What is an Actuary anyways?
- theangryactuary
- Sep 10, 2023
- 4 min read
So you’re wondering what an actuary is, let alone an angry one? Well, put simply, actuaries are the mathematics specialists of the insurance world. Actuaries are trained in statistics, focusing on probability and expected value outcomes. But we can also be a jack of all trades in the financial world as we are also required to have a reasonable understanding of economics (macro and some micro), corporate finance and basic accounting (yes balance sheets, income statements and to a lesser extent, cash flow statements matter).
Actuaries combine these various fields to assess risk and calculate expected loss outcomes for various events. But this is only the beginning as actuaries then generate insurance premiums for these expected loss outcomes. Actuaries are also heavily involved in reserving (making sure an insurance company has enough money to pay for claims) and capital management (making sure that there is enough capital backing the business).
Actuaries are typically concerned with frequency (how often in a given period a claim is made) and severity (how large the claim is). You could say that frequency and severity define actuaries, just like supply and demand defines economists.
There are four primary areas that actuaries are traditionally involved in:
Pensions:
Back in the day, a lot of companies set up defined benefit pension schemes. The employer contributed a set percentage of an employee’s money in a pool which was then invested. At the point where an employee retires, they are paid a pension (regular payments during retirement until death) with the amount based on a defined formula (hence, defined benefit). The formula would usually calculate the employee’s pension amount based on some final average salary (average earnings over the last three years of service was common) and years of service. However, plans varied and could be tailored to any number of formulae.
The problem with this type of retirement plan would be the fact that the investment risk was heavily borne by the employer, it was expensive to administer (employing actuaries every year for funding studies and calculation of final pension benefits don’t come cheap), and a lot of the formulae could be overly generous to long term staff who paid in very little money early on in their careers but then had the benefit of the formula determining their final pension based on a much higher salary at the end of their career. Government pension plans were a great example of how lucrative these could be.
As such, defined contribution plans have all but taken over now. As the name suggests, a set percentage of an employee’s salary is put into an investment fund. This is then invested in various retirement fund options such as stocks, index funds and bonds. At retirement, the employee has a pension pot with a value dependent on investment performance over their working life. This is now the standard as the investment risk has been moved to the employee and the calculation is very simple at the time of retirement.
Retirement is usually a predictable event, making frequency predictable and by definition, severity is known as it is formulaic or a final balance.
Life Insurance:
As the name suggests, this is where you get paid if you die. Well, your estate gets paid. As you can imagine, this is where having control of the outcome is kind of important to the life insurance company, hence, suicide is not covered.
There are various types of life insurance but the most common type is term life. You pay a premium for a year and if you die in that policy year, your estate is paid the policy value agreed at the time of policy purchase.
The severity of the risk is known as the insured amount is agreed. Frequency of death is relatively predictable, like retirement. At the time of writing, human technology has not yet overcome death, so the question of when a benefit payment is to be made becomes a matter of when and not if. In the US it is also a useful tax dodge in some cases as the death benefit is not taxable to beneficiaries.
Health Insurance:
Much more relevant for the US due to the large private health insurance market. Large insurance companies offer benefit plans through employers (more common) and on the open retail market. The various designs of benefits for different medical procedures and costing calculations are where actuaries play a vital role.
The frequency of claims for an individual are not certain but the law of large numbers allows actuaries to make predictions for groups. The severity is also quite variable but within a certain limit given benefit plan designs.
General Insurance (or Property and Casualty for you Americans):
Last but certainly not least, insurance for just about everything else. From home and auto on the retail side, to directors and officers, professional indemnity and of course property. Cyber insurance is a more recent product with much left o explore. Don’t forget Marine, how else do you think you got your cheap goods from China?
If you ever wondered why insurance companies ask so many questions when you purchase car or home insurance, it’s because actuaries (or a data scientist in some cases) have built a predictive model that is able to factor in all your answers and generate a required premium.
This is where the frequency is the most variable and the severity is theoretically limitless (don’t laugh, bodily injury coverage for auto accidents in the UK is covered in this manner).
There are a plethora of different types of insurance coverages offered in the general insurance world that are too many to list here.
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