Chris Lewin highlights the valuable skills that actuaries can bring to risk management, and proposes a system for applying actuarial principles in this area
The world is full of risk. It is also full of risk management practitioners, who are endeavouring to identify threats in every area of human activity, as well as the actions that could mitigate them. What can actuaries offer in this extensive field to make a difference for clients or employers? Actuaries are experts at managing the complicated risks in financial services, but would it be useful to society if this expertise could be applied more widely?
Risks are often so complex that they cannot be properly understood and managed by one person on their own. For risk management in the wider world, an actuary must work closely with members of other professions, whether at board level or in more junior roles. Such actuaries may therefore need to develop their skills in working as part of a team in which other members will have different but valuable skills, knowledge and experiences.
One benefit for the client who hires an actuary to work on risk management will come from the actuary’s skill in studying complicated risks and presenting results in terms that are easy to understand – and that facilitate decisions. Moreover, actuaries try to focus on the big picture while remaining conscious of continuing uncertainty and variability in the way results may unfold. Actuaries may be able to develop risk models that encompass all team members’ contributions, welding them into a compelling narrative for the business within an overall framework. Common sense suggests that such work will improve the chances of success when it leads to the right decisions on how the business responds to its risks.
A system for risk management
For managing risks at strategic level in any large enterprise, a practical system for applying actuarial principles can be summarised as follows and is illustrated in Figure 1. It starts with the reduction of uncertainty through the acquisition of as much knowledge as possible about the business or activity and its risks. Some assumptions may be needed to fill knowledge gaps, and these must be disclosed. A model of the business is then built, illustrating how various inputs will lead to key outputs. Risk scenarios and events – both threats and opportunities – will be identified. This will include an estimation of their likelihoods and possible impacts, as well as an understanding of connections between them and the wider world’s influences on them. Thought will be given to future scenarios that may develop if these risks, separately or in combination, were to occur, and an analysis of the model will help to show whether results in these scenarios are within the organisation’s risk tolerances.
The next steps are to identify options for improving outcomes through mitigation of threats and optimisation of opportunities, and to analyse which options are likely to be cost-effective. Secondary risks arising from the adoption of these options will also be analysed. Results will lead to a plan for mitigation and optimisation, and for continuing risk management in future.
The ongoing experience will be actively monitored. The monitoring process may lead to further actions as more knowledge is gained about the risks, and it will aim to identify and analyse emerging threats and opportunities while there is still time to do something about them. In addition, there are always some big risks which are uncertain and not capable of precise analysis, and actuaries will use techniques that enable practical decisions to be made, nevertheless.
However complicated the situations they encounter are, an actuary working with a multi-disciplinary team should be able to visualise the overall position, take account of relevant data, make necessary numerical estimates, apply tools and insights, and help to draw up practical and well-communicated conclusions as a basis for decisions.
At a technical level, actuaries possess a number of helpful tools. These include techniques for strategic risk management, enterprise risk management, risk modelling and evaluation, scenario analysis, stress testing, reverse stress testing, sensitivity testing, assessing cost-effectiveness of mitigation options, data analysis, pattern recognition, project risk analysis, multi-criteria analysis, economic capital planning, and the theory of investment portfolios. In practice there are often financial implications to risk, and actuarial methods enable these implications to be evaluated in monetary terms. Not all of the tools will be needed every time, but they are available when required.
Outside the comfort zone
Given that actuaries are acknowledged experts in risk management for financial services, why have they not made greater inroads into wider risk management? Perhaps some are comfortable with their existing roles and believe they would be taking too much personal risk in broadening their careers. However, some existing roles may be starting to disappear, for example with the vanishing of defined benefit pension schemes, and career-widening options may begin to seem more attractive. Actuaries should not assume they will immediately be able to step into wider roles, as they may need to prepare by intensively reading relevant material and learning from published case studies of actuaries who have already made the transition.
One item worth reading would be Strategic Risk – A Guide for Directors (bit.ly/3sD63fI), which actuaries helped develop; it describes a number of key issues and some techniques that can be applied. It underlines the need for risk leadership by the board itself and the necessity for the board to create the right culture, internal communication system and risk-management framework. For anyone not already familiar with enterprise risk management, there is also the Enterprise Risk Management Short Guide (bit.ly/2OnflNR). Actuaries interested in branching out into risk management will also want to absorb a wide range of excellent books and articles written by non-actuaries.
Unfortunately, the profession has not yet been able to make the wider world aware of the enormous value for money that actuaries could contribute outside their traditional fields. To increase awareness would require resources devoted to a focused campaign spread over several years.
Spreading the word
The fact that actuarial approaches to risk management have been successful in the financial services industry should give actuaries credibility when seeking recognition for potential contributions in other fields. There may be career opportunities in commercial companies and banks, either in enterprise risk management or in investment policy development. Some opportunities may be at board level. There could also be openings in the public sector as countries grapple with climate change risks.
Taking account of actuaries’ ability to handle complexity, tried and tested risk-management principles, comprehensive toolbox and professional ethics, they ought to be able to make a valuable practical contribution in wider fields. The profession needs to make this more widely known.
Chris Lewin is a former member of the Risk Management Board and is chair of the Infrastructure Working Party. He has managed risk in several roles as chief executive of major pension schemes