Actuarial Limit 100m Sprint

In June 2009 Professor of Statistics John Einmahl and (junior) actuary Sander Smeets, calculated the ultimate record for the 100-meter sprint. The actual World record - at that time - was set by Usain Bolt at 9.69 seconds (August 16, 2008, Beijing, China).

With help of the extreme-value theory and based on 'doping free' World Record data (observation period:1991 to June,19 2008) Smeets and Einmahl calculated the fastest time that a man would be ultimately capable of sprinting at: Limit = 9.51 seconds.

However....
As often in actuarial calculation, once your model is finally set, tested and implemented, the world changes...

Or, as a former colleague once friendly answered when I asked him if his ship (project) was still on course:

My ship's on course......
But the port moves !

In this case, the 'model shifting event' took place in Beijing, exactly one year later, on August 16, 2009: Usain Bolt sets a new astonishing 100m World Record in 9.58 seconds !

Of course 9.58 secs is still within the scope of Smeets' and Einmahl's model limit of 9.51 seconds...

Nevertheless, as a common sense actuary, you can see coming a mile away, that this 9.51 secs-limit will not hold as a final future limit.

As is visual clear, one can at least question the validity of the 'extreme-value theory approach' in this 100m sprint case.

Math-Only Models
In this kind of projections (e.g. 100m world records) it's not enough to base estimations only on historical data. No matter how well historical data are projected into future data, things will mesh up!
Why? Because these kind of 'math-only models' fail to incorporate the changes in what's behind and what causes new 100m World Records. To develop more sensible estimates, we'll have to dive into the world of Biomechanics.

To demonstrate this, let's have a quick -amateur - look at some biomechanical data with respect to Usain Bolt's last World Record:

Let's draw a simple conclusion from this chart:

Hitting 9.50 secs seems possible

Just like Bolt stated in an interview: "I think I can go 9.50-something", appears to be realistic:

• 0.026 secs faster by improving his reaction time to the level of his best competitors: 0.12secs, instead of  0.146secs
• 0.060 secs faster by reaching his maximum speed (12.35 m/s) at V50 and maintaining this speed for the remaining 50 meters. 

Biomechanical explanations
On top of this, Bolt outperforms his competitors on having a higher step length and a lower step frequency. This implies there must be deeper biomechanical factors like body weight, leg strength, leg length & stiffness (etc), that need to be included in a model to develop more realistic outcomes.

Newest biomechanical research ("The biological limits to running speed are imposed from the ground up" ) shows maximum (theoretical?) speeds of 14 m/s are within reach, leading to potential World Records of around 9 secs on the long run.....

Based on this new biomechanical information output in combination with an appropriate chosen corresponding logistic model, we can now predict a more realistic ultimate World Record Estimation (WRE) in time.

Curvefitting at ZunZun with the 1968-2009 data (including Bolt's 9.58 secs record) on basis of a Weibull CDF With Offset (c), led to the next, best fit equation:

 
With: y=WRE in seconds, x=Excel date number, and:
a =  -3.81253229860548
b =  41926.0524625578
c =  8.97894916004274 (=final limit)

As we may learn more about biometrics in the near future, perhaps the ultimate 9 seconds (8.9789 seconds, more exactly) can possibly be reached faster than we currently estimate (year 2200).


Playtime
Now, just play around with (estimate) world records in this Google time series plotter:

WRE Plotter

Finally

As actuaries, what can we learn from this 'sprinting example'?
 

Well... Take a look at estimating future (2030 a.f.) mortality rates.

Just like with estimating World Records, it seems almost impossible to estimate future mortality rates just on basis of extrapolating history.

No matter the quality of the data or your model, without additional information what's behind this mortality development, future estimations seem worthless and risky.

Although more and more factors affecting retirement mortality are being analysed, (bio)genetic and medical information should be studied by actuaries and translated into output that strengthens the devlopment of new mortality estimate models.

Actuaries, leave your comfortable Qx-houses and get started!

