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Actuarial science
Actuarial science is the discipline that applies mathematical
and statistical methods to assess risk in insurance, finance, and
other industries and professions. More generally, actuaries apply
rigorous mathematics to model matters of uncertainty.

Actuaries are professionals trained in this discipline. In many

countries, actuaries must demonstrate their competence by
passing a series of rigorous professional examinations.

Actuarial science includes a number of interrelated subjects,

including mathematics, probability theory, statistics, finance,
economics, and computer science. Historically, actuarial science
used deterministic models in the construction of tables and
premiums. The science has gone through revolutionary changes
since the 1980s due to the proliferation of high speed computers
and the union of stochastic actuarial models with modern
financial theory (Frees 1990). 2003 US mortality (life) table, Table
1, Page 1
Many universities have undergraduate and graduate degree
programs in actuarial science. In 2010, a study published by job
search website CareerCast ranked actuary as the #1 job in the
United States (Needleman 2010). The study used five key criteria to rank jobs: environment, income,
employment outlook, physical demands, and stress. A similar study by U.S. News & World Report in
2006 included actuaries among the 25 Best Professions that it expects will be in great demand in the
future (Nemko 2006).

Contents
Life insurance, pensions and healthcare
Applied to other forms of insurance
Development
Pre-formalization
Initial development
Early actuaries
Technological advances
Actuarial science related to modern financial economics
History
Actuaries in criminal justice
See also
References
Works cited
Bibliography
External links

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Life insurance, pensions and healthcare

Actuarial science became a formal mathematical discipline in the late 17th century with the increased
demand for long-term insurance coverage such as burial, life insurance, and annuities. These long
term coverages required that money be set aside to pay future benefits, such as annuity and death
benefits many years into the future. This requires estimating future contingent events, such as the
rates of mortality by age, as well as the development of mathematical techniques for discounting the
value of funds set aside and invested. This led to the development of an important actuarial concept,
referred to as the present value of a future sum. Certain aspects of the actuarial methods for
discounting pension funds have come under criticism from modern financial economics.

In traditional life insurance, actuarial science focuses on the analysis of mortality, the production
of life tables, and the application of compound interest to produce life insurance, annuities and
endowment policies. Contemporary life insurance programs have been extended to include
credit and mortgage insurance, key person insurance for small businesses, long term care
insurance and health savings accounts (Hsiao 2001).
In health insurance, including insurance provided directly by employers, and social insurance,
actuarial science focuses on the analysis of rates of disability, morbidity, mortality, fertility and
other contingencies. The effects of consumer choice and the geographical distribution of the
utilization of medical services and procedures, and the utilization of drugs and therapies, is also
of great importance. These factors underlay the development of the Resource-Base Relative
Value Scale (RBRVS) at Harvard in a multi-disciplined study (Hsiao 2004). Actuarial science also
aids in the design of benefit structures, reimbursement standards, and the effects of proposed
government standards on the cost of healthcare (CHBRP 2004).
In the pension industry, actuarial methods are used to measure the costs of alternative strategies
with regard to the design, funding, accounting, administration, and maintenance or redesign of
pension plans. The strategies are greatly influenced by short-term and long-term bond rates, the
funded status of the pension and benefit arrangements, collective bargaining; the employer's old,
new and foreign competitors; the changing demographics of the workforce; changes in the
internal revenue code; changes in the attitude of the internal revenue service regarding the
calculation of surpluses; and equally importantly, both the short and long term financial and
economic trends. It is common with mergers and acquisitions that several pension plans have to
be combined or at least administered on an equitable basis. When benefit changes occur, old
and new benefit plans have to be blended, satisfying new social demands and various
government discrimination test calculations, and providing employees and retirees with
understandable choices and transition paths. Benefit plans liabilities have to be properly valued,
reflecting both earned benefits for past service, and the benefits for future service. Finally,
funding schemes have to be developed that are manageable and satisfy the standards board or
regulators of the appropriate country, such as the Financial Accounting Standards Board in the
United States.
In social welfare programs, the Office of the Chief Actuary (OCACT), Social Security
Administration plans and directs a program of actuarial estimates and analyses relating to SSA-
administered retirement, survivors and disability insurance programs and to proposed changes
in those programs. It evaluates operations of the Federal Old-Age and Survivors Insurance Trust
Fund and the Federal Disability Insurance Trust Fund, conducts studies of program financing,
performs actuarial and demographic research on social insurance and related program issues
involving mortality, morbidity, utilization, retirement, disability, survivorship, marriage,
unemployment, poverty, old age, families with children, etc., and projects future workloads. In
addition, the Office is charged with conducting cost analyses relating to the Supplemental
Security Income (SSI) program, a general-revenue financed, means-tested program for low-
income aged, blind and disabled people. The Office provides technical and consultative services
to the Commissioner, to the Board of Trustees of the Social Security Trust Funds, and its staff
appears before Congressional Committees to provide expert testimony on the actuarial aspects
of Social Security issues.

