Two reasons motivate less

In an earlier TED Show psychologist Barry Schwartz illustrated in a humorous and catching way the effects od "Too much choice".

Now, in another TED Show video called, "The real crisis? We stopped being wise", he shows us that the current financial crisis can't be solved by more rules or incentive policy.

Schwartz pleads for a new approach based on a Obama's approach to solve the current financial crisis. Already before his inauguration Obama said:

“We must ask, not just is it profitable, but is it right”

Schwartz: "In his inaugrual address, Barack Obama appealed to each of us to give our best, as we try to extragate ourselves form the current financial crisis. But what did he appeal to? He did not, happily, follow in the footsteps of his predecessor and tell us to just go shopping. Nor did he tell us , 'Trust us, trust your country. Invest. Invest. Invest.' Instead, what he told us, was, to put aside the childish things. And he appealed to virtue.



Two reasons motivate less?
Schwartz brilliantly illustrates the common wrong notion that if you have one reason for doing something and you are given a second reason for doing the same thing, it seems only logical that two reasons are better than one, and you are more likely to do it.

This is not always true. sometimes two reasons to do the same thing seem to compete with one another instead of complementing, and they make people less likely to do it.

Schwartz illustrates this in the next example:

In Switzerland, back about 15 years ago, they were trying to decide where to site nuclear waste dumps. There was a national referendum and some psychologists went around and polled citizens who were very well informed. And they said, “Would you be willing to have a nuclear waste dump in your community?” Astonishingly, 50% of the citizens said “Yes.” They knew, or thought, it was dangerous, they thought it would reduce their property values, but, it had to go somewhere, and they had responsibilities as citizens.

The psychologists asked other people a slightly different question. They said, “If we paid you six weeks salary, every year, would you have a nuclear waste dump in your community?” Two reasons: it is my responsibility and I am getting paid. Instead of 50% saying yes, 25% said yes.

What happens is that the introduction of the incentive gets us to a point that, instead of asking, “What is my responsibility?”, all we ask is “What serves my interest?”

When incentives don’t work, when CEOs ignore the long term health of their companies in pursuit of short term gains that will lead to massive bonuses, the (wrong) response is always the same: get smarter incentives.

So, in general, adding more or better incentives will not motivate us more or increase our responsibility!

Actuarial lesson
As actuaries we often try to find as many reasons as possible to convince a board of taking the right decision. Perhaps we should emphasize more on finding and communicating that one and only reason to take the right decision: a prudent, healthy and solid decision (investment) that benefits all stakeholders on the long and short term, in a balanced way.


text version of video

Actuary Humor I

A priest and an Actuary were rounded up for execution by the French Revolution.

The priest had been taken over to the Guillotine and was asked if he had any last words. He said 'If I am innocent, let the Lord God Almighty prevent this execution!'

Everybody laughed until the Guillotine failed to come down on three consecutive tries due to a malfunction. So according French law, the priest was set free.

Then the Actuary had to be executed. He climbed the guillotine and calmly laid down his head on the block. Again the very same malfunction occurred on the first two tries, at which point Actuary looked up, examined the guillotine and exclaimed: "I think I see the problem"

Actuworry: Pension Math

According to Financial News the Pension Crisis is growing in Europe.
Except for Germany, most European countries are in trouble due to the credit crisis and subprime mortgages. On average, funding ratio's are below 100%.

As a lot of pension funds are mature, raising premium levels will not offer any help on the short term. Neither a 'selling stocks strategy' does. As a consequence all pension payments are at risk.

'Primarily' we should have learned from Einstein's Pensions theory:

Nevertheless, as actuaries have to be realistic, Einsteins' Pension Formule is a day after the fair. Let's look at at an other way out of this crisis.

When nothing helps, the only way out seems lowering pension rights and payments. However, this is premature and will most likely cause unnecessary social commotion.

Consider, what would you prefer:
A. $ 10.000 pension with a 100% funding ratio?
B. $ 8.000 pension with a 125% funding ratio?

Actuworry won't help. As actuaries we have to stay cool. The only realistic way out is simply to wait for better times.

Langton's Actuarial Ant

As an actuary, you believe in the consistency of your risk models.

You might think that with 10.000 observations you've got enough stuff to present a consistent statistical model with realistic expectations, variances, etc.

You are aware that the output of your model depends on the quality of the data and the assumptions. In your advice you try to communicate all that to the board in order to support sound and responsible decisions.

In other words, you've got a consistent model and, as an actuary with a professional and consistent life-philosophy, you have everything under control. No great changes will take place?

Well, 

you're probably wrong !

Just like our models, we actuaries, are not consistent

Even if we (or the risk reality we try to model) act in a stable consistent way, we (or risk reality) keep interfering with our environment and our environment responses to us.

At first this response seems meaningless and of no value. You think you're consequent and your work and achievements in life seem relatively stable, perhaps a little bit chaotic and of no great significance. But in repeating your proven receipts, way of doing or procedures endlessly, eventually

Something will change
This change often will not appear as an evolution in your life, but as a kind of revolution, out of the blue and most often unexpected.
Suddenly, just like in the credit crisis, there's an emerging situation. The way you always did it, doesn't turn out right anymore. Your model crashed, you crashed and there was nothing you could do about it. You couldn't have foreseen it, you could not have prevented it the classical way.