Related links and sources:
- Ultimate 100m world records through extreme-value theory
- 90 years of records
- Usain Bolt: The Science of Running Really Fast
- Biomechanics Report WC Berlin 2009 Sprint Men
- BP WC Berlin 2009 - Analysis of Bolt: average speed 
- The biological limits to running speed (2010)
- Limits to running speed in dogs, horses and humans (2008)
- Improving running economy and efficiency
- Factors Affecting Retirement Mortality and Their Impact ... 
- Cheetah Sets New World Record 100 meter sprint2009 (6.130 sec)
- 100m World record data and WRE (xls spreadsheet)

Exceptional Longevity Predictable

A genome-wide association study (Paola Sebastiani et al) based upon 1055 centenarians, showed that Exceptional Longevity (EL)  - living 90 years or more - can be predicted with 77% accuracy!

video

EL Genetic Passport
This research development will have major impact on 'life insurance' and pensions. With an EL Genetic Passport in your pocket, you'll have the power to conclude with 77% certainty whether it's profitable (or not) to buy life insurance or to invest more or less in your pension fund.

Genetic Loss by GAS

To prevent major losses caused by 'adverse selection', life insurance companies and pension funds have no other choice left, than to base life insurance premium prices and pension contributions on 'genetic passport information'.

Just like it's (from a company's perspective) devastating to sell mortgages to people who cannot afford it, it's also killing to sell life annuities to people who have knowledge of getting 90 years or older with 77% certainty.

As Genetic Adverse Selection (GAS) also negatively affects current provisions and value of an insurance company or pension fund, GAS development effects should be included and estimated in actual liability calculations.

Without doubt, GAS will generate large Genetic Losses in the next decades. Perhaps GAS can be qualified as a substantial new kind of risk in Pillar I calculations.


Related links - Sources:
- Science: Genetic Signatures of Exceptional Longevity in Humans
- PDF: Genetic Signatures of Exceptional Longevity in Humans
- BU: Signatures of Human Exceptional Longevity (video)
- Centenarians in some European countries, 2007

Death by Solvency

Risk Management can be a strange and deathly game. Normally one would expect that the more the demand of Probability of Insolvency (POI) is decreased:

• the more Prevention- , Risk-reduction- and Damage-control-measures will be taken
• the less actual Risk and corresponding Loss will actually occur
• the higher the resulting average yearly profit
• the lower the resulting yearly profit volatility

This appears to be true in situations where Risk Management is hardly developed and POI-Demands are relatively modest (5%-2.5%).

Increasing POI-Demands
However, depending on the type of risk, beyond certain POI-Demands (smaller than roughly 2.5%) , the costs of Risk management measures, maintenance and capital requirements become higher than the average expected Loss-reduction, resulting in - on average - lower profits.
Of course, these extra risk management investments and capital requirements can financed by raising consumers prices, but - on balance - this will result a smaller market corresponding with a lower profitability level.

The question can be asked if this still is what we, management and consumers, intended to achieve.......?

Next, in our passion to reduce Risk to an even more extreme low level, we can get carried away completely...

Excessive POI-Demands
When POI-Demands get to levels of 1% or less, a remarkable psychological effect enters the Risk management arena.

Management perceives that the Risk-level is now actually so low that they cannot fail anymore.
In their ambitious goal to outperform the profit level of their competitors, management gets overconfident and reckless. What would you attempt to do if you knew you could not fail?

When POI-Demands are set to levels of 0.5% or less (as they are mostly now in 2010) it becomes almost impossible to beat your competitors with an approach of 'taking more risk'. Even if one would try to manage or hedge these extra risks 'best' in the market. In the long-term, the price of this risk would equal or beat the expected loss.

In this situation some managers get desperate and instead of considering things 'right', they see only one option 'left'....

WAR

'Working Around (the) Rules"

WAR, Working Around the Rules, comprises actions like:

• Taking (extra) risks on non-measurable or non-measured financial transactions, or or 'non-obligated-reporting risks'
• Manipulating, disguising or mitigate risk information, or risk-control reports
• Misuse legally allowed methods and accounting principles to create legally unintended financial effects or transactions

 

It's perhaps hard to admit, but as actual developments show, we've entered the final WAR phase. Some Examples: subprime, Madoff accounting, BP-deep horizon oil failure, bank multipliers, etc, etc.

