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The Actuary The magazine of the Institute & Faculty of Actuaries

Solving Solvency: 100 Tips for Managing Insurance Capital in a Shifting Regulatory Landscape  by Dr Matthew C Modisett

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Photo: Shutterstock

Publisher: FE Steps 

ISBN-13: 978-0957681408

RRP £23.50

The Latin verb solvere – to loosen or dissolve – has provided us with, via quite different etymological paths, the two distinct words solve and solvency. Dr Modisett is therefore using a form of etymological tautology as the title to his wide-ranging book on the financial management of insurance companies. But the title feels more like an oxymoron at the current time, when the tide of Solvency II seems to bring only complication and obfuscation. 

The book is subtitled 100 Tips for Managing Insurance Capital in a Shifting Regulatory Landscape, and Dr Modisett divides his 100 tips into sections relating to, very broadly, capital management (and hopefully generation, providing the ‘virtuous spiral’ of his first tip); modelling; practical team and work management issues; and miscellaneous areas associated with insurance and financial risk analysis – for instance, such topics as uncertainty and market-consistency. 

Reading through the book, I was struck both by the variety of subjects, and by the generally penetrating cogency Modisett brings to bear on them. I found Modisett’s “idiot’s guide” introductions to areas such as efficient markets, Black-Scholes option pricing, risk-free rates, aggregation and overlapping data some of the best I have ever read. Part of the attraction of the book, and of Modisett’s stance, is that he is unafraid to take strong positions on almost every aspect he discusses – he is like an actuarial equivalent of 

Taleb, but unlike Taleb he has written something short and unrepetitive. 

Readers who specialise in some of the areas covered will no doubt enjoy disagreeing with him to some extent. More generalist readers will find it refreshing to read something written almost as if the topic were being properly broached for the first time. I found myself agreeing with the author on many things – for instance, the danger of setting assumptions via benchmarking as a substitute for thinking. Modisett is like a kindred spirit on the subject of uncertainty, something which much of the spurious quasi-science surrounding Solvency II seems to downplay. 

He writes: “Uncertainty is enormous. In particular, parameter uncertainty looms large over all capital models. Rather than deny the uncertainty, I advocate embracing it. By placing uncertainty in the shop window… we can save a lot of time not calculating to spurious accuracy… a large amount of time and money is spent chasing accuracy in some areas (for example reduced sampling error) but… this accuracy is completely overshadowed by other areas, in particular parameter uncertainty.”

Much of the book is about modelling, with particular reference to general principles of model design and practical aspects of best-practice modelling. Modisett is very much an advocate of small, comprehensible models, built with a modular structure. He uses the term ‘Deathstar models’ to refer to some of the monster systems and processes he has encountered in Solvency II programmes. The Deathstar is the ostensibly super-powerful planet-sized weapon of the Empire forces in Star Wars – but “its flaws and excess power made itself blow up, providing a planet-like explosion not quite intended by the designers”.  

Other aspects of modelling crop up throughout. For instance, in the section (‘tip’) on the Black-Scholes model, Modisett notes: “I am expressing a general caveat about not relying too much on models… do not rely too heavily on (option-pricing) models simply because they match prices. If a modeller adds enough parameters, he can match any data. This does not mean it models reality. It only means more free parameters provides a tighter fit. This is cheating. Adding enough parameters always gets a better fit. Adding parameters may not increase our understanding.” 

What are the drawbacks of the book? Some will find the whole ethos of the book, organised around ‘tips’, rather patronising. The cartoons that appear at the start of each chapter are awful. Some of the sections seem a bit far from the author’s ‘core competencies’, and, although what he writes about (for instance) music royalties or the location of decision-makers in company structures is interesting, is he just straining to reach the magic number of 100? Such reservations aside, it is an extremely interesting and useful book.

Matthew Edwards is senior consultant at Towers Watson. He is a former editor of The Actuary