Jul 27, 2009

Actuarial Fallacies

Just some light stuff, to chew the cud during holidays...

A good friend tells you that a certain 'John Nevermet' is an introverted professional and is either an actuary or a salesman.

Which one do you think John most probably is?


If your first thought was: an actuary, congratulations(!), you just got caught in what is called a classical

Thinking Trap

Most people - not actuaries of course ;-) - are tempted to think John is almost certainly an actuary.On the other hand, they think of a salesman as 'outgoing', 'extrovert' or maybe 'pushy', but certainly not as 'introvert'. Wrapped up : John is an actuary....

Sorry, but - as you know - this logic conclusion is definitely wrong. It neglects the fact that salesmen outnumber actuaries at most 100 to 1. Before you would even start to consider John's character, you should have concluded that even when all the actuaries were introvert, there would only be a small 1% probability that John is actually an actuary (only in the unlikely case that less than 1% of the salesmen would be introvert, this option would be logically to consider).

Top 10 Thinking Traps
This foregoing simple example is just one of the fabulous Top 10 Thinking Traps Exposed by Luciano Passuello.

On his blog Litemind, Luciano explains in a 5 minute 'must read' called 'How to Foolproof Your Mind' the next interesting and most harmful Thinking Traps, including suggestions on how to avoid each one of them. :

  1. Anchoring Trap: Over-Relying on First Thoughts
    Your starting point can heavily bias your thinking
  2. Status Quo Trap: Keeping on Keeping On
    We tend to repeat established behaviors
  3. Sunk Cost Trap: Protecting Earlier Choices
    Sunk cost shouldn’t influence a decision, but it does
  4. Confirmation Trap: Seeing What You Want to See
    Being less critical of arguments that support our initial ideas
  5. Incomplete Information Trap: Review Your Assumptions
    Overlooking a simple data element can mislead our intuition
  6. Conformity Trap: Everybody Else Is Doing It
    Other people’s actions do heavily influence ours
  7. Illusion of Control Trap: Shooting in the Dark
    The tendency to overestimate our personal control
  8. Coincidence Trap: We Suck at Probabilities
    A “miracle” is - given enough attempts - possible!
  9. Recall Trap: Not All Memories Are Created Equal
    “Special events” have the potential to distort our thinking
  10. Superiority Trap: The Average is Above Average
    People have much inflated views of themselves

Thinking traps are a special form of fallacies.

Example
A nice and triggering example of a composition fallacy is:
I fit into my shirt... My shirt fits into my luggage...
Therefore I fit in my luggage...

Can you tell what's going wrong here?
Yes? Then get ready for the next fallacy phase.

Although there a complete list of fallacies, another new interesting subset could be defined as 'Actuarial Fallacies'....

Actuarial Fallacies
Except for a 1988 homonymous, humorous intended, nevertheless still actual and relevant document by Charles L. McClenahan, nothing much has been published on actuarial fallacies.

Apparently fallacies are not an issue on the Actuarial Globe.

Therefore, I'll confine my remarks to a few actuarial events, of which each one could easily be nominated for the fictional 'Grand Actuarial Fallacy Prize':

  1. Longevity risk can be easily managed
    Longevity slowly but steadily increases. It's not a yearly smashing or impressing risk, but over the years it has the characteristics of a killing sniper: when you finally discover the accumulated longevity loss after a few years, it's almost too late to handle and take appropriate measures.

    Actuaries could have foreseen a few decades ago that the average life span would keep rising and adequate measures had to be taken at once. Instead, actuaries failed to catch the implications of the rise in longevity and were caught by the proverbial 'boiling frog effect'. In short: actuaries failed to act in time....

  2. Stocks are a hedge against fixed-income liabilities
    Already in 1994 in a document called 'On The Risk of Stocks in the Long Run', nobody else than Zvi Bodie already proved that stocks are not a hedge against fixed-income liabilities even in the long run.

  3. Credit Crisis
    Actuaries have failed in foreseeing the credit crisis. We have greatly underestimated the developments and put our head in the sand. We have trusted business plans promising ROEs of 15% and more.Read more in Actuary-Info's : "Wir haben es nicht gewuƟt!"

  4. VAR Model
    As an article in The Actuary shows, we got intimidated and overruled by the 'magic' quants with their Value at Risk (VaR) models. We did and do know better as actuaries, but missed the boat. Actuaries should be more than professionally trained in giving 'push back'.

  5. The relationship between risk and return
    As we know this risk-return relationship is central to strategy research and practice.

    In measuring risk as the variance of a series of accounting-based returns, Bowman obtained the puzzling result of a negative association between risk and mean return.The expected positive association between risk and return turns out to be elusive.

    Henkel explains in two must-read articles 'Risk-Return Fallacy' (2000) and The Risk-Return Paradox for Strategic Management: Disentangling True and Spurious Effects the problems and solutions in this field.

    Instead of only following what's happening on the other side of the balance sheet, actuaries should mobilize themselves and add some new insights!

    Asset Actuaries, please rise!


    Es ist nicht genug zu wissen, man muss auch anwenden
    - Johann Wolfgang von Goethe -

Now that we've unmasked several fallacies, in special the 'introvert actuary fallacy', let's conclude our fallacy course with a 'lessons learned?' actuarial anecdote:

Why it's better to work with an imperfect actuary
We all know: A perfect actuary draws perfect conclusions form perfect datasets.

Then of course : A perfect actuary certainly draws "wrong conclusions" from imperfect data.

It's a fact that the data are always imperfect.

So that we can conclude that there is at least a small chance that an imperfect actuary may draw the right conclusion.