In all these examples, managers (are pushed to) become over-creative by working around the rules to deliver what they've promised: more profit.

However this approach always results in

1. More short-term profits
2. Less long-term profits
3. Sudden bankruptcy in the end

This development, resembles the 2010 situation in the Insurance and Banking industry where, after each financial debacle, POI-Demands where successively decreased to a 0.5% level  and have resulted in marginal profits and a highly volatile Profits or even losses. Pension Funds (NL: 2.5% POI-Demand) appear to be the next patient the operating table.....

The situation is out of control. Nothing really seems to help anymore....

Solutions

Are there any solution to prevent this solvency meltdown process?
Yes, but that's for another blog as this one is getting too long...

Related links:
- Why excessive capital requirements harm consumers, insurers and...(2010)
- Presentation - Modelling of Long-Term Risk (2010)

Risk Symptoms Matrix

On INARM (International Network of Actuarial Risk Managers) ERM advisor Dave Ingram raises the simple question:

What must managers who are not modelers know about models?

Perhaps this question is one of the most relevant questions in Risk Management and the Actuarial profession. It's a key question that should be discussed on Board Level in every (financial) area.

Also this question is relevant in setting up and managing complex projects like Solvency II, ERM, Pension Fund Risk Management, ALM and even "In control" projects.

The answer
Now let's try to answer this intriguing question

Managers are experts in 'decision taking'. Modelers are experts in reducing and simplifying complexity to decidable parameters.

Now the Quality (Q) of a management decision (D) is defined by the equation:

[ Q(D)= Q(Manager) x Q(Modeler) ],

where Modelers are responsible for the Quality of the Input (data) of the model [Q(Input Model)] and the Quality of the modeling process itself [Q(Modeling)].

More refined, we may therefore define :

Q(D)= Q(Manager) x Q(Input Model) x Q(Modeling)

Luckily, not all Q's are independent!
Both Managers and Modelers can raise the Quality of the outcome of the Decision process by asking each other "What If" questions.

By asking WI-questions with regard to the 'Input of the Model" [Q(Input) = data, decision parameters] and examining the output, Modelers are able to raise the Quality of their (technical) Modeling by improving their technical Model [Q(Modeling)].

Moreover, decision parameters are not set in stone. So by asking WI-questions, Modelers become more aware of the Management Decision Consequences (MDCs), helping them to develop and simplify decision parameters to the most adequate, understandable and possible simplified form. Or as Albert Einstein quoted it:

"Everything should be made as simple as possible, but not simpler"

On the other hand, by asking WI-questions, Managers can study the effects of various decisions they might take in different (simulated future) circumstances (as roughly described by the Manager).

This process improves the decision taking skills of a Manager and therefore improves the Quality of the Decisions taken by Managers [Q(D)] in general. At the same time, the Modeler may use the given information from the Manager to improve his Model and (future) data as well.

Conclusion
We may conclude that the answer to the question 'What managers, who are not modelers, need to know about models' is:

Nothing, as long as Manager and Modeler intensively communicate with each other, ask WI-questions, are not afraid to admit their weakness or doubts, challenge each other and don't manipulate each other!

Perhaps an ever more tricky question to answer is:

"What must managers who are also modelers know about models?

Possibly Dave Ingram has the answer to this question....

Aftermath What happens when communication between Managers and modelers fails, is well illustrated in the Gulf of Mexico Oil Disaster, where BP CEO Tony Hayward stated before congress:
- “I simply wasn’t involved in the decision-making.”
- “Clearly an engineering judgment was taken.”

It's easy to spot failing Management-Modeler relationships by means of the next 'Management-Modeler Symptoms Matrix'.....

If you happen to be a modeler in the upper left quadrant, get out as fast as you can!

