the concept of 'confidence level'.

To make the concept of confidence level more understandable, one might argue as follows:

  1. The confidence level of a Dutch pension fund is defined as 97.5%
  2. This implies that there's a one years probability that the pension fund has an one year default probability of 2.5% (= 100% - 97.5%)
  3. This implies that the pension fund on average defaults once every 40 years (= 1 / 0.025)

This method of reasoning is completely


The mistake that's been made is more or less the same as the next two fallacies:
  1. If one ship crosses the ocean in 12 days. 12 ships will cross the ocean in one day
  2. I fit in my jacket, my jacket fits in my suitcase, therefore I fit in y suitcase

The probability of a pension fund with a confidence level of 97,5% going default, can be approximated by a simple Poisson distribution as follows:

From this we can conclude:

  • In 40 years the pension fund has a 63% default probability.
  • The probability that the pension fund defaults more than once is 26%
  • The probability that the pension fund defaults exactly once in a 10 years period is 19.47% 

Insurer Confidence Level
For an insurance company with a confidence level of 99.5% the results are:

So even an insurer has a 4.88% default probability in a 10 years period on basis of a 99.5% confidence level. Keep this in mind if you take out a life insurance policy!!!

Banking Confidence Level
It starts getting serious when it comes down to a 99,9% confidence level for banks:

Comparing the default probability of (Dutch) pension funds, insurers and bank on the long run:

Although this blog gives some more insight about the consequences of confidence levels on the long run, the real question of course is: what's the price you have to pay to avoid default risks?
That's something for another blog.....

- Spreadsheet with tables used in this blog

May 18, 2014

Bonds: a Crisis Risk Indicator?

As a risk professional you've learned to classify an increase in bond's interest volatility (or standard deviation) as an indicator that bonds have become more risky. Right you are....

Now, with this knowledge, let's take a look at the next chart, presenting the long-term (10Y) interest rate of some of the leading EU member states from January 1993 to April 2014:

This chart clearly shows that :
  • Since the introduction of the Euro in 1999, country spreads start declining
  • Interest rates converge to the year of the famous (Lehman) crisis in 2008
  • After the 2008 crisis, rating agencies wake up and spreads explode again

Let's take a look in more detail, by some log scale zooming......

To find out if the convergence of interest rates really is a kind of early warning crisis indicator, let's add some more EU countries to the chart.

Now the picture becomes clear: A structural decline in bond's standard deviation is not a decline in risk, but more the opposite....

As standard deviation decreases, (crisis) risk increases!

We can check this by looking at the cross-country standard deviation development in time:

These charts, presented on a vertical linear and log scale basis, clearly  illustrate that as soon as the standard deviation hits the 0.2% level, crisis can be expected soon.

Not only is the 0.2% SD-level an early warning indicator for the 2008 crisis that started with the bankruptcy of the Lehman Brothers bank, but it's also an indicator of 'Dot Com' crisis in 2000....

Meanwhile... as from February 2012, standard deviations are declining  again. Time to worry?

Key questions are:
  • when will standard deviation hit the 0.2% floor again? 
  • and when it does, will there be another crisis?

Remember lesson number 1 in risk management: Crises are unpredictable!
Nevertheless, once 0.2% SD  turns up: fasten your investment seat bells....

- Spreadsheet of charts used in this blog
- EU Interest Rates
- Big Picture Chart