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The Actuary The magazine of the Institute & Faculty of Actuaries

The control cycle

It was back in 1984 that the unified concept called ‘the control cycle’ was born. With the intention of explaining how actuaries have to make assumptions which then have real impact on the profitability of life insurance offices, the picture shown in figure 1 was presented in a paper by Jeremy Goford to the then Institute of Actuaries Students’ Society.
Almost by definition this process could then be described as revolutionary! The mathematicians and scientists among us will notice this as a good example of a feedback process the idea being that an original hypothesis of something’s behaviour can be tested against the arising reality, the original hypothesis be modified, retested, and so on in an endless cycle. Of course, hard-pressed executives in a modern business world and actuaries not least among them may be unimpressed by an endless cycle, and therein lies the potential for added value that the actuary can bring.
The actuary, in using the control cycle, will need to moderate the timing and pace of flow around the cycle. Judgement will be required at each potential step to assess how urgent and financially significant the step is likely to be for the office, taking into account the particular lines of business it writes and its surrounding financial circumstances. As far as a company’s chief executive may be concerned, the added value of the actuary then comes in, with ability to minimise the control cycle work done while maximising the (stability of) profits. We could term this the entrepreneurial value of the actuary.
Of course, the actuary’s other main value is the prudential one. Compared with the description in the preceding paragraph, the control cycle can be operated at a quickened pace with more prudent assumptions. The actuary will pause at leisure at the various points which could model reduced profits and reduced solvency capital, and give increased credence to those factors likely to reduce solvency over time.
The actuary is able to exercise some judicious endeavour here in the way value is added in the process of moving around the control cycle a good dose of foresight. At a glance it might appear that the control cycle delays the step revised assumptions until some post-assumption evidence has led to the next step interpretation and monitoring. Stochastic modelling, however, enables the actuary to predict right from outset under what circumstances profitability and solvency may be affected and to what extent. By doing such tests, the actuary can then possess foresight and speed of action, depending on the actual resulting experience in practice.
To be foolproof, such an approach requires not just a stochastic run of the assumptions, but also a stochastic run through the underlying possible models themselves, trying in essence to find the one which best models arising reality over a long period of future years. This latter problem will therefore continue to require much actuarial endeavour!

Necessary judgement
All of the above might lead one to wonder how actuaries fared before the invention of the control cycle. The reality, of course, is that actuaries have always been people of (among other things!) judgement. It will always have been the case that, in making assumptions, actuaries will have been aware of the resulting implications and, via the analysis of surplus, will have sought to find out and then understand the nature of the various elements of financial significance. The results would then be used to understand more about the process, and to update assumptions, and sometimes methods, for the future. So the heart of the control cycle has always been there in albeit a more shrouded guise. The control cycle has subsequently provided a very useful unifying and logical framework on which the actuary is able to hang planning and execution of key tasks.
Arguably the most powerful function of the control cycle is that it summarises the whole process of key parts of the actuary’s work in a quick and understandable pictorial form. In these modern times of executive summaries of reports and the perceived beauty of communication by picture, the control cycle representation fits the bill very well.
The representation plays a part in the increasing erosion of mystique in what actuaries do. By such erosion, we should ensure our own survival in the traditional areas of work and, perhaps more importantly, be able to market ourselves into wider fields.

Key messages
Things have, not surprisingly, developed since 1984. However, the key messages of the control cycle remain the same and its concept has become more centralised in a number of ways:
– The 300 series subjects are each now framed around the control cycle, which has itself:
been embellished to include the essential surrounding elements of allowing for professionalism, the general commercial and economic environment, and having a clear specification of the problem in the first place;
been made more generic: specify problem <> develop solution <> monitor experience <> Specify problem <> .
– A number of the Australian universities have their foundation actuarial education programmes actually called the Actuarial Control Cycle.
– Some recent studies by the Institute of Actuaries of Australia have been demonstrating how the control cycle can be a fundamental tool for the analysis of wider field problems. To take but one example, some highly complex factors come into play in modelling and planning for the maintenance of biodiversity in an ecostructure. The life office has become a forest, the products the flora and fauna of the geographical area, and the profitability a mathematical measure of the sustainability of that environment amid the highly complex and interrelated species involved.
A curious symmetry exists here in the last example. The problem is very much a wider field issue, but at the same time almost a classic case of life assurance. A fitting and worthy next step in the destiny of the control cycle.