Online Murphy Risk Calculator

Risk is like quantum mechanics:

If you think you understand Risk, you don't understand Risk
Maggid after : Feynman

If you are not completely confused by Risk, you do not understand it
Maggid after : John Wheeler

Sure, risk is hard to tackle. The more you learn about risk, the more you become aware of it's sneaky characteristics (clustering, tails, etc).

This is why becoming a qualified actuary takes an incredible amount of time, hard study and many years of experience.  As masters in Risk, actuaries understand the limits in modeling and calculating Risk.

Murphy

Probably one of the more intriguing risk quotes is :

Murphy's Law

"Anything that can go wrong, will go wrong"

by the famous Edwin Murphy.

A quote that keeps an actuary mind busy....  After all, as actuaries it is our duty to quantify and explain uncertainty (as much as is possible) in board rooms and on the accounting table. Not only when decisions have to be taken, but also after things turned out wrong or different from what we thought. This is - to put it mildly - no 'easy task' and it's not getting easier in the near future.....


Just like Murphy, actuaries experienced last decades that (statistic) bad luck often collaborates with bad timing. What drives God (i.e. quantum mechanics or 'Murphy probability') to confront us - (poor) actuaries - with 'fair value volatility', 'longevity explosions', 'subprime defeats', 'imploding real estate market's and 'extraordinary solvency demands by supervisors', all at the same time time?


(Un)Luckily, help is on the way....  In 2004 British Gas commissioned some scientists to create a formula to predict Murphy's Law, also known as Sod's Law.

Murphy's Formula
In a 2005 study, based on a survey of 1,023 adults, Murphy’s Law was shown 'statistically significant'. The final report also supplied a formula for predicting occurrences of Murphy’s Law. Here it is....


Let U, C, I, S, and F be integers between 1 and 9, reflecting respectively comparative levels of Urgency, Complexity, Importance, Skills, and Frequency in a given set of circumstances. Let A, which stands for Aggravation, equal 0.7 (Please, don’t ask why). The likelihood (L) of Murphy’s Law obtaining under those circumstances, on a scale of 0 to 8.6, turns out to be:

L = [((U + C + I) x (10 - S)) / 20] x A x 1 / (1 - sin (F / 10))

Murphy's Formula strikes itself
Unfortunately, Murphy's law suffered from self reference, as one of the  authors, the mathematician Phil Obayda, commented on a 2004 blog that this formula is wrong.

The correct formula according to Phil is:

 P= (((U+C+I) * (1-S))/2) * A * (1/(1-Sin F))

with P = probability of Sod's Law Occuring and U, C, I, S and F values greater than 0 and less than 1, keeping the mysterious A = 0.7.

Murphy's formula simplified
Simplifying this last formula leads to Maggid's formula for the probability (%) of Murphy hitting you, whenever you perform a task:

Although application of this formula is not (yet) an obligated part of the actuary's Code of Professional Conduct, please check this equation anytime you're about to defend an actuarial advice on a Board's table.

How to use Murphy's formula: an Actuarial Example
Let's do a simple exercise to demonstrate the power of Murphy's formula:

You've developed a risk model of the Stock market. In a meeting the Chair of the board asks you how certain you are of your model being right. You know the difference between risk and uncertainty, so you say "one moment please" and pick up your pocket calculator while reflecting: This is a ´U=3, I=9,C=10,F=3´ situation, and I'm a S=9 actuary. That calculates as P=10.4% of Murphy hitting me. Within 20 seconds you (over)confidently answer: I`m about 90% sure of my model!

The Chair of the Board looks desperate... His eyes reflect: ´Is 90% good or bad?` You didn't realize your model was that important to the board.  But.. if that's so, 'Importance' should not be rated at I=9 but at I=10, raising the failure probability to almost 11%. Now you start doubting yourself : What if you overestimated yourself? What if you're only a AA-Actuary (level S=7) instead of a AAA (level S=9)? This would increase the probability of failing to 31.3%. Suddenly you realize you're only one step away from a major personal actuarial meltdown.
You get yourself together, regain your self confidence, realize you're one of the best actuaries in the world (S=10) and full of confidence you reply the questioning eyes of the Chair with: "Sir, I'm almost 100% certain my model is right.

The Board is relieved and content. You're an actuary they can trust. Now they can decide without hesitation.