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Applied to other forms of insurance

Actuarial science is also applied to property, casualty, liability, and general insurance. In these forms
of insurance, coverage is generally provided on a renewable period, (such as a yearly). Coverage can
be cancelled at the end of the period by either party.

Property and casualty insurance companies tend to specialize because of the complexity and diversity
of risks. One division is to organize around personal and commercial lines of insurance. Personal
lines of insurance are for individuals and include fire, auto, homeowners, theft and umbrella
coverages. Commercial lines address the insurance needs of businesses and include property,
business continuation, product liability, fleet/commercial vehicle, workers compensation, fidelity &
surety, and D&O insurance. The insurance industry also provides coverage for exposures such as
catastrophe, weather-related risks, earthquakes, patent infringement and other forms of corporate
espionage, terrorism, and "one-of-a-kind" (e.g., satellite launch). Actuarial science provides data
collection, measurement, estimating, forecasting, and valuation tools to provide financial and
underwriting data for management to assess marketing opportunities and the nature of the risks.
Actuarial science often helps to assess the overall risk from catastrophic events in relation to its
underwriting capacity or surplus.

In the reinsurance fields, actuarial science can be used to design and price reinsurance and
retrocession arrangements, and to establish reserve funds for known claims and future claims and
catastrophes.

Development

Pre-formalization

Elementary mutual aid agreements and pensions arose in antiquity (Thucydides). Early in the Roman
empire, associations were formed to meet the expenses of burial, cremation, and monuments—
precursors to burial insurance and friendly societies. A small sum was paid into a communal fund on
a weekly basis, and upon the death of a member, the fund would cover the expenses of rites and
burial. These societies sometimes sold shares in the building of columbāria, or burial vaults, owned
by the fund—the precursor to mutual insurance companies (Johnston 1932, §475–§476). Other early
examples of mutual surety and assurance pacts can be traced back to various forms of fellowship
within the Saxon clans of England and their Germanic forebears, and to Celtic society (Loan 1992).
However, many of these earlier forms of surety and aid would often fail due to lack of understanding
and knowledge (Faculty and Institute of Actuaries 2004).

Initial development

The 17th century was a period of advances in mathematics in Germany, France and England. At the
same time there was a rapidly growing desire and need to place the valuation of personal risk on a
more scientific basis. Independently of each other, compound interest was studied and probability
theory emerged as a well-understood mathematical discipline. Another important advance came in
1662 from a London draper named John Graunt, who showed that there were predictable patterns of
longevity and death in a group, or cohort, of people of the same age, despite the uncertainty of the
date of death of any one individual. This study became the basis for the original life table. One could
now set up an insurance scheme to provide life insurance or pensions for a group of people, and to
calculate with some degree of accuracy how much each person in the group should contribute to a
common fund assumed to earn a fixed rate of interest. The first person to demonstrate publicly how

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this could be done was Edmond Halley (of Halley's comet fame). Halley constructed his own life
table, and showed how it could be used to calculate the premium amount someone of a given age
should pay to purchase a life annuity (Halley 1693).

Early actuaries

James Dodson's pioneering work on the long term insurance contracts under which the same
premium is charged each year led to the formation of the Society for Equitable Assurances on Lives
and Survivorship (now commonly known as Equitable Life) in London in 1762 (Lewin 2007, p. 38).
William Morgan is often considered the father of modern actuarial science for his work in the field in
the 1780s and 90s. Many other life insurance companies and pension funds were created over the
following 200 years. Equitable Life was the first to use the word "actuary" for its chief executive
officer in 1762 (Ogborn 1956, p. 235). Previously, "actuary" meant an official who recorded the
decisions, or "acts", of ecclesiastical courts (Faculty and Institute of Actuaries 2004). Other
companies that did not use such mathematical and scientific methods most often failed or were
forced to adopt the methods pioneered by Equitable (Bühlmann 1997, p. 166).

Technological advances

In the 18th and 19th centuries, calculations were performed without computers. The calculations of
life insurance premiums and reserving requirements are rather complex, and actuaries developed
techniques to make the calculations as easy as possible, for example "commutation functions"
(essentially precalculated columns of summations over time of discounted values of survival and
death probabilities) (Slud 2006). Actuarial organizations were founded to support and further both
actuaries and actuarial science, and to protect the public interest by promoting competency and
ethical standards (Hickman 2004, p. 4). However, calculations remained cumbersome, and actuarial
shortcuts were commonplace. Non-life actuaries followed in the footsteps of their life insurance
colleagues during the 20th century. The 1920 revision for the New-York based National Council on
Workmen's Compensation Insurance rates took over two months of around-the-clock work by day
and night teams of actuaries (Michelbacher 1920, pp. 224, 230). In the 1930s and 1940s, the
mathematical foundations for stochastic processes were developed (Bühlmann 1997, p. 168).
Actuaries could now begin to estimate losses using models of random events, instead of the
deterministic methods they had used in the past. The introduction and development of the computer
further revolutionized the actuarial profession. From pencil-and-paper to punchcards to current
high-speed devices, the modeling and forecasting ability of the actuary has rapidly improved, while
still being heavily dependent on the assumptions input into the models, and actuaries needed to
adjust to this new world (MacGinnitie 1980, pp. 50–51).

