Expert judgement. 8 June 2015
Presented to an IFoA Sessional Meeting in Edinburgh on 8 June 2015, and to the IAA Colloquium in Oslo on 10 June 2015
Abstract: Expert judgement has been used since the actuarial profession was founded. In the past, there has often been a lack of transparency regarding the use of expert judgement, even though those judgements could have a very significant impact on the outputs of calculations and the decisions made by organisations. The lack of transparency has a number of dimensions including the nature of the underlying judgements, as well as the process used to derive those judgements. This paper aims to provide a practical framework regarding expert judgement processes, and how those processes may be validated. It includes a worked example illustrating how the process could be used for setting a particular assumption. It concludes with some suggested tools for use within expert judgement. Although primarily focused on the insurance sector (including consideration of the impact of Solvency II), the proposed process framework could be applied more widely without the need for significant changes.
Sustainability in the financial system. 11 May 2015
Sessional Research Meeting, 11 May 2015, Staple Inn, London. Research commissioned by the Resource and Environment Board
Abstract: Much actuarial work is underpinned by the use of economic models derived from mainstream academic theories of finance and economics which treat money as being a neutral medium of exchange. The sustainability of a financial system whose understanding is based on a limited view of the role of money has increasingly been subject to criticism. In order to identify needed research programmes to address such criticisms and improve these disciplines, we sought to understand the current state of knowledge in economics and finance concerning the link between monetary and financial factors and sustainability.
We have approached this through a search for relevant literature published in the highest-rated academic journals in economics, finance and the social sciences for titles and abstracts containing both references to the financial system on the one hand and sustainability and environmental factors on the other.
The systematic search of a universe of 125 journals and 355,000 articles yielded the finding that surprisingly few research papers jointly address these concepts. Nevertheless, we find that current research shares a broad consensus that the implications of the growth-oriented economic model results in an increasingly interconnected and fragile financial system whose participants are not incentivised to fully recognise the natural environment and resource constraints. We further observe that the prescriptions offered are relatively limited and small-scale in their outlook and that there is a vital need for further research, particularly for actuaries who are required to take a longer term outlook.
The Resource and Environment Board has supported this work with two key objectives: first to identify research that may have direct application to actuarial work and, second, to identify gaps in academic research that would help drive the IFoA's own research agenda. With this in mind there are three further areas of potential actuarial research. These are the policy aim of pursuing growth without limit within a finite ecosystem; discount factors as the primary means of capital allocation and investment decisions; and the use of GDP as the key metric of economic activity and success. We also conclude that further academic research is urgently needed to understand the sustainability of the banking and monetary system.
Keywords: Literature review; Banking; Finance; Monetary policy; Sustainability; Green economy; Actuarial science
Model risk. 23 March 2015
Sessional Research Meeting, 23 March 2015. Paper by the Model Risk Working Party, presented by N Mojaria
Abstract: With the increasing use of complex quantitative models in applications throughout the financial world, model risk has become a major concern. Such risk is generated by the potential inaccuracy and inappropriate use of models in business applications, which can lead to substantial financial losses and reputational damage. In this paper, we deal with the management and measurement of model risk. First, a model risk framework is developed, adapting concepts such as risk appetite, monitoring, and mitigation to the particular case of model risk. The usefulness of such a framework for preventing losses associated with model risk is demonstrated through case studies. Second, we investigate the ways in which different ways of using and perceiving models within an organisation both lead to different model risks. We identify four distinct model cultures and argue that in conditions of deep model uncertainty, each of those cultures makes a valuable contribution to model risk governance. Thus, the space of legitimate challenges to models is expanded, such that, in addition to a technical critique, operational and commercial concerns are also addressed. Third, we discuss through the examples of proxy modelling, longevity risk, and investment advice, common methods and challenges for quantifying model risk. Difficulties arise in mapping model errors to actual financial impact. In the case of irreducible model uncertainty, it is necessary to employ a variety of measurement approaches, based on statistical inference, fitting multiple models, and stress and scenario analysis.
Keywords: Model; Model Risk; Model Error; Model Uncertainty; Risk Culture
Considerations of State Pension Age in the UK. 16 March 2015
Sessional Research Meeting, 16 March 2015, Edinburgh. Paper presented by Rob Hammond, Steven Baxter and Mark Sadler.
Abstract: State Pension Age (SPA) is an issue of topical interest in the UK at the time of writing due to the Government’s plans to link SPA at future dates to estimates of the projected longevity of the population. This paper considers the background to the current position, how the linkage is proposed to work, other factors that may need to be considered and some changes in the proposed State pension regime that could be alternatives to, or complementary with, a changing SPA.