So next time you want to know the failure probability of a task, use the next Online Murphy Calculater.

Good Luck with Murphy's calculator!

Used sources/Links:
- Sod’s Law: A Proof
- Newyorker: Murphy At the Bat
- The Engineering of Murphy's Law?
- Legend, Inc. Murphy's Laws
- The Stock Market: Risk vs. Uncertainty
- Murphy's Online Calculator

The LORD and Risk Management

The (2010) Louisiana Oil Rig Disaster (LORD) shows that oil industry Risk Management Plans fail.

In general, Risk Management Plans are focusing too much on Risk Control, too little on Risk Prevention and certainly not enough at Damage Control.

The LORD shows us that a sufficient Plan B is missing. The only 'hope'  in the LORD's current Plan B was the Blow-Out Preventer (BOP) at the bottom of the ocean.

Apart from the question whether that BOP has been tested well: what is Plan C if this BOP would fail, as it obvious does?

Plan C ?
Of course not, we don't need a Plan C. All we need is an adequate Plan B. Plan B should simply have included the installing of two other well tested BOPs at an appropriate distance under sea-level.




Supervisors fail as well
It was only after the LORD's appearance, that the House of Representatives began an investigation into "the competency of the companies' risk management and emergency response plans".

This action is a typical case of:

When the steed is stolen, the stable-door is locked

From all this (above) it's clear that not only Risk Managements Plans are failing, but also the preventive control of those plans by national supervisors.

Why care?
As an actuary you might think: BOPs and an exhausting Plan B are perhaps fine regarding the oil industry, but who needs those instruments in the financial industry?

Unfortunately, the financial industry makes the same mistakes as the oil industry. From a long list, in short, two financial examples:

• Only after the dramatic fall of coverage ratios in 2009, Pension Funds started to make recovery plans (Plan Bs)
• Only after Greece's financial crisis and the corresponding decline of the Euro, Europe started thinking whether or not they should help Greece out and developed a Plan B.

Rethinking Risk Management

It's undeniable, we fundamentally need to  rethink and restruct our Risk Management Plans.

Risk Control
First of all we'll have to distinguish more between Risk and Damage. Preventing, reducing and controlling Risk (not just damage!) is key. Testing and supervising (certification!) Risk Management Plans is a must and needs more attention.

Damage Control
Apart from  the probability of a Risk event, Damage Control needs more attention. Here 'Controlling' includes Reducing and definitively Stopping Damage. Both are essential. This implies that a serious Plan B is in place and regularly tested and approved by supervisors. This Plan B should include automatic shut off valves in every line of business and 'triple actions plans' in case a first or second case action plan B unexpectedly fails.

How to deal with Unthinkable Risks?
Moreover, to create effective Risk Management Plans, we have to deal with the issue of "Unthinkable Risks".



No matter how creative you and your organization are, one thing is sure: new 'risks you didn't think of' will always show up . Problem is that - just like the LORD showed us -  you'll only become aware of a new risk after its manifestation; when it's clearly too late.


A Risk Sensitive Mindset
This - however - doesn't mean that you can't deal with unthinkable risks. To manage unthinkable risks you'll have to create a 'Risk Sensitive Mindset' in your organization. It takes employees who are vigilant and empowered to take direct action. Creating such an organization pays off in more than one way, as vigilant employees will also have a nose for new business and sales opportunities.
This way, Risk Management costs are not just unavoidable costs but profitable investments.

The LORD and your own responsibility 

As we seem perfectly capable of managing our own personal life without a fifty-page Risk Management Plan, most likely this type of Employee Risk Attitude Development (ERAD) is the most important (but also most disregarded) part of Effective Risk Management. In this case the LORD can't help us, it'll have to be our own insight and decision to take action to develop risk sensitive and responding employees.

Still not convinced that ERAD is the right way ahead? Imagine what difference we actuaries could have made to the (financial) world if we would have been able to spot and address sub-prime mortgages or the weakness of our ALM models in an early stage.....

Many LORD's blesses and Good Luck with this new view on Risk Management!

Related Links / Resources:
- Government Branches Investigate Louisiana Oil Rig Disaster
- UBC: Case Studies of Engineering Failures
- SKY: Emergency Declared As Oil Approaches US Coast
- Strategic, organisational and risk management context

New Actuarial Ethics

As actuaries we have to act in a complex world. This is no easy task. If we're honest, we have to admit that in this last decade we got ourselves dragged along the road of unrealistic and too optimistic ROI outlooks.

