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The Actuary The magazine of the Institute & Faculty of Actuaries

Letters to the editor

The editorial team welcomes readers’ letters but reserves the right to edit them for publication. Please e-mail us at letters@the-actuary.org.uk

The deadline for receiving letters for the November issue is 8 October 2008.

Letter of the month:
The right direction

With reference to your editorial on actuaries in the banking sector (The Actuary, September 2008), I got my first degree in Actuarial Science and subsequently started pursuing the professional qualification. Presently, I work in a commercial bank, where the skills of an actuary are not fully appreciated. When colleagues asked about my course of study, my response sounded so bizarre. Some retorted, “Did you say ‘architectural science’ or ‘aquarium science’?”

However, I am glad I was able to educate them on the profession and, to a great extent, I can say a good number of my colleagues now have an appreciation for a course they had never heard about before they met me. Today, whenever they have a need to perform statistical analysis on the job, they do not fail to call me in for help. After such events, some of them cannot but ask, “How come we have never heard of such a course before now, since it seems so integral to financial applications?” My response, after a smile, is always: “It was never meant to be a popular one. Actuaries are the directors behind the movies, which you never get to see. You only see the actors often but the directors determine the outlook of the movie.”

Miller Kingsley
14 August 2008

The writer of the letter of the month receives a Venecia fountain pen kindly supplied by

Silent majority
The letters pages of The Actuary have been largely anti-merger, yet the Faculty survey and the Institute vote have been pro-merger by large majorities of those sufficiently motivated to vote. Perhaps it is a classic case of the silent majority, where those who are against something are more vociferous than those who are content with it.

There will always be some people who cannot be persuaded, no matter how much we try to accommodate them — and we are trying very hard. However, I appeal to those who voted against to take note of the sizes of the majorities, and to join us to create a strong, unified base on which to build the UK Profession for the 21st century.

Stewart Ritchie
1 September 2008

Last year’s model
Congratulations to Solomon Green on his cautionary article on financial modelling (The Actuary, September 2008). I do wonder, however, whether it is only those with long experience of investment markets, and less immersion in sophisticated mathematical techniques, that really appreciate the dangers of an uncritical mindset with respect to basic statistical assumptions of normality. The quotation from Eugene Fama about extremal events, alleged to be due only every 7000 years, being prone to arise somewhere every three or four years, is hardly an overstatement. The recent disruption in credit markets is only the latest example.

For those who feel a need to delve into this subject in more depth, I strongly recommend a book by Benoit Mandelbrot and Richard Hudson entitled The (Mis)behaviour of Markets. This provides a readable critique of many of the basic assumptions underlying parts of financial economics, as conventionally practised, and leaves no doubt as to the potential hazards of failing adequately to allow, in projections based on financial markets, for much more frequent occurrence of extremal events. While the alternatives, in terms of ways forward, are rather lightly sketched in, they may also provide some stimulus to future research. I am not intending to suggest that financial modelling should be abandoned, only that the underlying assumptions in the input need much more critical examination than they often seem to get. Otherwise there is a significant risk of the results from the use of very poorly anchored models being treated almost as some form of holy writ, with potentially fatal consequences from a business management standpoint.

John Bishop
31 August 2008

Weather or not
I was interested to read the articles on climate change and energy resources in the July 2008 issue of The Actuary. Some readers will recall the use of Spencer’s 21-term formula for the graduation of life tables. Some rather similar formulae have been developed for smoothing time series with seasonal variations (see Herbert and Scott, Scandinavian Actuarial Journal (2006), p368-377), and have applied some these formulae (with additional calculations to deal with the tails) to the annual Global Temperature Anomaly 1950-2007, as published by the Financial Times on 3 June (I do not have access to the original data and used a ruler to estimate the heights in the published figure). The smoothing formulae used were developed for data with period 4 and it is not claimed they are especially suitable for scientific data of this kind, though the series is generally believed to contain cyclic variations caused by, for example, sunspot maxima and El Niño events.

My conclusion is that global temperatures peaked in 2004 and have since fallen a little, though it should be stated that smoothing formulae are not an infallible guide to the trend and others may reach different conclusions. I do not claim to have any expertise in climate science, and it is of course unclear whether the current falling trend (if I am correct in my judgment that there is one) is a temporary feature or the beginning of a longer-term movement.

William F. Scott
22 August 2008

Words of warning
I write to congratulate Solomon Green for his very perceptive article in the September issue. It is also very timely, since I am certain that much of the responsibility for the terrifying severity of the present worldwide credit crisis can be attributed to the unthinking use of dangerously unsound financial models by US and European banks.

I should like to add two further eminent warning voices to those cited by Solomon Green. In a 1954 paper in Econometrica, Maurice Allais (who won the Nobel Prize in Economic Sciences in 1988, the year before the modern finance trio of Markowitz, Miller and Sharpe) draws attention to the very serious dangers of building an apparently rigorous mathematical theory on simplifying assumptions that have no real world relevance. Accordingly, he suggests that only those who have extensive practical experience gained over a period of many years should attempt to formulate financial models.

In the second chapter of his General theory of employment, interest and money, John Maynard Keynes criticises unsound financial models through a brilliant metaphor that is as apt in today’s distressed economic conditions as it was in the Great Depression years of the 1930s: “The classical theorists resemble Euclidean geometers in a non- Euclidean world who, discovering that in experience straight lines apparently parallel often meet, rebuke the lines for not keeping straight — as the only remedy for the unfortunate collisions which are occurring. Yet, in truth, there is no remedy except to throw over the axiom of parallels and to work out a non-Euclidean geometry.”