That's why we always have to add some non-classical extra 'common sense' safety margin thinking in our models.

Progress?
The other side of this is also true. Fore example, when you study, you'll probably, once in a while, think: what progress am I making?

But don't worry, if you keep on your track, there'll be a day your future suddenly comes to you (out of the blue: as a kind of emergent property) instead of "the you trying to make your future" in this Game of Life.

A good demonstration of this principle is

Langton's ant Langton's ant is an virtual ant that starts out on a grid containing black and white cells, and then follows the following set of rules. If the ant is on a black square, it turns right 90° and moves forward one unit. If the ant is on a white square, it turns left 90° and moves forward one unit. When the ant leaves a square, it inverts the color. The result is a quite complicated and apparently chaotic, but relatively stable, motion. But after about 10.000 moves the ant starts to build a broad diagonal "highway".

So keep in mind "Langton's Actuarial Ant" next time you design a new risk model.

Anyhow, stay on your track as an actuary and remember, whether it's you in life or your models, someday there'll be

a collapse of chaos

Coastline Fair Value

Close your eyes and take a guess at the Australian coast length? Answer : 'Exactly' 25,760 km.

1. Right, according to Wikipedia
2. Wrong! Because the exact coast length depends on the length of your ruler!

If you would measure the Australian coastline with a 1-mm ruler, you would get a length of more than 100 .000 km!

This leads to the question:

Does a 'coastline fair value' exist?

After all, as the ruler gets diminishingly small, the coastline's length gets infinitely large.
This phenomenon is also known as the Richardson Effect (or the coastline paradox).

Coastline Formula?
In 1967 a document called "How long is the coast of Britain?" was published by the great mathematician Mandelbrot

In 1967 he revived the original formula, earlier developed by Richardson :

L(G) = F . G^(1-D)

with

L=length of the coastline as a function of G

G=Ruler length

F=positive constant factor,
D=constant (D>=1). D is a ‘‘characteristic’’ of a frontier, varying from D=1 for a straight frontier to D=1.25 for a very irregular coastline like Britain. It turns out that D = 1.13 for the Australian coast and D=1.02 for the very smooth South Africa coastline.

Fractals
The constant D also stands for 'Dimension' and in 1975 Mandelbrot develops this Dimension- idea to what is called the Fractal Dimension.

Fractals turn out to be the perfect (math) language for describing all kind of natural phenomenas like leaves, trees , etc.

Fractals are even used to describe the stock market, the credit crisis or the coastline of the law.


Coastline Formula & Valuation
What can we learn from this fractal coastline measurement with regard to valuations?

1. Stop changing the rules
   If accounting standards like IFRS , GAAP and IAS or legislation are constantly changing (e.g. amendments) and getting more and more specific, valuing a company becomes like measuring the coastline with different rulers.
   
   In this case management, supervisors, stake- and shareholders lack a sustainable view on their business. You can't justify the results and value of your company if you have to measure yourself with a dynamic ruler!
   
   
2. Stop digging
   More and more deep going risk research will eventually lead to an substantial increase or even 'infinite' Value at Risk.
   
   Therefore it's important to define portfolio-, market- and product-risk- limits and structures first, right from the companies (risk) strategy.
   
   These instruments reduce the needed depth of risk research and therefore increase the control- and efficiency-level of the company.

Try to think scale free and have fun by applying fractals in actuarial science!

Actuary Quiz

Take the actuary quiz!

1. Qualify as U.S. Actuary?
2. The likelihood of death?
3. Skills quiz for students

Have fun !

Longevity escape velocity

Aubrey de Grey, a British biomedical gerontologist, states in his book "Ending Aging," that that the fundamental knowledge to develop effective anti-aging medicine mostly already exists.

In a Ted Show presentation he states:

Why should we cure aging?

Because it kills people!

Age damage
There are seven types of aging damage :

Damage rising with age	Proposed as contributing to aging by
Cell loss, cell atrophy	Brody (1955) or earlier
Extracellular junk	Alzheimer (1907)
Extracellular crosslinks	Monnier and Cerami (1981)
Cell senescence	Hayflick (1965)
Mitochondrial mutations	Harman (1972)
Lysosomal junk	Strehler (1959) or earlier
Nuclear [epi]mutations (cancer)	Szilard (1959) and Cutler (1982)

Although, for more than 25 years, science suspiciously didn't seem to develop, all kind of medicines to repair these damages are already within reach for mice.

Age damage for human beings is strongly age related:



As the chairman of the Methuselah-Foundation, De Grey stimulates scientists to develop medicines that repair age damage for this living generation.

Experiments on mouses showed that medicines didn't only slow down the aging process, but could reverse it as well (condition: start in time!). It turns out that every time a new medicine is developed and applied, it restores - above a certain threshold of reserve capacity - the lost reserve capacity for about 50%.

