Module 4: Actuarial Solutions
Section 2: Designing the Risk Management Solution
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- Objectives
- Identify categories and characteristics of actuarial solutions.
- Describe how approaches to managing risk are related to the types of risk.
- Recognize the significance of successful solution design.
- Describe elements of designing actuarial solutions.
- Design a solution for managing reinvestment risk in an insurance company when asset and liability cash flows do not match (asset-liability management).
- To understand how the Control Cycle is applied to life insurance product development, read Understanding Actuarial Management (2010), Chapter 8. This chapter discusses the Control Cycle in the context of an actuary's role in financial services product development.
- Defining "Solution":
- One definition of solution is “the method or process of solving a problem.” The application of the Control Cycle allows actuaries to effectively establish the optimal method or process. All actuarial solutions involve the quantification and management of risk in situations involving future contingencies. Given an uncertain future, actuarial solutions invariably involve the use of a combination of assumptions and intuition commonly referred to as “actuarial judgment.” Actuarial judgment derives from an understanding of certain mathematical interrelationships and years of experience.
- Solution is also defined as “a set of values of the variables that satisfies an equation.” “A set of values” can be expanded to mean data and assumptions. The “equation” is rarely simple. An actuarial solution often involves models.
- When approaching an actuarial problem there is usually no single best solution. There are many methods, many processes—or even sub-processes—from which to choose. An actuary must consider a range of possible solutions and select one that meets many if not most of the stakeholders’ needs without subjecting the financial security system to undue and unmanageable risk. The actuary will help the financial security system identify and select a single optimal solution.
- Read m4s2-01_Designing_RM_Solution.pdf about the different types of risks, managing risk and the Control Cycle, and to complete an activity on frequency, severity and time frame.
| Examples of Products | Frequency (High, Low or Variable) | Severity (High, Moderate or Low) | Time Frame (Short-Term or Long-Term) |
| Hurricane insurance | Low | High | Short-Term |
| Group term life insurance | Moderate | Moderate | Short-Term |
| Dental insurance | High | Low | Short-Term |
| Individual and group whole life insurance | Variable | Moderate | Long-Term |
| Retirement Benefits | High | Moderate | Long-Term |
| Auto insurance | Low | Moderate | Short-Term |
| Long term care | Low | High | Long-Term |
| Landfill Case (Post-closure costs) | High | Moderate | Long-Term |
- According to Segal, there are three distinct components in the risk quantification ERM process. Read Chapter 5, pages 174-224 in Corporate Value of Enterprise Risk Management (2011) for an in depth look at these three components. The three distinct components are: (1) Calculate baseline company value, (2) Quantify individual risk exposures, and (3) Quantify enterprise risk exposure.
- The three items listed below are aspects of calculating the baseline company value: (1) Input of data and assumptions, (2) model calculations and (3) output of results.
- There are four key ways to manage risk:
- Reduce it.
- Avoid it.
- Transfer it.
- Exploit (retain) it.
The Asset-liability Management (ALM) case study demonstrates a technique for exploiting a risk that has been retained by the financial security system (Life Insurer); the following examples (m4s2-02_ManageRiskEx.pdf) provide an overview of managing risk in the context of the ALM case study. As you read the examples, recall the Risk Control Cycle to get a sense of where each of the examples fits within the financial security system.
- The following examples (m4s2-02_ManageRiskEx.pdf) provide an overview of managing risk in the context of the ALM case study.
- Read m4s2-03_IllDefinedProbSol.htm to see possible consequences of failing to design an appropriate solution.
- Read an example (m4s2-04_UNAC1.pdf) of a small insurance company whose management believed they had found a way to solve the problem of meeting investor expectations. It planned to achieve rapid growth by producing a product that would solve the loss of income needs of a niche market. Instead, the solution led to new problems.
- Read about (m4s2-06_Aspects.pdf) some elements to consider when designing solutions.
- There are many times when the situation does not allow the actuary to ensure that all elements important to typical actuarial solutions are followed. Read two brief examples (m4s2-07_Thought_Questions.pdf) with some incompletely addressed elements.
- Summary:
- Actuarial solutions involve the quantification of risk with respect to future contingent events.
- An actuary uses actuarial judgment when designing solutions.
- The profession is now moving in a direction where actuarial solutions are being applied outside the traditional areas of practice. When applying actuarial methods in new practice areas, it becomes more important to remain aware of the fundamentals: Use the Control Cycle. Manage your assets and liabilities together. Apply enterprise risk management techniques. Know your constraints. Be professional and communicate your thoughts well.
- This section showed how designing solutions is what actuaries are all about. The actuary’s problem-solving toolkit includes confirming that the problem is well-defined, balancing stakeholder’s needs, asking the right questions, understanding the constraints and effectively communicating the solution. During this section you also learned about the importance of successfully designing solutions and the implications of failing to solve the problem. You read about the components of a typical actuarial solution and the process for designing a solution.