Actuarial Cookery in the Boardroom

Suppose your friend gave you the recipe for a delicious 'Paleo Tomato Soup'.

Does that recipe also guarantees you a delicious meal ?

Undoubtedly you answered this question with a clear "no".

Why?

As we all know, it is the 'touch of the chef' that determines the quality and final taste of the meal. The recipe is the score and the chef the performer of the culinary piece of music, that will end up on your plate.

Although the above example probably sounds logical to us, the actuarial cooking practice appears different. Let's take a look at the next example.

An Excellent ALM Advice

What about a 'plate of five' asset mix advice that's on the board's breakfast table, as the ultimate outcome of your excellent ALM analysis...

Illustration: Colin Daniel

Does this ' computer recipe' actually guarantees a sound decision about an adequate investment policy?

Actually, the answer to this question can hardly be other than 'NO'.

Your advice is a static advice in a dynamic world and - on top of - the final question remains whether the asset manager is able to 'spice up' your recipe.

The actuary as Risk-Director

Key question is whether we as a profession - keeping ourselves inadvertent in the role of  'technical experts' - merely feel responsible for delivering the recipe for a cold asset mix salad on basis of 'expected values' ​​and variances.

Or ... that we actuaries are willing to act as 'risk-director' in the interactive process of creating a dynamic investment policy that's based on a nonlinear constructed healthy and varied based asset mix over time. Albeit..., without taking the driver's seat in the advice process, but with the obligation to report the eventual existence of any GMCs ('Genetically-Modified Cickens') in the asset-mix.

Economic Risk Management or ALM?

In the thorough process of adopting a dynamic investment policy, financial boards more and more take decisions based on the study of different future economic scenarios.

This development challenges actuaries to invest more in the development of "Economic Risk Management" (ECRM) models instead of traditional ALM modeling. In ECRM 'asset class data' (as in ALM) and economic data (GDP, inflation, consumer confidence, etc) are mixed in an integral set of data, that's analysed and - with future expectations, 'stress-test conditions' or of 'believes' -  (nonlinear) translated and optimized in a dynamic asset mix.

This economic risk approach requires new nonlinear economic-asset models that urge for a close cooperation between economists and actuaries, resulting in an serious interactive board discussion (board members and economical & actuarial experts) of the ECRM models.

This approach is not limited to the well-known three or four so-called 'muddle through scenarios', but covers the outcome and impact of a large number of more precise formulated possible economic scenarios on the asset mix and the investment strategy.

Scenarios that help determine the overall risk appetite and result in a major impact on the composition of the strategic asset mix.

New Q&A's

In other words, new scenarios that give answers to questions like:

• What happens if China suddenly withdraws from U.S. bonds?
• What happens when the U.S. Fed stops its QE program?

As with the current ALM approach, the focus should not be only on the quantitative outcome of the ECRM model, but more on the discussion and wider perception of how economic risk affects the optimal asset mix and the dynamic asset policy, allowing boards to take more informed and underpinned investment policy decisions.

In this approach, ALM and ECRM are helpful but not dominating decision support tools in the creation of the final investment policy and not an unintended consultant's dictate that's implicitly adopted ("take note") by the board and then subsequently implemented.

How to Check the Quality of your ALM or ECRM Advice?

Fortunately, it is easy to check whether your ECRM or ALM advice is actually a good quality decision document or just a bite-sized chunk.

If your advice offered only 'one option' or was adopted without a serious debate or any amendments, then -  to put it euphemistically - your advice is 'ready for improvement'.

Actuaries: Backroom to the Boardroom

Finally, it all comes down together whether we as actuaries want to profile ourselves as 'recipe writers' or pick up the 'risk-director role' as an 'actuarial chef'. If you choose the latter, please stand up and help to bring out actuaries from the Backroom to the Boardroom. Success!