Actuarial science related to modern financial economics

Traditional actuarial science and modern financial economics in the US have different practices,
which is caused by different ways of calculating funding and investment strategies, and by different
regulations.

Regulations are from the Armstrong investigation of 1905, the Glass–Steagall Act of 1932, the
adoption of the Mandatory Security Valuation Reserve by the National Association of Insurance
Commissioners, which cushioned market fluctuations, and the Financial Accounting Standards
Board, (FASB) in the US and Canada, which regulates pensions valuations and funding.

History

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Historically, much of the foundation of actuarial theory predated modern financial theory. In the
early twentieth century, actuaries were developing many techniques that can be found in modern
financial theory, but for various historical reasons, these developments did not achieve much
recognition (Whelan 2002).

As a result, actuarial science developed along a different path, becoming more reliant on
assumptions, as opposed to the arbitrage-free risk-neutral valuation concepts used in modern
finance. The divergence is not related to the use of historical data and statistical projections of
liability cash flows, but is instead caused by the manner in which traditional actuarial methods apply
market data with those numbers. For example, one traditional actuarial method suggests that
changing the asset allocation mix of investments can change the value of liabilities and assets (by
changing the discount rate assumption). This concept is inconsistent with financial economics.

The potential of modern financial economics theory to complement existing actuarial science was
recognized by actuaries in the mid-twentieth century (Bühlmann 1997, pp. 169–171). In the late
1980s and early 1990s, there was a distinct effort for actuaries to combine financial theory and
stochastic methods into their established models (D’Arcy 1989). Ideas from financial economics
became increasingly influential in actuarial thinking, and actuarial science has started to embrace
more sophisticated mathematical modelling of finance (Economist 2006). Today, the profession,
both in practice and in the educational syllabi of many actuarial organizations, is cognizant of the
need to reflect the combined approach of tables, loss models, stochastic methods, and financial
theory (Feldblum 2001, pp. 8–9). However, assumption-dependent concepts are still widely used
(such as the setting of the discount rate assumption as mentioned earlier), particularly in North
America.

Product design adds another dimension to the debate. Financial economists argue that pension
benefits are bond-like and should not be funded with equity investments without reflecting the risks
of not achieving expected returns. But some pension products do reflect the risks of unexpected
returns. In some cases, the pension beneficiary assumes the risk, or the employer assumes the risk.
The current debate now seems to be focusing on four principles:

1. financial models should be free of arbitrage

2. assets and liabilities with identical cash flows should have the same price. This is at odds with
FASB
3. the value of an asset is independent of its financing
4. the final issue deals with how pension assets should be invested

Essentially, financial economics state that pension assets should not be invested in equities for a
variety of theoretical and practical reasons (Moriarty 2006).

Actuaries in criminal justice

There is an increasing trend to recognize that actuarial skills can be applied to a range of applications
outside the traditional fields of insurance, pensions, etc. One notable example is the use in some US
states of actuarial models to set criminal sentencing guidelines. These models attempt to predict the
chance of re-offending according to rating factors which include the type of crime, age, educational
background and ethnicity of the offender (Silver & Chow-Martin 2002). However, these models have
been open to criticism as providing justification for discrimination against specific ethnic groups by
law enforcement personnel. Whether this is statistically correct or a self-fulfilling correlation remains
under debate (Harcourt 2003).

Another example is the use of actuarial models to assess the risk of sex offense recidivism. Actuarial
models and associated tables, such as the MnSOST-R, Static-99, and SORAG, have been used since
the late 1990s to determine the likelihood that a sex offender will re-offend and thus whether he or
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she should be institutionalized or set free (Nieto & Jung 2006, pp. 28–33).

See also
Actuarial control cycle
Actuarial exam
Black swan theory
Category:Actuarial associations
Data mining
Scenario optimization
List of actuarial topics
Ruin theory

References

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p://www.actuarialfoundation.org/research_edu/fundamental.pdf) (PDF) on 2006-06-29. Retrieved
2006-06-28.

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External links
Actuarial science (https://curlie.org/Business/Financial_Services/Insurance/Actuarial_Science) at
Curlie

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