Actuarial Model World Cup 2010 Winner

In 'The Actuary June 2010', Greg Becker (actuary) and Arminder Kainth (annuities pricing analyst) present the outcome of an actuarial model they developed, to  predict the probability of a country winning the Fifa World Cup 2010.

With Brazil as a clear winner, here's the outcome:

Perhaps trading on the World Cup 2010 Bet Market can become a new interesting alternative for traditional investment categories....
Anyhow, let's hope (fingers crossed) that actuaries are right and Brazil, Germany, Italy and England all end in the semi-finals. In this case we'll ask both actuarial whiz kids to develop a new actuarial investment model to settle (for ever!) the everlasting bonds-stocks discussion....

Place your own (free) bet
Meantime if you want to place your World Cup bets for free, join The Actuary World Cup PredictorPro game in association with Star Actuarial. For your chance to win an iPad register at Predictorpro.
Start right away, because betting already started....

Used Sources:
- The Actuary: Article 'World Cup fever' (pdf)
- The Actuary:Who will win the World Cup?
- Free bet at Predictorpro

Related:
- Estimating the Real Rate of Return on Stocks Over the Long Term (2001)

- Pension Fund Investments: Stocks or Bonds? (2004)
- Social Insecurity? (2008)

Pension Fund Coverage Ratio Analogy

Let's compare driving your car with managing a Pension Fund. Are you ready?

You, the Car Driver Suppose you plan a trip from New York to Washington, about 200 miles, in a tight time schedule of four hours . You're know your car's average fuel consumption is on average about 25 miles per gallon and your dashboard computer tells you, you've got 10 gallons left in the tank. Simple mental arithmetic shows you'll finish in Washington without any major 'out of gas'  problem if you keep your average fuel consumption above a rough 20 miles per gallon. You tell your partner, who's next to you in the car, you're quite sure (97.5%) there's enough gas left for Washington. Suddenly - your half way climbing a small hill - your Miles Per Gallons (MPG) Meter drops from 25 to 13. A bit worried you take a look at the Average MPG Trip Meter on your dash board computer that shows an average of 35 miles per gallon on the first 100 miles. You conclude there's no problem or real gas shortage issue to be expected and decide to keep checking your dashboard every 5 minutes to find out how the Average MPG develops. Your partner, who's not familiar with driving a car or arithmetic exercises, tells you to stop at a gas station immediately and to end this silly arithmetic game. You - quietly - explain that there's no need to go to a gas station and if you would go to a gas station, the two of you will be late on your appointment in Washington. You tell her that you'll take no direct measures and have decided to look for a gas station if your average GPM meter shows a 25 gallons per mile. Your partner is satisfied and you continue your trip. Problem solved.

You, Pension Fund CEO Suppose you run a 30 year old Pension Fund and your target is to keep a save coverage ratio of 125% on the long run. The outcome of intense and professional Risk Modeling, ALM studies, VaR analyses, FIRM approach and other sound risk techniques, has concluded in an agreed asset mix, implicating that daily coverage ratio's may vary (97.5% CI) between  65% and 185%, corresponding with an average long term coverage ratio of 125%. Suddenly, exactly at the Pension Funds 30th  birthday, interest rates collapse.... Your Dashboard's Daily 'Pension Fund  Coverage Ratio' (PFCR) meter shows a surprising meltdown to 65%! All pension board members look worried. They take a look at the '5 years Average Pension Fund Coverage Rate Meter' at their Dashboard. This meter  shows a trustful 132%. You and your board conclude there is no urgent or substantial problem of  shortage on the long run. Problem solved!, one would think. Unfortunately: No!. At this point the Supervisor starts interfering. The Supervisor is worried and orders the Pension Board to develop a recovery plan outlining measures on how the pension fund will restore minimum funding requirements within a five-year time frame. This Recovery Plan (RP) was not included or part of the original  strategic risk management plan as foreseen. The extra costs of executing this RP and the effects of reallocating the assets to a lower risk position, result in a lower return of the pension fund on the long run with a lower coverage ratio than the original 125% objective average. The pension fund was forced to improve the short term (daily)  coverage ratio a little bit at the cost of substantially lowering the coverage ratio on the long run. Congratulations!

