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The Actuary The magazine of the Institute & Faculty of Actuaries
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Modelling extreme events remains a challenge

The impact of the current market turbulence on insurance modelling for extreme market events was the subject of a recent sessional meeting of the Faculty of Actuaries.

Based on a paper produced by the Profession’s Benchmarking Stochastic Models Working Party, insurance actuaries shared views on the methods and pitfalls involved with developing models for extreme events such as interest rate changes, equity market falls, and the economic upheaval of 2008.

Paper co-author Ralph Frankland stated that the issue of modelling extreme market events was particularly important in the context of the current economic climate.

“Recent market volatility serves to remind us that sudden dramatic shifts do happen perhaps more frequently than we tend to expect,” he said.

“The problem is similar to that in general insurance. Considering how you put a price on insuring the launch of a satellite when, following just a few years’ claimfree experience, the last two launches had resulted in failure and consequential enormous claims. I fear that potentially we may have a very similar problem in assimilating 2008 into our experience.”

He added the research in the paper could have relevance across a range of different industries: “Although our paper is clearly focused on the needs of the Financial Services Authority’s ICAS regime, the methodologies and analysis can be applied elsewhere in risk assessment including, potentially, Solvency II, as well as in the assessment of market risks outside of life insurance.”

To read the paper Modelling extreme market events, please go to www.actuaries.org.uk/sessional/sm20081103.pdf