Actuarial pricing, capital modelling and reserving

Pricing Squad


Issue 12 -- March 2017

Welcome back to Pricing Squad!

Pricing Squad is a newsletter for fellow pricing practitioners and actuaries in general insurance.

Today's issue puts actuarial pricing in the framework of BIG philosophy.

You can also read an opinion piece sent to the Actuarial GI board.


Aristotle vs Plato (or Actual vs Predicted)

The big picture

The entirety of Western philosophy is a conversation between Aristotle and Plato.

Aristotle believed that humans could learn what was true by experiencing reality through senses. For Aristotle empirical reality mattered. He observed nature and people and accepted what he saw.

Aristotle's approach encouraged experimentation, science, growth and self-esteem.

Plato thought that ideals were more essential than reality itself. To him, empirical reality was only an imperfect reflection of the perfect world of ideas. Plato wanted people to strive towards ideals - for instance, by transcending human selfishness.

According to Plato, since people were not capable of finding the truth with their senses, they needed philosopher-kings to guide them. For millennia, Plato's teachings have been music to the ears of various mystics and tyrants.

The small picture

Hey, what does this have to do with insurance pricing?

Every time you use very a very complex pricing theory you are in Plato's la-la Land.

Here are some characters straight from this La-la Land:

  • 1-in-200 years capital models;
  • nearly all by-peril GLMs;
  • using GLM at individual policy level;
  • using Life Time Value at individual policy level;
  • any model which requires more than 1 week to build;
  • any model not frequently checked against actual numbers.

Actual vs Predicted

The humble Actual vs Predicted chart (a.k.a. Actual vs Expected) shows how the Aristotle vs Plato debate comes to life in actuarial practice.

Here is one:

This particular chart shows how a very expensive burning-cost model fits by scored loss ratio band. (There is a reason why this fit is normally so poor but let's skip over that for now.)

The actual loss cost is empirical, simple and real. This represents Aristotle's ideas.

The predicted loss cost has been derived from a statistical model. This theory is not accessible to ordinary people. It takes an actuary to make this prediction. This is Plato's domain.

Because insurance is volatile, we cannot do away with theoretical predictions. But we can keep them to a minimum and empirical evidence should always trump theory.

***

Does insurance need more philosopher-kings? I think not.

Do actuaries sometimes aspire to this role? Absolutely.


GI board feedback

The Actuarial Profession's GI board asks in the February newsletter "what are your thoughts on the current level of regulation"?

Below is my response.

Dear Sharon,

In response to your request for comments on the current level of regulation related to actuarial work, I would like to share my opinion with you.

There is too much regulation.

Kind regards

Jan

You can email your opinion to: Sharon.Cumberbatch@actuaries.org.uk


Do you need support?

If you need access to pricing tools to radically simplify your work and deliver reduced loss ratio quickly, or if you are simply looking for an actuarial contractor, get in touch.

Thank you for reading, and have a great day,
Jan Iwanik, FIA PhD


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