The Financial Systems Thinking Innovation Centre, or FinSTIC, launches this month. But what is systems thinking, and how can it help actuaries? Ashok Gupta explains.
One dark night, a policeman finds a drunk on his knees searching for his keys under a lamppost. The drunk explains that he lost the keys on the other side of the street, but is searching under the lamppost because "that's where the light is".
We all operate in silos - whether that's a department, a business or an industry sector. Inside our silo, the light is bright and we have good visibility. Outside the silo, it's darker, and visibility is poor - so it is easier to find solutions and identify risks inside our own silo than it is to find those from outside.
However, our silos do not operate in isolation. They form part of a network, connected to other organisations, suppliers, customers and governmental bodies, such as regulators. In an increasingly connected world, understanding the linkages between our silo and others is essential if we are to manage exogenous risks, develop sustainable organisations and products, and implement effective policy solutions.
Organisations operate in a complex, crowded, integrated and rapidly changing world, resulting in many emerging risks, some difficult to mitigate and others difficult to spot. Consequently, it is easier for us to look for solutions within our own silos - but are we searching for our keys on the wrong side of the street? Systems thinking may help.
What is systems thinking?
Donella Meadows, for many the doyenne of systems thinking, defined a system as "an interconnected set of elements coherently organised in a way that achieves something". It comprises those elements, interconnections and a function (or purpose). A company is a system; so is a tree, a factory or an economy.
However, our world consists of systems embedded within other systems. While a company is itself a system, it also resides within an industry system, which in turn resides within a national economic system. Systems thinking is a holistic, multidisciplinary approach to analysing systems, focusing on the way elements interrelate and how systems work over time within the context of larger systems. It can be used to analyse a business or a sector, such as insurance, investment, wealth management or pensions. By focusing upon the interrelationships, you can gain insights.
How can we use systems thinking?
The use of systems thinking in finance is still quite limited; regulatory bodies used it to try and understand what happened to international banking in the aftermath of the global financial crisis. It is increasingly being used to manage risk, create sustainable, resilient companies and develop policy.
For example, policy solutions derived predominantly through political negotiation and compromise run the risk of failing to achieve the desired outcome, or of resulting in unintended consequences. One study reviewing pressures in the defined benefits pensions sector used systems thinking to identify that the principals (members and employers) have been largely disenfranchised, and that fees extracted by agents (fund managers, advisors, etc) are considerably in excess of the value provided. Levels of risk to scheme members can be concealed if investment and liability risks are not appropriately integrated with rapidly increasing levels of covenant risk. This study has led to pension scheme consolidation being adopted as government policy.
While conducting a review of long-term investment by life insurers and pension funds, a senior civil servant commented: "Everyone within the system is acting in a completely rational way based on their mandates or objectives, but the system as a whole is not delivering what it should." This is true of many of our financial systems.
The insights provided through the application of systems analysis can lead to profound, beneficial solutions. However, given that systems evolve over many years, often in an amorphous way, those seeking 'silver bullet' solutions may be disappointed.
The IFoA has set up FinSTIC to promote the development of systems thinking work within the financial sector. A significant number of actuaries are already applying systems thinking in their existing work; FinSTIC will act as a forum where they can share thinking, promote their work and network with like-minded practitioners. Given that systems analysis is inherently multidisciplinary, FinSTIC will be open to non-actuaries and will link with academics, businesses, regulatory and other non-profit organisations that are interested in producing more effective financial systems. In this way we can work with and learn from other professionals, and generate more opportunity for actuaries toapply their analytical skills and judgment. It will also act as a source of learning for actuaries new to systems thinking.
I would encourage people to get involved. You can sign up (via LinkedIn), engage and contribute. If you are aware of a piece of systems work or application, you can write a case study or support a blog. If you have something of particular interest and want to record a podcast, come and talk to us.
Through their analytical skills and multidisciplinary training, actuaries can develop appropriate interventions and help ensure financial systems operate effectively. There are significant career opportunities for actuaries to get involved in this - tell your friends and colleagues.
Listen to FinSTIC podcasts covering a broad range of topics around systems thinking. Learn about how systems thinking has been applied by Chika Aghadiuno and Neil Cantle to implement a new emerging process at Aviva, and how Professor Doyne Farmer at iNET has used agent-based modelling to assess the impact of Solvency II on catastrophe insurance.
Financial Systems Thinking Innovation Centre
What is systems thinking?
Systems thinking is a holistic multidisciplinary approach to understanding systems, focusing on the links between components in a system. When we understand agent-agent and agent-principle dynamics and their potential impacts on stocks and flows, we gain insights into the resilience of systems and how they can be made more effective.
Who is FinSTIC for?
The Resource and Environment Board wants actuaries to take the lead in adopting systems thinking approaches, becoming professional advisers with greater awareness of the systemic impacts of their work, and of the impact of system dynamics on their clients and employers. FinSTIC was established to aid this.
What is the aim?
- To discuss, debate and collaborate on the application of systems thinking
- To connect and work with other partner organisations to further understanding of this important field
- To discover more information and resources on the subject of systems thinking.
What are the goals?
- To provide a community that enables participation, collaboration, discussion and debate between systems thinking practitioners and those interested in the field
- To identify, support and collaborate on projects that address common shared defects within and of the financial sector
- To identify partner organisations with whom members of FinSTIC can collaborate and engage, to further our systems thinking knowledge and practice
- To enable members of the community to participate in the future evolution of FinSTIC, suggesting projects and collaborating on key activities
More information and resources
For further information and details on podcasts, case studies, blogs and further reading, visit bit.ly/35R9IL5
Ashok Gupta is chair of FinSTIC