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The Actuary The magazine of the Institute & Faculty of Actuaries

From uncertainty to certainty… and back

The final paragraph of the article by Zaki Khorasanee and Christopher Day in the March issue will come as no surprise to those of us who saw their paper as an exercise in rediscovering assumptions and making arbitrary decisions using arbitrary criteria. However, their key message that ‘there is no such thing as certainty of pensions provision’ will add further despondency to those of us becoming increasingly disillusioned with traditional actuarial methods and the declining respect for our profession.

Of course, there is no such thing as absolute certainty, but that is no excuse for providing no certainty at all.

What is particularly frustrating for those of us who have been promoting a more modern perspective on financial risk management is that providing security in long-term financial transactions is hardly rocket science. Investment banks enter into 30-year swaps without handwringing about the fact that ‘there is no such thing as certainty’.

They get around the risk of default by straightforward collateralisation – if the swap becomes a liability to one party then they post collateral to ensure that if they default, the other party (to whom the swap is an asset) is not left out of pocket. The irony of this banking approach to risk management is that it is simply using the classical actuarial principle of funding up to the amount required to settle a liability on discontinuance. The uncertainty referred to by Zaki and Christopher arises simply because the pensions are not funded to this level and is then compounded by investing in equities. Worse still, they suggest a complex stochastic methodology that comes to the conclusion that the liabilities should be underfunded because they are invested in this way and then stress the importance of understanding the uncertainty they have created by these antics.

Huge uncertainty is not a necessary feature of a long-term financial contract, but merely an inevitable consequence of lax and incoherent risk management policies. If, as seems likely at present, the profession splits on this issue, maybe those rejecting modern financial risk management could kindly distinguish themselves by reworking their motto into something like ‘from certainty to uncertainty’ or, for those with grasp of their once proud history, ‘from uncertainty to certainty… and back’.