Keywords: State Pension Age; State pensions; Life expectancy;
The link between classical reserving and granular reserving through double chain ladder and its extensions. 2 February 2015
Forecasting death rates using exogenous determinants. 26 January 2015
Towards the optimal reserving process. 19 January 2015
Sessional Research Meeting, 19 January 2015. Paper by the Toward the Optimal Reserving Process (TORP) Working Party presented by Neil Bruce
Abstract: Our principal focus in this paper is on ways that a Fast Close process (or indeed any reserving process) can be structured to maximise the value added within the process given the time and resource available. This builds on the use of actual vs. expected techniques investigated in our previous paper, and also looks at forces external to the reserving function that may derail smooth progress. We highlight a number of practical ways that the balance can be restored in favour of adding value rather than crunching numbers. This paper forms the second in the TORP series.
Keywords: Fast Close, TORP, Reserving, Actual vs. expected
The benefits and challenges for insurers considering non-traditional investments. 19 January 2015
Sessional Research Meeting, 19 January 2015, Staple Inn, London. Paper by the Non-traditional Investments Working Party
Abstract: Life insurers have historically relied upon investment markets as a key source of profit and crucially have been able to do this whilst embarking on relatively ‘vanilla’ investment strategies. In the current low yield environment, broadening their investment horizons is critical to maintaining profitability.
This paper summarises some relevant external literature and the working party’s own research in understanding the potential benefits and pitfalls for insurers seeking to invest in non-traditional assets.
The objective of this paper is to help educate and promote understanding by all (the many) relevant parties. In doing so, we hope to help organisations to achieve some further economic success for the ultimate benefit of society.
Whilst this paper has primarily been written from the perspective of a life insurer, we hope it will be of interest to a much wider audience. Many of the asset classes considered here are relevant to general insurers, pension funds and the wider capital markets.
It is very important to note that the paper does not contain investment advice and the analysis represents the views of the individuals and the working party and not the companies which they represent or the Profession. The paper does not make any comment as to the suitability (or otherwise) of specific investments for particular investors.
Keywords: Non-traditional assets, alternative assets, investments, ALM, loans, infrastructure, PPP, PFI, social housing, real estate, residential mortgage, commercial mortgage, ground rent, student accommodation, asset backed securities, ABS, RMBS, CMBS, aircraft lease, emerging markets debt, high yield, private placement, private equity, hedge fund, insurance linked security, ILS.
Longevity basis risk methodology. 8 December 2014
Executive Summary: This paper summarises the work to date of Cass Business School and Hymans Robertson LLP in relation to assessing longevity basis risk. This work was commissioned by the Longevity Basis Risk Working Group (LBRWG) and funded by the Life and Longevity Markets Association (LLMA) and Institute and Faculty of Actuaries (IFoA). The LBRWG was formed by the LLMA and IFoA in December 2011 with a remit to investigate how to provide a market-friendly means of analysing longevity basis risk.
The key outputs of this work are:
- for modelling books which are ‘self-credible’ (i.e. a large number of lives & sufficient back history) a shortlist of ‘best of breed’ 2 –population models (specifically the M7-M5 model, or in some situations the CAE+Cohorts model);
- for modelling the majority of books which are not self-credible, an alternative, easy to apply “characterisation approach”;
- a clear decision tree framework to aid the selection of an appropriate methodology for assessing basis risk from those mentioned above;
- a clear recognition of the importance of choice of time series underpinning any 2- (or multi-) population model
These outputs are backed up by an extensive body of research, including:
- a review of how trends have varied between different (sub) populations in the past, covering both the highlights of existing literature and additional research based on the Club Vita dataset of UK occupational pension schemes;
- a review, classification and general formulation of two-population models that could be considered for modelling longevity basis risk;
- a thorough and systematic assessment of candidate two-population mortality models to identify those which provide the most suitable balance between flexibility, simplicity, parsimony, goodness-of-fit to data and robustness;
- case studies, review of key challenges and consideration of practical issues in relation to both the M7-M5 model and the characterisation approach.
The effect of model uncertainty on the pricing of critical illness insurance. 24 November 2014
Quantitative approaches to model uncertainty. 29 October 2014
Sessional Research Meeting, 29 October 2014, at Staple Inn Hall, London. Presented by Andreas Tsanakas, Cass Business School, City University, and Andrew Smith, Deloitte
Adverse selection in a start-up long-term care insurance market. 22 September 2014
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