Conclusions...
It's clear that ...

• Pension Funds shouldn't be managed just on daily coverage ratio's, but more on 5 or 10  years average coverage ratios.
  
  
• Demanding recovery plans after a disappointing 'two year coverage ratio' is not wise and damages the long term objectives and financial results of the pension fund.
   
• In case of  long term (more than 5 years) failing coverage ratios, there's enough time to take measures to redefine the Pension Fund's strategy and funding policy. The same applies for interest rates, returns and other Dash Board parameters, excluding liquidity scores.
   
• Much more than banks, Pension Funds are financial institutions with mainly long term obligations and should therefore mainly be managed, controlled and supervised by "long term" score card parameters.

Therefore, Supervisors should change their Risk Management philosophy as well as their control policy on this subject. Supervisors should redefine dash board parameters and only demand recovery plans in case of more than five year consequently failing coverage ratio's.

Related Links
- GN26: Pension Fund Terminology (pdf)
- Coverage ratio Dutch pension funds.png
- ABP assets up, but funding ratio down
- Fuel Convert
- New York Senate passes gallons per mile bill
- GPM psychology

- Volvo Penta (Meter)

Spanish Risk Management

Why does Europe support Greece with a bailout? And why will Europe support other PIGS countries when they get into trouble as well?

Greece

It all started with Greece.
After Greece joined the Euro (2001),  it became clear that the Greek government lied about its deficit, the Greeks simply 'cooked their books'.

Unfortunately there's no way back. The Greeks held us by the hand in their 'systemic dance'.  Ancient Greeks always believed that dancing was invented by the Gods. The Spartans not only danced before battles, they also fought with rhythmic movements to the strains of flutes. And so, still it is in the year 2010.

Spain
Let's dive a little deeper and ask ourselves the question why the EU needs to help Spain out, once it gets into trouble.

ING
Just have a look at ING Bank, as a simple example.
In 2010 ING has a € 41.3 billion (total) exposure to Spain. That's 124% of their equity.

It's clear, despite of all effort in explaining and defending an excellent (?) risk policy in their 2009 annual report,

ING Risk Management Fails

Even an amateur in Risk Management and Diversification can tell you blind-sighted, that a single country exposure exceeding ING's total equity is a major and unacceptable risk.



What about the Dutch regulator?
This ING debacle also implies that Dutch supervisor DNB has failed as well. DNB did not notice the 'exposure mismatch' in ING's 'Spanish Risk Management' adventure.

If DNB continues 'checking boxes and formulas' while warning the whole world about every detailed risk, instead of using common sense, keeping an eye on the headlines and demanding adequate actions, the future of Financial Institutions will remain at risk. The control approach and attitude of DNB has to be fundamentally revised.

Other European Banks
Back to the banks. Although 'Exposure Lader Spain', ING turns out not to be the only bank at risk.

Just have a look at Deutsche Bank (DB). At first Deutsche bank stated that the exposure to Greece was 'very limited' and that they had 'no comment on others'.

On May 25, 2010 the DB CEO stated he has 500 million euros exposure to Greece in sovereign loans and debt and DB has no sovereign exposure to Spain and Portugal.

As we can conclude from a EVO Research report, these statements are simply not true.


Conclusion
It's clear that European Banks are not transparent about their exposures. They're hiding and mis-communicating information.

Thanks to the bailout and financial support of the European government, European banks are (temporarily) saved (by the bell).
Key Question: For how long?????

 Related Links / Sources:

- Complete European banks exposure to Spain

- Youtube: Espeluznante cogida a Julio Aparicio en Las Ventas en el cuello 

- Greek debt crisis a hazard for EU 

- Greece : dance history 

-  ING annual report 2009

Bank on the Run

Let's dive into the development of banking failures......

How many banks are on the run?

