In a bid at clarity, Anthony Burpitt gives the gist on being a pricing actuary in (precisely) 824 words…
It is funny – the actuarial world. It is generally true that most actuaries one would meet expect or assume that the rest of the insurance world has an idea what is involved in actuarial pricing. Yet most people outside of the actuarial circle see what actuaries do as a mystical science that mere mortals were never supposed to understand.
So this instalment of Nuts & Bolts is going to look at what it is like to be a pricing actuary, what they do and the problems they face.
Firstly, what do pricing actuaries do? As most would expect, the job is to calculate the price that the eventual policyholder pays. There is a slight difference between a pricing actuary at an insurer and a pricing actuary at a reinsurer. Reinsurer’s premiums are more risk based, so a pricing actuary at a reinsurer would spend most of their time calculating future claim rates rather than on calculating expense costs. On the other hand, most insurers do not actually hold much of the risk, but do have larger expenses (as they pay for costs of administration and underwriting) so their pricing actuaries will concentrate more on the costs of running the office.
Pricing actuaries need to make sure that they make allowance for paying claims, all expenses (both at the start, at claim time, and in between), policies that lapse (especially when the policy lapses before the initial costs are recouped), profit and distribution costs (like adviser commission or internet/search engine optimisation (SEO) maintenance).
This is easy as long as nothing ever changes. The difficulty is in predicting the future – this is the so-called ‘actuarial crystal ball’. What if there is a bad flu pandemic? What if the NHS starts cancer screenings at an earlier age bringing claim dates forward? What if a new wonder drug means that annuities are paid to pensioners for five years longer than expected? What if technology massively reduces the costs of on-going administration? What if there is a deep recession and a wave of policyholders cancel their policy?
Just to make things even more difficult (sorry ‘challenging!’), the life industry’s products can last for up to 40 years or more. There is no real reason to think that the rate of change over the last 40 years will be the same as the rate of change over the next 40, so we have to do forecasting.
We also have to consider who is subsidising who. So for example, policyholders with larger sized policies tend on average to cross-subsidise those with smaller policies. And those who purchase direct tend to subsidise those who seek advice through an adviser. So actuaries have to consider when it is appropriate for a cross-subsidy to exist, and have to make assumptions about how many ‘big’ and ‘small’ policies will be sold in the future so that the cross-subsidies work.
Then there is the commercial side of what pricing actuaries do. Insurance is a commercial business. All insurers and reinsurers have to compete within their space. Take the life reinsurance sector in the UK. It is fair to say that there are eight key reinsurers operating in the UK life market. Each of those will have their own pricing team (remembering of course that the reinsurer’s focus is mainly on predicting future claim rates).
What happens when a rival reinsurer has a lower price than your firm? It is back to the drawing board and figuring out what assumptions they are making about the next 40 years.
If the actuary thinks a mistake has occurred – great (so long as it means the firm can go lower). But what if the months of research you do back up your findings, and you are actually right? Then you have a problem because you are in a position where your competitor is not charging enough – so you can either also write at a loss or lose market share.
In most industries you can wait a little while and your competitor will realise they have made a mistake and will raise their prices and you are back in the game. Our industry is different. Typically it can take twenty years until a firm see the results of its pricing assumptions. By then in all probability the original actuaries would have moved on and there will be no one left to blame (there may be some similarities between banking here).
Luckily however, actuaries tend to be a trustworthy lot and will give their all to provide the most accurate forecast that they can. There may of course be problems when inexperienced actuaries get it wrong, but no industry gets it right every time, especially industries trying to predict trends and issues up to 40 years in the future.
And, that is actuarial pricing in a nutshell. By the way, if you checked that there really were 824 words, then you might have a little bit of pricing actuary in you too.
Anthony Burpitt is research and development manager at Munich Re