This would imply that if new medicines for human beings would be developed within the next decade and the rate of developing new medicines will be fast enough to stay 'ahead of the game', all people of 50 years and younger would be able to live a thousand years or more and people just slightly older could still live for hundred years or more.

In 2006 Technology Review announced a $20,000 prize for any molecular biologist who could demonstrate that De Grey was wrong. Nobody succeeded!

If De Grey is right, actuaries don't even have to start calculating new life expectancies or other (financial) consequences. Life insurance and pension will have to be redefined.
Even stronger: We'll have to redefine our life!

Sources: Ted Show presentation, Pres. 1, Pres 2

Related links:
A model of aging as accumulated damage matches observed mortality ...

Table Converter (Free!)

Do you recognize this? Sometimes you spend hours copying a simple table from a WORD-document, Internet Page or PDF-file to your (Excel) spreadsheet.
What should take about two minutes work, ends in frustration. Finally you decide to fill your spreadsheet by hand.

These times are over. With the next simple javascript application, called

Table Converter

, you'll be able to copy most tables to your spreadsheet in minutes.

Success!

Wir haben es nicht gewusst

Let's be humble and take a look at home. The home of actuaries, accountants and last but not least 'quants'.

Gewußt oder nicht gewußt?
Actuaries and accountants have failed in foreseeing the credit crisis. Together, we have greatly underestimated the developments and put our head in the sand. We've also failed to bring the emerging crisis to a possible end through enhanced cooperation with each other or by sending out common strong signals. In short: "Wir haben es nicht gewußt!"

Without an adequate technical substantiation, we have trusted business plans promising ROEs of 15% and more. This, while we all know that the average risk-free rate is still about 10% below this level and that such high returns can certainly not be made without taking additional risk.

VaR Model
As an article in The Actuary shows, we got intimidated and overruled by the quants with their Value at Risk (VaR) models. The consequences of the advices of these magic mathematicians and their VaR models are well explained in an excellent article called 'Risk Mismanagement' in the New York Times.

In another article, Global Association of Risk Professionals Review, David Einhorn explains:

VaR ignores what happens in the tails.

It specifically cuts them off.
A 99% VaR calculation does not evaluate what happens in the last 1%.

This makes VaR relatively useless as a riskmanagement tool and potentially catastrophic when its use creates a false sense of security among senior managers and watchdogs. " Quote:

VaR is like an airbag that works all the time,
except when you have a car accident

Also, according to Bloomberg, the risk-taking VaR model is broken and everyone is coming to the realization that no formula or rating system can substitute for old-fashioned 'due diligence'.

Quantum mechanics
Because of the complexity of these new VaR-like models, experienced actuaries, accountants, managers and supervisors were all afraid to ask deeper questions or to admit that they didn't totally understood these complex models that were presented as 'simple manageable board instruments' with 'simple steering parameters'. Just like nobody is eager to admit that 'quantum mechanics' is hard to understand and therefor every amateur quantum guru can say what he wants, because nobody checks it.

Consequences
This way, indirect and by our advice and our models, CEOs and CFOs of large companies and pension funds got the (wrong) impression that 'complex financial markets' were based on 'a sound statistical model', where (annual) deficit risks of 2.5%, 0.5% or 0.1% are exactly calculable and moreover also acceptable.

Whatever, lessons learned, new opportunities for actuaries to set a new benchmark for '21 century riskmanagement'.

However..., stay careful, to catch a tiger by the tail is risky!

Unfair Value

How can you be against something that's fair, like "Fair Value"?
What could be wrong, valuating a company at market value?

IceComp Case
Let me take you along in a story about IceComp, a fictitious ordinary wholesaler in ice creams.

The daily demand for ice creams turns out to be in line with the outside temperature. In an average summer, with an average temperature of 16°C (about 60°F), IceComp sells 10 million ice creams a year. Annual turnover the past 10 years, $ 20 million with a net margin of 10%.

In order to regulate demand and to maximize profit, IceComp defines the daily ice cream selling price (P) in line with the market by the formula:

P = DAYTEMP / 8

So at 32°C an ice cream will sell at $ 4 and at 16°C it will sell at $ 2 a piece. To always deliver on time, IceComp keeps an average stock of about 2 million ice creams. Based on on the average selling price of the last 10 years, this stock is valued in the balance sheet at $ 4 million, resulting in a fair and trustworthy P&L, that reflects the actual sales level at current prices.

Two years ago, inventory (stock) valuation based on market prices ('fair value'), i.e. the price daily selling price of an ice cream, became mandatory. From that moment on, things started to go wrong.

Consistent with the daily temperature, the daily inventory value starts to oscillate heavily, with explosions and variations up to $ 6 million per month. To the 'surprise' of all stakeholders, equally strong alternating monthly gains and losses are reported. It's crystal clear, the company is no longer 'in control'.

The national supervisor interferes and demands extra securities (funds). Now the monthly P&L of IceComp starts to oscillate even more, as the investment results of the extra securities, that principally do not have anything to do with the core business of IceComp, also start to vary on basis of 'fair value' (market prices) valuation.