FDIC
The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by the Congress to maintain stability and public confidence in the nation's financial system by (1) insuring deposits, (2) examining and supervising financial institutions for safety and soundness and consumer protection, and (3) managing receiverships.

Just have a look at the reported (half May 2010) FDIC Bank Failures (words don't apply):

Things ain't getting better, I'll leave a 2010 Bank Failure forecast to the imagination of your actuarial mind.

Let's hope for the best...

"Thought of giving it all away
To a registered charity
All I need is a pint a day
If I ever get out of here
If we ever get out of here"

Related Links/ resources:
- The Big Picture: FDIC Bank Failures (5.15.10)
- FDIC Failure Stats

Actuary Professional Test

So you think, because you're an actuary, you must be a top professional....

Well.... Put yourself to the test by taking the next two minute IQ-test.
Remember: Don't cheat!

2 Minute Intelligence Test

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

Pension Fund Gambling

The essence of a DB pension fund's risk strategy can be captured in a single graph:

Key issue is that the portfolio duration of a DB-plan's Liabilities varies between 12 and 14 years, whereas the duration of the DB plan’s Assets is generally much shorter, 4.5 to 5 years (Moore 2007).

Secondly, 2008, 2009 and 2010 have proven that investment statistics and models have failed. Sustainable models are nearby dead.

All this implies that, despite all (developed) models, risk strategies, derivatives and experts, ultimately, a Pension Board has to take a decision without a reasonable amount of certainty. In other words they have to gamble.... And to brighten up your day, it's your responsibility as an actuary to advice this pension board!

Read more about this fundamental pension challenge in:

The Prudent Man Standard

Legal and Investing Implications of LDI Safeguards for Pension Risk

Links:
-Public Pension Funds Gamble With Risky Investments
-The Prudent Man Standard

Actuarial Risk Management Humor

During the pause of a Risk Management conference, a professional risk manager, an accountant and an actuary were in the gents room standing at the urinals. The risk manager, who finished first, walked over to the sink to wash his hands. He then proceeded to dry his hands very carefully. He used paper towel after paper towel to ensure that every single spot of water on his hands was dried. Turning to the accountant and actuary, he said, "We risk managers are trained to be extremely thorough to prevent any risk at all."

Then the accountant finished his task at the urinal and proceeded to wash his hands. He used a 'single paper towel' and made sure that he dried his hands using every available portion of the paper towel. He turned and said, "We accountants are not only trained to be extremely thorough in preventing risk, but we are also trained to be extremely efficient in managing and controlling risk as well."

Finally the actuary finished and walked straight for the door, shouting over his shoulder, "We actuaries, we never get our hands dirty"


Links:
- If people think other people are watching them, then they are more likely to wash hands

ABP Pension Fund ROI Travesty

What is a 'good' return on investment?

Dutch Pension Fund ABP, the industry-wide pension fund for employers and employees ( 2.8 million participants) in government and educational institutions in the Netherlands and the world’s third largest pension fund, reported a 20.2% return on investment in 2009.

In the 2nd half 2009 Press Release, ABP qualifies it's own performance as a 'Good Rate of Return'.
Now theologists as well as actuaries are familiar with the risk of calling something 'Good' ....

ABP ROI Stress Test
Let's put the ABP investment strategy to the test.

In the same Press Release,  ABP publishes the long-term rate of return from 1993 to 2009. ABP's average annual rate of return over this period of 17 years is 6.7%.

ABP's 'Signs of Hope Strategy'
To achieve this phenomenal return, ABP has developed a spectacular - every three years changing - Investment Strategy Plan (latest plan is confidently called: 'Signs of Hope') with a strong diversified 'winning' (?)  investment mix in combination with zero transparency or accountability information with regard to 'investment costs'.

Alternative T-Bond Strategy
Alternatively, ABP would have been better of if it would have applied a no-risky defensive European (10 years) Treasury Bond Strategy from the start. In this case the yearly average 1993-2009 ROI would have been around 6.9%.

Take a look at the next chart and decide for yourself. What pension fund would you prefer, Red or Blue?

