ACTL4001 Notes PDF

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ACTL 4001: NotesChapter 1: Introduction1 What this Book is About? The Actuarial Control Cycle represents the processes typically required in the ongoing management of a financial enterprise, product or scheme, and the relationships between those processes.1 What is an Actuary? An actuary is a busi...

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ACTL 4001: Notes Chapter 1: Introduction 1.1 What this Book is About? 

The Actuarial Control Cycle represents the processes typically required in the ongoing management of a financial enterprise, product or scheme, and the relationships between those processes.

1.2 What is an Actuary? 

An actuary is a business professional who analyses financial repercussions of risk through mathematics, statistics and financial theory.

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They evaluate the likelihood of those events and design creative ways to reduce the likelihood and decrease the impact of adverse events that actually do occur.

Evolution of Actuarial Practice 

1703: Bernoulli’s invention of the law of large number and methods of statistical sampling

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1760: Bayes established a mathematical basis for probability inference.

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20th Century: Rapid growth due to changes in public attitudes towards risk i.e., reinsurance.

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Modern Society: actuaries address a wide range of risks ( derivatives) and emerging problems including population growth, mortality changes and climate change.

1.3 The Control Cycle Framework 

The Actuarial Control Cycle is a conceptual framework that is useful in describing the processes needed for the development and ongoing management of a financial enterprise, product or scheme.

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The ACC always involves uncertain cash flows

Control Cycle Define the Problem

Description  Uncertain future cash flows which require fully identifying all issues and specifying them clearly to ensure the client and actuary agree on the work to be done. Compares all elements of the problem including subgroup analysis (comparing different  age-groups), whole system analysis, experience & external factor changes and modification of modelling for subgroup and whole system.

Design the Solution Monitor the Results

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Usually involves modelling. Ongoing responsibility for monitoring the experience as it develops and advising on the response or may seek to build flexibility into the solution.

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The cycle is iterative; three steps may be repeated at any stage.

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External Forces: Economic conditions and commercial setting, cultural/social values (i.e., Asians’ high saving behaviour), demographics, government influences, physical environment.

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Professionalism: Whole process operates within the context of professionalism which is an inner guide to attitude and practice that governs the actuary in carrying out the work.

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The Actuarial Control Cycle involves:  Identifying Variables  Modelling Interactions  Monitoring Results  Making Recommendations  Modifying Models

1.7 Applying the Control Cycle Framework 

The control cycle framework can be applied to the management of an entire financial institution.

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It can also be applied to subdivisions of the whole, such as subsidiary companies (reinsurance), business units (funds management), operational functions (claims handling), product groups (retail banking products) and individual products (disability income insurance)

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Uncertain future cashflow almost always or value of assets or losses that may cause harm (shares)

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Manage the risk by: 

Reducing or avoiding it (product design and hedging)

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Providing for it (capital)

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Absorbing it i.e., no insurance

1.8 Communicating the Results of Actuarial Work 

Both good listening and strong oral and written communication skills are essential for an actuary.

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An actuary has to communicate effectively with clients and employers and with other professionals such as accountants, lawyers, marketers and IT specialists.

1.9 Conclusion 

The Actuarial Control Cycle is a useful framework, but it should not be viewed as a template for every piece of work.

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Some roles that actuaries fulfill deal with only one stage of the cycle or may not seem to have any direct connection with the cycle.

The Actuarial Judgement 

Actuaries identify, assess and manage risk regardless of area of specialization or function.

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Actuaries work on security systems to protect individuals, companies and other organizations from unforeseen or burdensome financial effects of random, contingent events.

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Define risk: 

The possibility that an undesirable event will occur.

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The potential for adverse consequences

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Uncertainty arising from the possible occurrence of given events.

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The possibility of losing economic security; or

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Exposure to loss

Chapter 3: Being Professional 3.1 Introduction 

People will be inclined to trust your opinion and to rely on your advice when making decisions.

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In return, you are expected to conduct yourself in a way which justifies the trust placed in you, and which contributes to the reputation you share with other actuaries.

