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The Actuary The magazine of the Institute & Faculty of Actuaries

Optimism, pessimism, and actuarialism

EVERY ACTUARY should accept that heor she is destined to be labelleda pessimist every now andthen. Or, in the case of areserving actuary like me,almost every day. More thanonce I have been accused ofproviding a cloud whereverthere’s a silver lining.Are actuaries too cautious?When we’re asked to give abest guess of what’s going tohappen, does our actuarialnessmake us err on the gloomy side?To answer this we need to be clearabout what is a ‘best guess’. What is‘normal’ experience? Perhaps more critically,what is abnormal?I have had a look at annual reports and accounts fora number of different UK insurers for the past fewyears. Many of them contain some version of the line‘this year’s results were on target, except for [event X”’,where event X is considered to be extraordinary. Inmany cases, these events are, individually, extraordinary,but extraordinary events seem to appear in insurers’annual reports more often than not.Here are some of the events reported as ‘unusual’over the past 15 years in UK general insurers’ accounts:1987 October storm1989 Mortgage indemnity crisis1990 January storm1991 Subsidence ‘event’1994 Freeze1996 Subsidence ‘event’1998 Flood; Ogden I1999 Road Traffic (NHS Charges) Act2000 Autumn storm and flood2001 World Trade Center; Ogden IIIt doesn’t look unusual to have an unusual event.Insurers must make allowance for these events in theirplans. Whether their profit targets are expressed as x%of premium, y% of capital, or some other measure,prices cannot be set based on ‘normal’ events – theymust allow for the cost of unusual events as well.Admittedly, it is quite a challenge to foresee the costsof unforeseen events of an unpredictable nature, buttherein lies the thrill of working in general insurance.We can’t blame poor profitability of insurers on oneoffadverse events – these are what we are supposed tobe good at dealing with.A related feature of many companies’ accounts(although this doesn’t just apply to insurers) is thetreatment of the redundancy payments andrestructuring expenses (iethe costs of change) as oneoffitems. When many companiestalk about ‘today’s rapidlychanging environment’, it seemsvaguely hypocritical to pretend that the costs of changeare not just part and parcel of normal expenses.In conclusion, too many things are consideredabnormal for my liking. In years when no significantunforeseen event occurs, insurers should make profitsthat surpass, rather than simply meet, their long-termtargets, and ensure that they have the funds to dealwith the next extraordinary event, which is probablyjust around the corner.That is not pessimism, it’s common sense, and it’sone of the areas where actuaries should jump at thechance to show off their ability to make sense of thefuture.Editorial departureI am sorry to say that BrianMorrissey, who has been TheActuary’s features editor for thepast two-and-a-half years, hasdecided to stand down. This will be his last issue.I would like to thank him for his commitment to thejob, which was made all the more demanding by hissecondment to East Asia for the majority of his time asfeatures editor. Thanks to Brian’s efforts, the magazinehas been able to publish a greater variety of articlesthan ever before.As a result of Brian’s departure, there is now a vacantposition at the magazine. If you are keen to raise yourprofile within the profession, build up a network ofcontacts, and enhance your CV, this might just be theopportunity for you. If you are interested in findingout more about the features editor role, write to meat conor.dolan@uk.royalsun.com.