ABP stated in their objectives that, in order to keep pensions affordable in the future, the return on investments must attain an average of 7% per year. It's clear that this objective will never be met on basis of the developed investment strategies in the past.

ABP's Future perspective?
Let's 'hope' that, after the recent step down of Ed Nijpels, ABP's new to be appointed chairman will have enough power, (pension) experience and time available to resist and combat the opportunistic and risky plans of the headstrong APG investment specialists.
Anyhow, the new chairman should be at least someone who knows how to spell the word 'Risk Management' and is experienced in (ac)counting from 1 to 10.... maybe an actuary?

Solution
Perhaps the best thing to do is to:

• turn the ABP scheme into a "pay as you go system",
  
• transfer the ABP administration to the efficient Dutch Social Insurance Bank,
  
• fire most of the ABP Asset Management Department (APG) (as they are confused about time and cannot tell the difference between Tomorrow and Today anyway) and finally,
  
• use the € 208 billion on assets to reduce most of the Dutch National Debt ( € 375 billion)

Good Luck ABP!

Links
- Top 10 largest pension funds in the world
- ABP Press release 2nd half 2009
- APG: Tomorrow is Today 
- Joshua Maggid: Excel ABP (.xls) 

Actuarial Smurf

Question is whether actuaries are best positioned for the role of Chief Risk Officer (CRO)....

More and more the CRO becomes one of the most important positions at board level to analyze, control and optimize risks in (financial) institutions. Qualified actuaries are pre-eminently positioned to qualify as CRO. After all, managing risk has been their primary task for decades. Rolling out the new Chartered Enterprise Risk Analyst (CERA) credential, actuaries will get better trained and educated than ever before.

CRO Role at Risk
Despite of all this, the CRO role is 'at risk' itself. CRO responsibilities and position are by definition conflicting with certain other stakeholder roles.

This is clearly demonstrated in a graph developed by Professor Emeritus Harry Panjer(Actuarial Science University of Waterloo).

Let's take a look at the slightly adapted graph of Harry Panjer:

• Regulator
  Regulators’ primary responsibility is to protect customers. Thus avoiding downside risk is their focus.
  
• Rating agencies
  Rating agencies focus on both the possibility of large losses as well as the possible gains to shareholders.
  
• Investors
  Investors are interested in both gains and losses and are willing to take the risk of the loss of capital as long as there is compensatory opportunity for gains.
  
• CEO
  The CEO with big stock options, has huge upside potential but little downside risk. Getting fired is one of the embedded options of the CEO's personal strategy.
  
• CFO
  The CFO's first responsibility is to stay 'in control'. The CFO will try to prevent excessive unforeseeable or unexplainable results, whether down- or upward.
  
• Clients
  Clients are primarily interested in value for money, service, quality and the continuity of the (financial) institution. Clients will keep satisfied as long as the financial results of the company remain stable and (average) positive within limits.
  
• CRO
  The CRO is trying to control the downside risk. The CRO is a kind of 'Risk Management Smurf' who only has a big STOP sign to limit the CEO and shareholders in their (short term return) demands. 

It's clear, acting as a CRO is like:

• Walking on eggshells
• Communicating with a silver tongue
• Listening like a fly on the wall
• Looking like a policeman
• Convincing like a missionary
• Calculating like an actuary

Don't wait any longer, become a professional Actuarial Smurf!

Links:
- Panjer: ERM and the Role of Actuaries (2009,pdf)

Return of a U.S. Debt Dollar

Take a (compressed) look at what author and business owner Nathan Martin calls:

The Most Important Chart of the Century!

This chart, based on the latest (March 11, 2010) U.S. Treasury Z1 Flow of Funds report, shows the change in GDP divided by the change in Debt. Or in other words: it illustrates how much extra economic productivity is gained by pumping one extra dollar of debt into our debt backed money system.

As is clear, the economic return of one dollar of 'debt infusion' declined from a positive $ 0.70 in the sixties to a negative $ 0.45 return by the end of 2009!