Ultimately, lack of confidence from share- and stakeholders drives IceComp into bankruptcy.

Conclusion
What was meant to be 'intentional Fair', turns out to be 'Unfair' in practice. Valuing balance sheets on bases of daily prices is like playing 'Russian roulette'. It can be compared to making 'climate statements', based on the daily weather forecast.

The analogy to banking, pension and insurance business may be clear. Don't base valuation methods on daily prices, but on a, per product or market defined, 'moving average market price' for a fixed chosen period (depending on product or market cycle).

The current (credit) crisis calls for development of new valuating principles by auditors and actuaries.

Maarten Dijkshoorn leaves Eureko

Maarten Dijkshoorn steps down as chairman and CEO of the Executive Board of Eureko, effective January 1.



















Source: beursduivel, silobreaker

Happy Actuarial New Year

Did you know there are more than 100 "new year's days" in a calendar year?
It just depends on where you live or what you believe.

Before 1752, Americans celebrated New Year's Day on March 25th (Lady Day according to the old Celtic religion and the Feast of the Annunciation according to the Christian religion).

Great Britain and its colonies changed their New Year's celebrations to January 1st when they changed from the old Julian calendar to the Gregorian calendar in 1751.

How shall we define our actuarial new year?

Read more about it on

Celebrate New Year's Day
Every Month of the Year!

Price of Greed and Fear

Despite of all our knowledge, training and experience we sometimes decide to follow our heart instead of our head.
What's wrong with that?

Answer:
Nothing, as long as your decisions are not based on greed and fear

Illustration: We all know.....

I. How to advice on getting a better reward/risk ratio.
Modern Portfolio management (MPT) helps us.

Risk/return trade-off between bonds and stocks1980-2004 (AAII)
Bonds: 60% 5-year Treasury Notes+40% LT Treasury Bonds
Stocks:(S&P 500)

II. The performance/time model of stocks

III. Asset allocation is key behind portfolio returns
So it's not about Market Timing!

Moreover Market Timing is a dangerous game as research firm DALBAR showed.

Although the S&P 500® 1988-2007 Index had an annualized return of 12%, the average equity fund investor (in equity mutual funds) only generated a 5% return and market timers, who tried to outsmart the market by timing their inflows and outflows, generated an annualized loss of 1%.

Market Strong ... Investors Wrong

*Measures returns of investors in equity mutual funds. Source: Bureau of Labor Statistics, DALBAR

Greed and Fear
When the asset strategy has been chosen and implemented, it comes down to strong nerves, to hold this strategy.

But nothing human is strange to us. Who can resist the pressure of shareholders, advisors or analysts to question the current strategy after 2 or 3 years of extremely high (or low) stock returns?

In straightening out and defending your policy, stakeholders and advisors will often argue that you're a rearview mirror actuary or board member. They'll stress that the actual situation is not comparable with any situation in the past.

However, always keep in mind the words of Sir John Templeton (1912-2008) :

The four most expensive words in the English language are
'This time it's different'

So how successful are you, in cashing in on your emotions an withstanding pressure?

Still, if you nevertheless give in and are going to change your bond/stock ratio based on fear, greed or hype, all bets are off.

Example



As is clear form the example above, when your strategy is vulnerable to heart cries, you'll end up in the famous Pork Cycle , which - in this case - leads to a return level beneath that of risk free assets. The price of Greed and Fear!

Lesson
When you've set your assets according your chosen asset strategy, only change this strategy when the underlying long term asset-modeling parameters substantially change. In every other case, don't decide on basis of 'heart over head'.

Define and allocate equity (as security) for an 'up front' defined period of time in wich you're willing to except lower or even a defined maximum negative performance. Agree this strategy up front with the supervisory board and national Supervisors.

Sources: MyMoneyBlog , Schwab, DALBAR

Credit Crisis Predicted

Lyndon LaRouche, economist, long-range forecaster, risk manager 'avant la lettre' and one of the initiators behind the SDI-project (Strategic Defense Initiative) in the 80s.

With firm quotes like "there has been no economic growth on this planet, since the end of the 1960s. None, if you measure the right magnitudes", he takes stand in the sometimes overoptimistic and misleading world we've created.

Back in 1995, in Germany, he stated "We are at the end of an epoch".

He warned that a global financial bankruptcy and collapse would be under way and introduced in an econometric form his 'famous' "Typical Collapse Function" or "Triple Curve"to illustrate that power statement.

In his daring view, he describes the interplay of the three curves (non mathematical directionalities) that characterize the collapse process:

1. Physical-economic input/output (bottom curve)
   The productivity and functioning of the physical economy, upon which all human existence depends;
2. Monetary aggregates (middle curve)
   The increase in monetary aggregates (approximately represented by money supply measures; injections)
3. Financial aggregates (upper curve)
   Growth—which can become hyperbolic growth—in financial aggregates of all kinds: run-up of debts and other obligations, speculation in currencies, stock markets, futures (derivatives), etc.