3.2 What is a Profession? 3.2.1 The Characteristics of a Profession 

Knowledge-related: A profession is based on a specialized body of knowledge. Members of the profession undertake lengthy training in the science and its practical application.

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Value-related: The members provide a service which is valuable to society and live up to a high standard of ethical behaviour.

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Organisational: The members belong to an organization which supports the knowledge- and value-related elements.

3.2.2 Theory about why Professionals Exist.

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Benefits of being a member of a profession include:  Members gain status and respect as professionals.  Legislation may specify that certain jobs are only done by members of the profession.  Governments may listen to opinions which are expressed by the profession  There is mutual support between the members.

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To be recognized as a profession, the occupation must provide a service which has the following characteristics:

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The service offers solutions to problems that society considers to be important. The quality of the service cannot easily be assessed before or at times after it is performed

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The service cannot be delivered by applying a standard set of rules. Instead, an expert has to bring a broad and deep practical knowledge and theoretical understanding to determine the best solution to fit the specific case.

3.2.3 How the Concept of Profession is Changing over Time.

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The wil1ingness of individuals and regulators to entrust decisions to professions has reduced. In some ways, professions are more important than ever but they have to be more open to scrutiny with more formalized codes and standards.

3.3 Role of the Professional Body 3.3.1 The Actuarial Profession: International Level 

For full membership of the International Actuarial Association (lAA), a professional actuarial body must have:  an acceptable code of conduct.  an acceptable disciplinary procedure.

 an acceptable procedure for drafting and enforcing standards of practice, if these are issued; and a commitment that the education of its fully qualified members at least meets the minimum education guidelines set out by the IAA.

3.3.2 Professional Guidance: Code of Conduct 

The professional Actuarial body will have a code of conduct

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A fundamental part of all the codes of conduct is that actuaries should only take on tasks which they are competent to perform.

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Individuals must apply their own professional judgment to assess whether they have the necessary knowledge, skills and practical experience.

Other Professional Guidance 

There are usually written standards of practice covering different aspects of actuarial work.

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These may be issued by the professional body or a separate actuarial standards body usually after consultation with the wider profession.

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The professional body may also issue other documents which guide actuaries in their work in particular areas, but do not have the force of standards which must be followed.

3.3.3 Monitoring Standards within the Actuarial Profession 

All actuaries have a joint responsibility for the standards of the profession. This means that you not only have to make sure that your own behaviour is up to standard but you must also take steps if you see other actuaries failing to meet the standards.

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Most professional bodies generally relied on self-monitoring and the threat of disciplinary action to ensure that members followed the standards.

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Another possibility is peer review, requiring members to check that they are in line with common practice by submitting their work for inspection by other members of the profession.

3.4 Regulatory Role of the Actuary 3.4.1 Prudential Supervision 

Prudential supervision means that regulators watch over financial institutions to try to ensure that they are operating sensibly, and to reduce the risk that policyholders, depositors and other vulnerable individuals will suffer losses from the collapse of an institution.

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If you look at the Actuarial Control Cycle. you will see that much of it can be applied to keeping a financial institution from failure.

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The institution needs to understand the risks it is taking, and not rashly sell products or otherwise take on commitments which may expose it to unexpected problems.

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It needs to charge sufficient prices or otherwise generate sufficient cash inflow and then set aside sufficient assets, suitably invested, to cover the liability for its commitments plus a margin for safety. To do all this, it needs to analyse its experience and build models of the future.

3.4.2 Other Customer Protection 

Financial institutions often provide products that are difficult for their customers to compare, or which contain areas where the institution can apply discretion. Actuaries may be given a regulatory role to protect the customers from unfair treatment in these areas.

3.4.3 Disclosure to Third Parties 

To improve the quality of disclosure, regulators may require insurance companies to use actuaries to determine the amount of money to set aside for the insurance liabilities.

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This will particularly apply for life insurance business and for types of non-life insurance business where there is a lot of uncertainty about the amount and timing of the outstanding claim payments.