From a macroeconomic point of view the U.S. economy is fully saturated with debt. Flushing more debt in the U.S. economy will no longer help the economy out. Moreover, it will damage the economic growth!

Interested? Read the full blog of Nathan A. Martin

Links:
- Source: The Most Important Chart of the Century!
- U.S. Treasury Z1 Flow of Funds report (March 11, 2010)

Country Default Probability

National debts are growing worldwide. It seems we're drowning in a sea of debt. Who's gonna survive?


By experience we know that whenever our gut-feeling takes us for a ride, help of statistical models is necessary to rebalance and get sight at the real problem.

Sovereign Risk Monitor
In this case of 'national debt', the help of CMA's Sovereign Risk Monitor comes in. The CMA Sovereign Risk Monitor identifies and ranks the world’s most volatile sovereign debt issuers according to percentage changes in their 5 year CDS. CMA also calculates the Cumulative Probability of Default (CPD), the 5 year probability of a country being unable to honour its debt obligations.

Let's take a look at the world's most risky countries in Q4 2009:




Yet, the 'Default Landscape' is rapidly changing as becomes clear in CMA's interesting daily 19 March 2010 report showing Greece 'Cumulative Probability of Default' rising to 24.27%.

On the other hand we've got the world's best Countries, with Norway on top....

More actual information is available at CMA (registration required).

Latest CMA Update

Let's hope for the best....

Links:
- CMA Sovereign Risk Report for Q4 2009
- Source: CMA
- Latest CMA Update

Hedge Fun

Do you recognize the next situation?

You're at a birthday party or having a social evening. Everybody is having fun, talking to each other and - like usual - discussing the latest financial topics, scandals and solutions.

Suddenly someone turns to you and says: Heee.. you're an actuary, you can tell us what a a hedge fund is!

Of course as born or raised actuaries we all know what a hedge fund is. But when it comes down to explaining what a hedge fund is to clients, board members, friends or family, probably not one of us can explain it better than Paddy Hirsch, Senior Editor at Marketplace, can in the next Youtube video:

Video: What is a Hedgefund?

Now, when a Hedge Fund or a (Lehman)bank 'unexpectedly' gets into trouble, it simply uses the Repo 105 technique to to survive. Paddy Hirsch explains again.....

Video: Repo 105

As professional risk managers we would expect these high risk Hedge Funds to operate under excessively severe capital requirements. Too bad...., this is not the case, as Mr. Timothy Geithner explains in the next video......

Video: Geithner: No Capital Requirements For Hedge Funds

From Mr. Geithner's statements it's clear that Hedge Funds are de facto treated as 'Hedge Fun' until the systemic risk shows up.

However, when this risk becomes manifest, it will be to late to take appropriate measures.

Misunderstanding: Risk management
One of the great public misunderstandings of Risk Management is that most people - obviously including Government -think that Risk management is all about 'Managing Damage' after the corresponding loss has occurred.

As we know, Risk Management is about something else:

I. Identify, Analize & Prevent Risk
About 70% of Risk Management is about constantly identifying, analyzing and preventing risks from happening.

II. Emergency Response Plan
Another 20% is about proactively creating and updating Emergency Response Plans (ERP's) on how to deal with loss and how to limit and reduce that loss in case of the unfortunate event that a risk materializes in a loss.

III. Damage Reduction
Only the last 10% is about 'damage reduction' by executing the ERP's and tackling losses in case a risk - notwithstanding the measures taken - has resulted in a loss.

Perhaps we should offer (one volunteer is worth two pressed men) Mr. Geither a free Risk Management Course from the institute of actuaries.....

Read more about (the regulation of) Hegde Funds in an excellent (2006) paper by Dale A. Oesterle called Regulating Hedge Funds.

It's clear: there's nothing funny about fundy hedge funds....

Corresponding Links:
- Derivatives study center : Hedge Fund
- Regulating Hedge Funds (2006)
- Marketplace videos
- Will Lehman Brothers and Repo 105 allegations bring down Ernst & Young?
- Wikipedia: Repurchase agreement, Repo 105