'Good' and mathematically sound advices turned out 'Bad'. Pension Plans are in trouble. New ROI-hope seems to be on our doorstep. With a look of weariness and despair, board members and clients seek our advice.

It's our duty to advice them in this financial jungle. Unfortunately we can not look into our Cristal Ball and predict the future. Moreover, topics like the ROI and longevity outlook become more and more an ethical issue instead of a mathematical exercise in uncertainty.

Yes, it's our responsibility to guide insurance companies, pension funds and other financial institutions through an unsure future. As new age risk managers, we have an enormous responsibility on our shoulders to winnow the Bad from the Good advices. One thing is sure, we have to do better than we did in the past, but how?

E=A-L ?
It's not enough to judge whether a 'one point Equity estimate' keeps the Assets and Liabilities in balance. What's even more clear, there is no one point E, A or L. There are only probabilities and to judge those, our personal ethical principles become even more important than our essential technical skills and experiences.

Our main puzzle is that this decade has shown that observations of the past are no convincing guarantee anymore for predictions of the future. This implies that we have to fall back on other, more ethical, principles in our advice. The good old ethical principles and methods to deal with actuarial dilemmas, need a fresh up.

Genuine Moral Intelligence (GMI)

Main issue is, that the more 'objective' and significant our data get and the more sophisticated our models may become, the more our advice becomes susceptible to unpredictable developments.

On top of all this, more control, increasing data or more advanced models, will only create a false sense of certainty. These old instruments won't  help us anymore en will only reduce the long term returns and aggravate the ultimate volatility. The only way out is to throttle back on our 'risk attitude' on basis of some new ethical principles.

These new ethical principles are not just about 'minimal legal compliance'. Modern actuary ethics goes further than that. In fact ethics is reincarnated as 'Genuine Moral Intelligence' (GMI).


GMI, as defined by Richard E. Thompson, is: Aristotelean decency, vision, purpose, and uncommon sense.

The applicable GMI equation is given by:  

GMI = ER + UPVs + RSI

ER = Ethical Reasoning
Rather than "pick an ethical theory and stay the course," one may ask and answer a series of questions.
Some examples: Who are the stakeholders? What ethical principles apply? How do they apply?

UPVs = Underlying Personal Values.
UPVs are used to answer the above questions.
Some examples:

• As a board member, do you vote for continuing a needed community medical service that is losing money, or for cutting the service to avoid financial problems?
• As a pension board member, to what kind of probability are you willing to increase the pension of the pensioners at the risk of having to raise the contribution of future pension fund members?

Underlying personal values also determine whether we act according to our morally intelligent conclusion, or choose to ignore it.

RSI = Reasonable Self Interest
Ethics only makes sense if we can come up with a sound answer to the question "Why act ethically?"

Here, Aristotle comes in with a helping answer: "To serve one's own self-interest".
Keep in mind there's a difference between self-interest and greed. The wise Aristotle explains: "Love of self is a feeling implanted by nature, but selfishness is rightly censured, because selfishness is not mere love of self but the love of self in excess, like the miser's need for money."

So self-interest is nothing unethical in itself. An example from the famous Adam Smith stresses this:

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest." (reasonable self-interest)

From now on actuarial advice is different!

GMI could be the new key to economic recovery. We have to get back into realistic pension plans. We need to establish the necessary changes (due to aging) in our social security systems. It's our task as actuaries to share and discuss the above principles with our clients and the boards we advice, in order to force the crucial (economic) change that's needed. This is no easy task, as board members are often not used to such transparent en open discussions involving their own underlying personal values, preferences and (reasonable) self-interest.

So from now on, when you discuss an actuarial report or advice on board level, it's different! From now on, we've got New Actuarial Ethics, where GMI is inclusive. 

This new ethical theme, including the communication and discussing techniques, should be incorporated in our actuarial education program....


Used Sources/ Related Links:
- Thompson: Ethics is dead, what do we do next?
- The crystal ball 
- When Bad Things Happen to Good Plans
- Actuarial Ethical Dilemmas(2010,ppt)
- Actuary Duty (Vrystaat)
- Clay Bennett Cartoons