As in the case of a "typical collapse function," the interaction of the upper two curves sucks the underlying physical economy dry.

But at a certain critical point (around 2000 in the USA), no matter how much money is injected in the economy, the financial bubbles cannot be kept aloft! The rate of rate of growth of monetary aggregates becomes higher than the rate of rate of growth for financial aggregates. In graphical terms, this is the "inevitable crossover" point of the middle, monetary curve, breaking up through the top financial curve.

Although this looks like intuitive econometric science, LaRouche illustrates this with some striking examples.

In the year 2000 LaRouche stated that compared with a worldwide GDP of about $41 trillion, the total amount of financial aggregate in short-term obligations was over $400 trillion. In other words, at least 10 times the amount of the total annual product of the world as a whole at that time. "

In 2008 he publishes in 'The Time Has Come for a New System':

• We are a credit system, not a monetary system.
• Outstanding obligations: $1.4 quadrillion, derivatives, short-term obligations of speculative nature
• This mess is coming down.
• System will be put into bankruptcy, by governments

And than to realize that there are still leading prominent professionals that like to make us believe that it's just some limited subprime issue. Regretful, it's the other way around. Subprime will just turn out to be the proverbial little stroke that'll fell the great oak.

Read more about LaRouche Writings

Let's hope that LaRouche is a pessimistic man....

Estimation of World Credit Loss

Have a guess. How much would you estimate the World Credit loss?

Answer: '$ 2.8 trillion' and still growing...

According to Bloomberg the actual losses and writedowns surpassed $1 trillion today,

More details at the Credit Crisis Timeline.

Who cares....
The cost of the US war in Iraq are estimated at Three Trillion Dollar (infosthetics.com).

Video link

Do(n't) worry, be hapy...

IPE: Ballendux goes it alone

According to IPE, Frans Ballendux, former business leader of Mercer Investment Consulting in the Netherlands, is starting his own investment consultancy business.

Frans joined Mercer in July 1997.


We wish Frans lots of success!

European Mortality

The Groupe Consultatif Actuariel Europeen published end 2005 a study, which for the first time compares how companies in different European countries measure life expectancy for their pension schemes. It reveals vast differences in mortality assumptions and indicates that practice across the EU varies widely when assessing company pension liabilities.


As you may see from some examples to the left, a wide area of classic mortality formulae in the different European countries passes by.

It's clear that that mortality assumptions in company pension schemes vary from
country to country, due to variations in underlying population mortality as well as in
variations of the profile of typical membership of a company pension scheme. However, the
variations in mortality assumptions are much greater than would be justified by these
factors alone.

Some of the variation is due to the fact that some countries incorporate an allowance
for expected future improvements in mortality, while others use tables that relate to mortality observed over a period in the past, without allowing for the fact that life expectancy continues to increase.

The total actuarial deficit with regard to (future) longevity in company pension schemes is substantial.


As a 'Survey of Actuarial Education in Europe' showed, not only mortality rates differ, but also the the education of different European actuarial professionals.

In short, work enough for actuaries.

More information:

• Mortality findings revealed
  
• Executive summary (pdf 70Kb)
• Full report (pdf 1.67MB)

Netherlands Best EU Healthcare system 2008

The Netherlands are the overall winner in the Euro Health Consumer Index 2008, launched today in Brussels at a press conference hosted by the Health Consumer Powerhouse.

The Euro Health Consumer Index is the annual ranking of national European healthcare systems across six key areas: Patient rights and information, e-Health, Waiting time for treatment, Outcomes, Range and reach of services provided and Pharmaceuticals.

The Euro Health Consumer Index 2008

• The Euro Health Consumer Index 2008 report (pdf) »
• The Euro Health Consumer Index 2008 matrix (pdf) »
• General Press Release (pdf) »
• EHCI Tables and Figures (MS Word) »
• Euro Health Consumer Index 2008 Policy Recommendations (pdf) »
• Data sheets for all 34 indicators in the EHCI 2008 »

Client Lifetime Value (CLV)

In a Harvard Business Review called "Why satisfied customers defect", Jones & Sasser explain that even a 80% 'satisfied clients score', is no guarantee for sustainable success.

Common management misconceptions are:

1. A client satisfaction level below complete or total satisfaction is adequate.
2. It's not profitable to invest in changing customers from 'satisfied' to 'completely satisfied'.

Their conclusion is that, in most cases, 'complete customer satisfaction' is key in order to secure customer loyalty and generate sustainable financial performance.

Loyalty & Satisfaction
Despite of what sometimes intuitively is assumed, the relationship between loyalty and satisfaction is in most cases not linear, but depends on the competition level of a specific market segment.

In a Dutch presentation, called "CRM Myths", direct marketing professor Janny Hoekstra confirms this relationship and shows that even 'satisfied clients' are in the so called 'indifference zone'.

The 'art of client management' is obviously to create 'Apostles' and to avoid creating 'Terrorists'.

So stimulate, instead of discourage, your clients to give you feedback and to complain, because this is the only way to create new apostles.