With modern finance models, it is obvious that the crucial axiom of rational behaviour is at variance with the empirical evidence of behavioural finance, that the Markowitz-style use of correlation coefficients is inconsistent with the existence of what are euphemistically described as ‘volatility clusters’, and that attempts to extrapolate “99% confidence levels” for financial losses from short runs of historic data are misguided in the extreme.

However, what might not be so obvious is the manner in which these and numerous other failings have combined with one another to create a vicious circle of financial and economic destruction. This is the ‘migration of risk’ element to which Solomon Green refers. To set out my preliminary conclusions in this regard, I have posted an article entitled Playing with fire on The Actuary website (see www.the-actuary.org.uk/814325).

I am confident that a new and much better theory of finance will emerge from the ashes of the present economic dislocation, but if, as I earnestly hope will be the case, actuaries are to play a significant part in its construction, as a profession we must put our own house in order first. Too much of our education and training is dominated by what I see as the failed methodologies of modern finance. An impartial high level review of this dominance is long overdue.

Robert Clarkson
2 September 2008

Business as usual
Further to the Soapbox column on the introduction of the UK Equality Bill (The Actuary, September 2008), David Worsfold may wish to take a look at the New Zealand system. Similar requirements were brought in back in the 1990s with the Human Rights Act. To the best of knowledge, things are ticking along fine. Perhaps our New Zealand readers or the New Zealand society has some comments of value to add?

Jefferson Gibbs
29 August 2008

Cultural awareness
Thomas Gataker, who in 1619 helped to prepare the ground for probability theory, was well aware of the writings of Aquinas 350 years before, contrary to the opinion expressed by Dr Dermot Grenham (The Actuary, August 2008). Gataker, who studied at Cambridge University, was very learned and his book contains numerous cross-references to the works of his predecessors, including Aquinas.

The latter seems to have envisaged the existence of a two-part system, where God determines certain outcomes himself but has prescribed a framework where other outcomes occur in accordance with a multiplicity of underlying causes and may not necessarily be outcomes of which He would approve. Aquinas succinctly sums up his conclusions: “And thus it [divine providence” has prepared for some things necessary causes, so that they happen of necessity; for others contingent causes, that they may happen by contingency [i.e. chance”, according to the nature of their proximate causes... Therefore, whatsoever divine providence ordains to happen infallibly and of necessity happens infallibly and of necessity; and that happens from contingency, which the plan of divine providence conceives to happen from contingency.” [Aquinas, Summa Theologica, I, Q22, Article 4, translated by Fathers of the English Dominican Province”.

Gataker seems to have accepted this doctrine, but he came up with the profound additional insight that chance is founded on, and wholly depends upon, our ignorance of the underlying causes of events and the interactions and effects of those causes. Gataker also discusses the point that we cannot be sure whether a particular observed outcome was ordained by the specific will of God or happened purely by chance. He would not have agreed with the conclusion, which Dr Grenham attributes to Aquinas, that we should expect that the winner of an office, however chosen, “is the best from the viewpoint of the good of the whole universe.” In fact Gataker states clearly that it is unwarrantable to conclude, when two people stand for office and the outcome is decided by lot, that the one is fitter and more sufficient for the place than the other, because the lot lighted on him, “as if God by that event had given sentence on his side”.

Thus, while it is true that Gataker was influenced by Aquinas (among others), I do not think it would be fair to dismiss his own contribution to the development of thought about chance events as unimportant.

Chris Lewin
13 August 2008

A high price to pay?
On the 20 June I received an email from the profession congratulating me on completing the exams required to become an associate. The attached pdf file stated: "Taking up associateship will have no immediate financial impact for you or your employer. However, it is possible that the higher status of associate may be reflected in a higher subscription in the future." The next eNews bulletin, sent out on 15 July, contained the news that: "

For associates, in line with the Profession’s strategy of repositioning this qualification as a fully qualified actuary, the subscription fee will be increased to £456 for fully regulated and £228 for partially regulated." Seeing as a student fee is £282, that’s an increase of over 60% - compared to no increase at all if student membership was retained. Did the profession honestly not know at 20th June that its Associate fees would be increased, as announced to members less than one month later?

Giselle Woodhead
12 August 2008

Planet Actuary?
I was pleased to see that July’s editorial was a response to the Evening Standard’s critical article on the Actuarial Profession. However, I was disappointed that the response to this criticism was that better communication with the press would solve all the problems with the profession’s image.

The article in the Evening Standard was only a few lines long and the journalist was clearly not trying to present a fully-reasoned critique of the Institute. However, I certainly don’t disagree with him when he claims that the Institute is out-of-touch.

The slogan on the Institute’s website is “making financial sense of the future”, yet the actuarial exams hardly make any attempt to teach students how to do this (and when they do try, they do a very bad job of it).

By choosing such a grandiose slogan and then failing to live up to it, the Institute is setting itself up for the kind of criticism seen in the Evening Standard article. This kind of pretence the Institute is teaching aspiring actuaries more about finance and risk-management than they actually are is the kind of thing that places us firmly on “planet actuary”, without much of a place in the wider universe of finance.

If the institute really wants to “promote us as the serious professionals we are”, then it needs to start focusing on skills that will be relevant in finance, and to stop focusing so much effort on quick fixes like communication.

Sam Anon
12 August 2008

The editorial team welcomes readers’ letters but reserves the right to edit them for publication. Please e-mail us at letters@the-actuary.org.uk

The deadline for receiving letters for the November issue is 8 October 2008.