A brief history of actuarial science
The need for insurance and pension arrangements comes from personal risk and uncertainty. Goods and properties are at risk of loss through theft or fire. There is a risk of breadwinners dying and leaving their families without income or the ability to repay borrowings. Or of their savings not lasting throughout their retirement.
In early times, the usual method of relieving these sorts of poverty was charity, but this provided inadequate and uncertain relief, and carried a social stigma. People tried to protect themselves financially against the risks of life and death by developing elementary insurance or risk-sharing arrangements, which often failed because of a lack of knowledge and understanding.
Advances in mathematics
The 17th century began to see personal risk placed on a more scientific basis, due to advances in mathematics in Germany, Holland, France and England. Compound interest was studied, and probability theory emerged with a publication in 1657 by the Dutch mathematician, Christian Huygens. Another important advance came in 1662 from a surprising source, a London draper called John Graunt. By analysing the London Bills of Mortality, he showed that there were regularities in the patterns of life and death in a group of people, despite uncertainty about the future lifetime of only one person. His famous life table showed how many of every 100 babies survived until ages 6, 16, 26, 36, 46 and so on.
It now became possible for the first time to envisage setting up an insurance scheme providing life assurance or pensions for a group of people, where it could be worked out how much money each person in the group should contribute to a common fund assumed to earn a fixed rate of interest. The first person to demonstrate publicly how this could be done was Edmond Halley, the famous mathematician and astronomer, after whom the comet is named. Halley analysed data relating to births and deaths in the German City of Breslau to construct his own life table in 1693 (for individual ages, not just age groups), which was found to give a reasonably accurate picture of survival and became well known throughout Europe.
Applying the science to annuities
He also used his life table to work out how much money someone of a given age should pay to purchase a life-annuity, estimating the probability that the person would survive to receive that instalment. The resulting probability was multiplied by the sum which would need to be invested now in order to pay for that instalment if one were certain to receive it. Halley then went on to do likewise for the next instalment, and so on. Summing these present values for all future instalments up to the end of life then gave the value of the whole annuity. Actuarial science had been created.
The first actuaries
The first life assurance company to use premium rates which were calculated scientifically for long-term life policies was The Equitable, founded in 1762. The techniques used to calculate these premiums were developed from Halley's method by James Dodson, a London mathematician. The Equitable used the term 'actuary' for its chief executive officer in 1762. Previously an actuary was an official who recorded the decisions, or ‘acts’, of ecclesiastical courts.
In 1848, the actuaries of a number of life assurance companies established the Institute of Actuaries. While its aims included the improvement of the mathematical theories upon which life insurance is based, it was also concerned about establishing correct principles relating to subjects involving monetary considerations and probability. Thus, even so long ago, it was clearly envisaged that actuarial science would have wider applications, as has proved to be the case. In 1856, the Scots in the Institute decided to form the Faculty of Actuaries in Scotland.
Adapted from an article in Inside Careers 2003-2004 by Chris Lewin FIA