NPS
A relatively new and, according to Harvard (The One Number You Need to Grow), probably better method to measure client loyalty is the 'Net Promoter Score' (NPS). Simply score your clients on a 0-10 points scale on the question: "Would you recommend company X ?'

Now simply calculate the NPS score (%) as:
NPS = Promoters% (rating 9&10) - Detractors% (rating 6 or less)

NPS scores of 75% or more prove world class loyalty.

Loyalty effect
Another, intuitively driven, perception is that the more customers are loyal, the more they generate profit.

In general this seems true, however as Hoekstra shows: not every 'more loyal' client is also per definition 'more profitable'.

Just like Reinartz (Insead) stated in his article : 'Not all custumors are equal'.

Reinartz defines different client groups called: Butterflies, Strangers, True Friends and Barnacles.

Each group urges a different approach in a Customer Client Strategy.

Investing in 'True friends' appears essential and eventually pays out.



Customer Lifetime Value
Actuaries that combine marketing an actuarial sciences could help by defining and calculating what is called: The Customer Lifetime Value (CLV)

The CLV of a specific client(group) could be defined as the discounted value of the yearly margin (m = profits - costs), with discounting rate (i) and the (client) retention rate (r).

CLV:Rule of thumb
In the strongly simplified case with constant margin, the CLV - as a rule of thumb - could be defined as the margin (m) multiplied with the so called margin multiple = r/(1+i-r).

Example: Discount rate = i =12%, Retention rate = r = 90%, results in a CLV of approximately 4 times the yearly margin.

As is clear from the formula and table above, the choice and impact of the discount rate is only significant in combination with a high (>90%) retention rate.

Modeling and creating Client Value is not only in the interest of the shareholder, but moreover a case of creating creating added value for clients, in particular 'best satisfied clients'.

More info at: Modeling CLV(insurance), Customer Metrics

Investment Banking explained!

As actuaries we all know investment Banking is a complex business.
This Youtube video explains the essentials of Investment banking in about 8 minutes.

Be sure to study the video seriously, it will be the best study investment you've done in years.

Credit Crisis Indicators

Credit Crisis Indicators: Treasury, Libor, Ted, Paper & Bonds.



The credit markets indicators give a better measure of the crisis than the stock markets. NYT gathered five ways to measure the recent disruptions in the credit markets.

Source

Actuarial aerodynamic careers

Did you know that actuarial careers follow the laws of aerodynamics?



Read more about this and find out whether you are a "Balloon Career Maker" or a "Wing Career Maker.

Source

Whistleblower Risk Management

We all know Risk Management is key in our business.


Yet, almost all risk models (e.g. Coso) emphasize mainly on known or knowable risks.



Of course, as we could have seen in the 2008 credit crisis, the art of Risk management is in managing the unknown or unknowable risks.

But how?


Let's try to learn from two main major accidents:

I. The Challenger shuttle disaster (1986)
The accident was caused by failing O-Rings. Warnings of many engineers were overruled and ignored. This crash was the consequence of a typical effect called GROUPTHINK. Groups naturally look for consensus and will often come up with a false consensus, even when individual members disagree.
Watch a video of the space shuttle Challenger disaster that illustrates this GROUPTHINK phenomenon.

Other examples are the Columbia shuttle disaster and the 9/11 attacks. In all cases Management failed because the information suggesting a disaster was weakly transmitted within an bureaucratic system, and managers failed to authorize action because of bad communication and performance or time pressure.

II. The 2008 credit crisis

• Underestimating early signals
  The first indication of the coming credit crisis was the collapse of Enron in 2003, uncovered by whistleblower Sherron Watkins.
  
  After the collapse, the FED refused to come out with new 'rules based' guidelines . A Senate investigation showed that - starting already in 2000 - some major U.S. financial institutions had "deliberately misused structured finance techniques". But the Fed and the SEC underestimated the situation, kept to their 'principles based' system and consequently missed the opportunity to to flex their muscle by regulating market conditions for subprime mortgages.
  
  Lesson: It's not about 'rules OR principles', Football Or Soccer, but it's about 'Rules AND Principles'.
  
  

• Mixed Central Banks (FED) responsibilities
  Central Banks, The Fed in particular, have at the same time two main responsibilities with regard to (other) financial institutions:
  1. Supervision
  2. Providing financial (banking) services
  
  Those two functions clearly conflict with each other. It's impossible to independently supervise the financial company you're financing at the same time. Supervisory advises will be suspicious by definition.
  
  Secondly you can't supervise yourself as central bank. Therefore, every country needs an independent (that is 'without central bank board members'), professional supervisory board, that audits and supervises the central bank and the national bailout plan(s).
  
  
• Whistleblowers
  How could the credit crisis technically happen?
  Not an official, but a more outside kind of whistleblower, businessman Warren Buffet, warns in a 2003 BBC article that “Derivatives are financial weapons of mass destruction and contracts devised by madmen". The financial world isn't listening.
  