That's why it's better to work with an imperfect actuary.

Client Quote
As we know, clients are always right. Remarkably, the next client quote seems to stress the mentioned successful outcome of the imperfect actuary:
I once had an actuary tell me that, because the future is uncertain, his numbers were almost certainly wrong, but he believed they were less wrong than guessing outcomes with no analysis.

You think - by now - you know everything about fallacies?
Well, test it by taking the next fallacy Quiz:


Success!

Original source :
The November 1983 Random Sampler article Actuarial Fallacies

Jul 16, 2009

Hypegiaphobia

What's that spell? Hypegiaphobia?

Yes, Hypegiaphobia is the unpronounceable 'short' for:

A fear of responsibility

In a 2008 white paper, called Hypegiaphobia, KPMG stresses the importance that organizations want to be and must be 'in control' of a multitude of risks and therefore make enormous sacrifices to achieve this goal.

CEO, management and employees have to comply to so many simultaneous goals, and the consequences of not being compliant on a single issue are that high, that people fear to take individual responsibility in a organization.

In search of the balance between rules and trust, KPMG
calls upon the parties involved to provide more space for individual responsibilities. In the mentioned white paper KPMG answers two key questions:

  • Are the high investments in risk management effective and do they really lead to a lower risk profile?

  • Does risk management overshoot its goal and produce undesirable effects, such as reduced entrepreneurial spirit, increasing litigation, a culture of fear and a potentially adverse effect on the competitive position?


Trust Rules

Moreover, in 2009 KPMG extended their view on Hypegiaphobia by publishing a document called 'Trust Rules'.

Guts, vision and trust go hand in hand in a time of increasing litigation.

Unplug
Lately, numerous persons and organizations in the Netherlands have had the guts to “unplug”. Unplug is a new work style by which numerous (compliance) issues are handled in unconventional ways :
  • Getting rid of unnecessary rules, of fixed places and times
  • Dealing better with knowledge
  • Collaborating more
  • Taking more personal responsibility
All this with a a single focus: The client.

Principles
To organize trust and to be able to trust, KPMG has formulated (on basis of client interviews) nine principles they call trust rules (mark: the noun has turned into a verb) :
  1. Make contact personal
  2. Define common goals
  3. Set the right example
  4. Build trust with sensible rules
  5. Share responsibility and trust
  6. Stay on course and keep calm, even when things go wrong
  7. Rely on informed trust, not on blind trust
  8. Be mild on misunderstanding but crush abuse
  9. Dare to experiment and learn from experience

Risk

In a document called Signs of Safety, risk is defined as an increasingly defining motif of the social life of western countries.

However, risk is almost always seen as negative, as something that must be avoided.

Killing Black Swans
To put it simply: everyone is worried about been blamed and sued for something. Thus organizations have become increasingly risk-averse to the point of risk-phobia. Elimination of every Black Swan risk at any price, seems the unrealistic and never ending target.

New solutions
The challenge for management, actuaries and accountants is to see and define Risk in terms of a potential big win and investment instead of only a potential big loss. This also means that - as a society - we have to reformulate rules and laws in a way that risks can be taken in such a way that failure, bankruptcy are or catastrophes are not (nearly) completely excluded anymore.

Often economies of scale lead to the rise of international (financial) companies that overshadow individual countries in terms of VAR.
If country governments of such 'inhabited' international enterprises are convinced that an eventual bankruptcy of such a company would create great collateral damage and therefore is not an realistic option, things will have to change. In these cases governments have no other choice than to order by law:
  • a limitation of (international) company size
  • a limitation of reciprocal contracts between big companies
or...
  • to demand and allow companies to restructure themselves in such a way that, in case of a catastrophe, only a part of the company goes bankrupt and not the company as a whole

In these cases state (re)insurance is not a preferable solution. Pricing this risk would be too expensive or - even worse - not charging for this risk would lead to a situation where management can take every risk they want, because in case of a bankruptcy, the government would back up anyhow.

Risk-Phobia Virus
As actuaries we're extremely vulnerable to the 'risk-phobia virus'.
Let's not get caught by this virus or hide in the bush, but take a calculated risk and go out to present our new solutions that make the difference in tomorrows risky world. Risk..., a never ending issue....

Links: Hypegiaphobia Video , List of phobia's, Dutch nine trust rules
Sources: Signs of Safety

Jul 12, 2009

Actuary Core Qualities

Apart from an official outstanding actuarial education, what core qualities does an actuary need to be successful?

Summarized, here are some of the main qualities:
  • Great Mathematical skills and experience
  • Outstanding multi level, oral and written communication skills
  • Interpersonal and social skills
  • Being able to downgrade complex problems to simple decisions to be taken
  • Self-motivated, ambitious, creative, independent, team worker
  • Conflict solving capabilities; Empathic but also decisive
  • Professional integrity, commercial outlook
  • A professional discussion partner for professionals in other areas as Pension, Investment, Health, Risk, Governance, ICT, Finance, Administration, Marketing, HR, Legal & Fiscal affairs, etc.

To put is simply: an actuary has to be a kind of 'White Raven', a 'one in a million professional'.....

However, actuaries are just like humans, they do not only have their core qualities, but also their pitfalls.

Besides, how can you find out what your core quality is?

Core Quality Test

Well, the simple answer is that -thanks to Daniel Ofman - you can find out in a one minute online test what your core quality is.

This test doesn't only defines your core quality, but also your pitfall, challenge and allergy.


Now you know what your qualities and pitfalls are, you may as well start working on them!

Links: Core-Qualities
Sources : Wiki, RSS,