Actuaries and underwriters operate differently, but the positive effect of their complementary skills is undeniable, says Rob Barritt
In the late 1980s and early 1990s, non-life insurance actuaries mostly held reserving roles. Since then, however, areas of involvement have expanded - particularly following the soft market of the late 1990s, events of 9/11 and now Solvency II. Actuaries are employed in underwriting, financial reporting, business planning, risk and capital management.
Numeracy, technical modelling, ability to interpret large quantities of data, and a rigorous, logical thought process are also skills ascribed to actuaries. Underwriters are likely to be considered more entrepreneurial and instinctive, with their strengths lying in the assessment of individual risks, wider market and commercial awareness, communication and negotiation. It is arguable that all of these skills are needed in the process of risk selection, product design, portfolio construction and strategy. The market is changing and those who do not adapt risk being left behind, or selected against. Clients and brokers are now sophisticated in understanding risks to their businesses, and wanting to address ever-more complex risk transfer requirements with flexible, value-for-money products.
We recently conducted an internal prediction survey that broadly found, given a generic insurance-related problem, both actuaries and underwriters used similar thought processes and rationalisation. There was no statistical evidence that either group tended to be more pessimistic or optimistic. Indeed, the outcomes were more closely related to individual interpretation of the data.
Changes in business mix, underlying exposure, policy coverage, claims handling or case reserving philosophy are often important to factor into projection analyses. The results of this work should also be challenged and validated; underwriters can apply sense checks based on broader market knowledge, alternative estimation methods and common-sense logic.
It is of great benefit to companies where underwriters and actuaries are able to work together in a constructive way. The challenge for actuaries is to build these relationships and demonstrate their ability to add value - particularly in areas where they have traditionally been met with scepticism.
Personal lines and SME businesses have been quicker to incorporate statistical pricing methodologies given the extensive data available. By contrast, specialty lines business is neither high volume nor tightly defined and in many cases pricing may attempt to incorporate potential causes of losses that have never occurred. The characteristics of the more instinctive, technically minded specialty underwriters operating in the London Market are also different with their strong entrepreneurial traits. Successful outcomes in this market are dependent on actuaries tailoring their approach. This involves a bigger picture vision together with greater flexibility and pragmatism, as well as a focus on the areas where they can be most effective.
Actuaries can help to increase value by focusing on stakeholders' requirements in the decision-making process. It is important for actuaries to explain the risks and uncertainties in their estimates and projections. Any projected result will rely heavily on the data inputs, assumptions and the quality of the underlying models. Giving an answer that is not sufficiently qualified can be damaging if it causes overconfidence in the result. It is healthy for both actuaries and users of actuarial work to have a level of scepticism over the results of any model - the natural tension between actuaries and underwriters can be of benefit as it stimulates wider debate.
London Market specialty business is inherently volatile, skewed by the potential for extreme outcomes. An actuarial 'mean best estimate' is intended to represent the average of all possible outcomes, even those which may be considered highly unlikely. It will not necessarily be the single outcome that is most likely to happen (the mode), or the mid-point of an ordered list of outcomes (the median). Actuaries consider the mean to be a more appropriate way of averaging because it explicitly allows for the shape and size of all other possible outcomes.
Management of insurance companies will seek to avoid shocks, particularly in terms of quarterly performance, though given the volatility it is clear that specialty business is better assessed over a longer time horizon. A sudden material erosion of and/or a significant under-pricing issue can dramatically affect results and raise questions of actuarial techniques. There is also a detrimental effect if, conversely, cautious reserving leads to an over-capitalised company, or conservative and uncompetitive pricing leads to a loss of profitable business. There will always be differences in the way that actuaries and underwriters operate within insurance companies, but the two disciplines offer complementary skill sets and different perspectives which, when combined, should have a much greater positive effect than the two operating in isolation.
Rob Barritt is a general insurance reservin and pricing actuary at Aspen