  Derivatives like Collateralised Debt Obligations (CDO's,) were developed to (re)fund the subprime loans. CDO's are packaged portfolios of credit risk, made up from different sliced and diced loans and bonds. They were hard to uncover without a whistleblower. At last an anonymous banker e-mails journalist Gillian Tett of the Financial Times about the situation. Only after she publices early 2007 what's wrong, the dices start rolling. This case also stresses the important role of journalism and whistleblowers in our aim for a healthy transparent financial market.
  
  
• The Greed Game
  One can argue about the roots of the credit crisis. However, essential in the 2008 credit crisis were, or still are, the excessive remuneration practices at private equity companies, hedge funds and banks. They encouraged unhealthy and excessive risk-taking. Key is the lack of balance between possible earnings and possible losses of board members.
  
  To prevent unhealthy pressure management (with groupthink effects), board members' total rewards should always be in line with the long term realized added value of the company and not be based on yearly P&L profits or short term added value.
  

Manage the unknown risks
Risk Management is not a static, but a dynamic process.

To gain and behold control of the unknown risks, it's necessary to create a transparent organization and company-process that guarantees whistleblowers' and whisperers' (= whistleblowers, that wish to stay anonymous) safety and encourages and even rewards compliance reports from employees, clients or any other stakeholders.

Because of GROUPTHINK and - on the other hand - possible negative employee outcomes (demotion, dismissal, etc) in case a reported compliance issue turns out to be compliant after all, it's important that whistleblowers are always given the opportunity to report directly, anonymously and safely to the independent federal Supervisor. Employees must have the choice to report internal within their company (small compliance matters) or to report directly to the federal Supervisory board.

Conclusions

• Separate the Supervisory and Financial Services functions of the central banks (FED)
  
  
• Redesign whistleblowers management
  Whistleblowers should have the opportunity to report compliance issues directly and anonimously to an independent federal Supervisory board.
  
  Whistleblowers that choose to report within a company, should always directly reporte to the compliance officer, the executive board and the supervisory board. On top of this they should always, especially in case of discharge, dismissal or demotion, have the right to escalate to the federal Supervisor.
  
  
• Change supervisory procedures and criteria
  Approval of (company) board members by the federal Supervisor should als be based upon:
  
  1. The 'ethical track record' of a candidate
  2. The feasibility of, in macro economic perspective, "realistic and balanced" board member performance parameters.
     
     The federal Supervisor should audit and approve the existence of a consistent 'company reward plan' that guarantees a sound and measurable balance between long term company results and board member rewards.
     
     CEO's that haven't established measurable long term added value for their company, shouldn't receive any bonus or golden parachute at all.

The Actuarial Black Eye

In his blog David Merkel gives a fabulous book review of the book:

While America Aged

The book and blog show that actuaries (and accountants as well) were not disciplined enough to resist politicians pressure and large companies board (and shareholder) short-term result demands. As a direct consequence those companies got into serious trouble.

Stick to one's guns, and keeping a save eye on the future, is one of the essentials of the actuarial profession.

Training (not just study alone) in giving the right push back on board level, should therefore be an obligate part of the education (and accreditation) of actuaries and accounts.

As (UK) Sir Derek Morris stated in his "review of the actuarial profession: interim assessment" (2004):

Too much has been expected of actuaries and, explicitly or otherwise, too much has been promised by them.

Clients have looked to actuaries to provide certainty, and actuaries have often appeared to provide it.

For Dutch actuaries, see also Willemse and Wolthuis in: "On the practical meaning of probability based solvency".

Actuaries are almost just like real human beings: after a few years successful studying and modeling, they gain confidence. They start to believe that reality will also act according their models. Moreover, they might get overconfident and think that their view and expertise on reasonably well predictable issues like life, death and disability are - with the same amount of certainty - also applicable on other issues like 'inflation' and the development of the 'stock market'.

This it typically a case of :

That what develops you, eventually might kill you

Practice hasn't shown that good actuaries are,by definition, also good weatherman.

The book also shows that self-regulating without clear targets and constraints is a fairy tale.

Keep in mind the Mongolian Proverb:

Of the good we have an understanding,
for fools we keep a stick upstairs

Success in being a PBA (Push Back Actuary)!

Regret

Bloomberg's Fred Pals reports on Oct. 29 that Rijkman Groenink, the former chief executive officer who earned about $33 million from the sale of ABN Amro Holding NV, said he regrets the takeover and wants to work again for the Dutch lender.

Groenink stated:

• he would really like' to become a supervisory-board member at ABN Amro
  
• "There is no one else in the Netherlands with as much banking experience and specific knowledge of ABN Amro as me,''
• "I'd be more than willing to put my knowledge and experience at the bank and my management experience in the service of the new bank and therefore of the Dutch people.''
• "My reality is one of loathing, sadness, I didn't need the money, I didn't want it. But the reality of public opinion is that I'm a money-grubber and I bargained away the bank.''

Source

Value for Money!

Now that Obama will be the next (44th) US president, confidence will rise and we'll get value for money......

That leads to the question of how you measure the Purchasing Power of Money?


The measure most often used, is the Consumer Price Index (CPI).

Other comparison series might be preferable, depending on the context of the question.

In fact there are:

Six Ways to Compute the Relative Value of a US Dollar Amount, 1774 - 2007

Calculate the actual value of a original year 1900 Dollar, Euro, Guilder or Pound and see how you get value for money.

Shareholder or Stakeholder model?

Does the corporation exist for the benefit of shareholders, or does it have other, equally important stakeholders, such as employees, customers and suppliers?

In a study titled, "Stakeholder Capitalism, Corporate Governance and Firm Value" (2007), finance professor Franklin Allen (e.a.) tackles this issue. In showing the various benefits of the stakeholder approach, he demonstrates that the issue is not as settled as some researchers and business people in the US or the UK might think.

Several conclusions emerge from the study, which uses a mathematical model to explore the advantages and disadvantages of stakeholder-oriented firms. First, stakeholder-oriented companies have lower output and higher prices, and can have greater firm value than shareholder-oriented firms. Second, firms may voluntarily choose to be stakeholder-oriented because it will increase their value, according to the study.

In a recent study (2008) called, "Rhineland Exit", Dutch (CPB) researchers Bovenberg and Teulings defend the victory of the Shareholder model over the stakeholder model (Rhineland model). They also state that the principle of maximization of shareholder value, being the ultimate goal of the firm, is at odds with the Rhineland philosophy of a balanced treatment of the interests of all stakeholders.

Why arguing so much about share or steak? By choosing the "stakeholdermodel with weights" it's simple to accomodate and optimize the final model to the company goals.

Source

Credit Crisis Manageable?

In order to succeed in a certain action, we often develop an action plan, a process that defines sub-actions in terms of who, what, when and where.

To guarantee that we succeed as much as possible, we have to maximize the control of this process of sub-actions. Make the process manageable.



In managing this process it's important to identify the nature and co-dependency of your sub-actions.

In general it's important to characterize sub-actions as follows:

Characteristic	Understandable	Predictable	Solvable
Simple	++	++	++
Complicated	+	+	++
Complex	-	-	+
Chaotic	--	--	-

Examples

Characteristic	Example	Description
Simple	Doorbell	Single component/ process with defined output
Complicated	Watch	Several components working together with defined output
Complex	Weather	Many interdependent components with hardly predictable output.
Chaotic	Clouds (form)	No sub components to identify, output unpredictable

Always analyze and characterize the components or sub actions of your action plan.
Not doing so will certainly cause trouble.

Example
One of the causes of the 2008 credit crisis is that we try to manage an in essential 'chaotic process' as a 'complicated process'. More traditional regulation rules (or governance back up) won't stabilize the banking system on the long run (in fact they make it worse), because these rules would imply that the nature of the financial markets is known and can be captured in a controllable mathematical linear system.

Financial markets are complex and chaotic systems, just like the weather. This implicates that regulation should be much more focused on "Plan B" measures than on detailed rule based regulation.

This means that regulation has to be formulated in such a way that Banks, instead of proving more and more that they will 'never' be insolvent (e.g. calculated risk=0,5%, that can't be calculated!), are forced to deliver Plan B's in which they state how they'll act in the 'unexpected' case of insolvency or iliquidity (average at least once in 200 years).

Just like you've got an umbrella in your car (Plan B), because you know that even though the weather forecast was 'sunny', you never can tell precisely when it's going to rain.

Most processes in life turn out to be chaotic on the long run. Analyze and control them, but don't forget to (always) carry your "Plan B" in your pocket.

---

Credit Crisis caused by Pyramid scheme

"Modern banking principles, as defined in the fractional reserve banking system, are essentially an ordinary (and illegal!) Pyramid scheme based on the arithmetic (geometric sequence) of fractional banking.

In an interview, called The Game Is Over, Michael Hudson states that the Fed and Treasury are following the traditional “Big fish eat little fish” principle of favoring the vested interests.

Just like in another Youtube movie he remarks that instead of bailing out the big financial institutions and rescuing billionaires and private investors, the government should have saved only the savings of savers at the bank, pensioners, Social Security recipients and other small fry.



No doubt, given How The Credit Markets Work, current measures will not solve the credit crisis ( Nothing Proposed Will Solve the Credit Crisis ).

World Facts

Just some DYK's as published by the Harvest Field Index and based on the free downloadable CIA World Fact Book 2008.


Do You Know the worlds population size?



Do You Know the world's Average Life Expectancy at Birth?
Answer: 66 years!

Now do you know the answer to the next DYK's?

- Top 3 of biggest continents?
- Top 3 of largest countries?
- Top 3 of biggest world cities?

Just check if your answers are right and you belong to the worldwide best non introvert actuaries,




Answers!


Biggest continents?
1. Asia 4,002 Million people
2. Africa 934 Million people
3. Europe 730 Million people

Largest countries?
1. China 1,330 Million people
2. India 1,148 Million people
3. United States 304 Million people

Biggest World cities?
1. Tokyo, Japan 35 Million people
2. Mexico City, Mexico 20 Million people
3. New York City, U.S. 19 Million people