3.5 Professional Issues to Consider while you work on any Task 3.5.1 Ethical Behaviour 

Should behave with integrity and respect for others.

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But being professional means that you have to meet higher standards because that is what is being assumed by those who know that you are a professional.

3.5.2 Conflicts of Interest 

As professionals, actuaries have a duty to put their clients' interests first. The only exception is in the whistleblowing role, where the actuary has a higher responsibility to the public interest.

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This may say that you can proceed to give advice even if a conflict of interest exists. as long as it is disclosed to all parties involved.

3.5.3 Consideration of Other Stakeholders 

In many situations where actuaries are giving advice there are stakeholders other than the direct client. You need to be aware of their interests. Some of the regulatory roles make this explicit.

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For example, an Appointed Actuary in a life insurance company has to consider the interests of the policyholders and of the shareholders.

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When you prepared your report, you should have considered exactly this possibility that the company would be using your words to persuade others.

3.5.4 Materiality 

Materiality means how much something matters, or how much difference it will make to the final outcome. For example, if you are calculating the present value of cash flows of millions of dollars payable over the next decade, the choice of discount rate is very material.

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Having regard to materiality will also involve your professional judgment as to which parts of the task will require the most attention in the context of the particular job.

3.5.5 Reliance on Other Experts 

You should be prepared to call in an expert to provide advice in areas in which you don't have expertise. Don't be overconfident. Knowing your limitations is a key to being professional; giving advice or opinions where you are not capable is unprofessional.

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There are special considerations when using models designed by others. i.e., you should have some idea of how the model works and how it has been tested, validated and calibrated and check results for reasonableness.

3.6 How to do a Professional Job 3.6.1 Before You Start 

Fundamental to being professional that you only take on actuarial tasks which you are competent to perform. You must have up-to-date knowledge of relevant legislation and standards, technical and practical skills, and the necessary experience.

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If you are inexperienced you may work under the guidance of a more experienced actuary.

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You must also be sure you have the time and any other necessary resources to complete the job within the required timeframe.

3.6.2 Define the Task 

The next step is to make sure that you understand what is required, and your client knows what you will deliver as a result of your work.

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You also have to understand your client's background and the issues the client is facing.

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In defining the task, be clear about whether you are expected to simply calculate the numbers needed, or if you are to create a final report/presentation to deliver to the client. The difference between the two can greatly affect the amount of time needed to complete the project.

3.6.3 Collect the information you Need 

This is one of the biggest areas where pressure is placed on professionalism: data is always difficult and expensive to obtain in a timely manner and you will often be pressured to come up with answers from inadequate data,

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Be sure to review the data as soon as you receive it. If the first time you look at it is when you need to use it. you may find a problem and need to request new data.

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This could take some time and potentially delay the entire project.

3.6.4 Check for Reasonableness 

Should check for reasonableness when you receive data, and when you rely on the output of models provided by others. Naturally, you must also check the results of your own work, at intermediate stages and at the end of the job.

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A few simple checks may save you from a serious blunder.

3.6.5 Communicating the Results 

Communicate the results in the appropriate format.

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If the client has asked you a quick question, a short email may be more appropriate.

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If the client has no actuarial background do not use technical terms without explanations of their definitions and importance.

3.7 Practical implications for Actuaries 

Being a member of a profession is very important for any actuary. Some aspects of behaving in a professional way are quite obvious. such as complying with all the relevant professional standards.

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Other issues such as being sensitive to conflicts of interest. or thinking about the impact of our work on all stakeholders. are more subtle.

Chapter 5: The Context of Actuarial Work 5.1 Why Consider the Context? 5.1.1 Introduction 

Actuaries provide solutions to risk-related problems and those solutions have to work in a particular context.

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We have to also know how the context has changed in the past, because that influences how we use past experience as a guide in developing a model of the risk process.

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The model captures and represents the most critical elements of the real world processes (i.e., the context) that affect the risk-bearing entity.

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The model is used to project what may happen in the future.

5.1.2 Context: External Forces 

Another way to think of the context is in terms of the external forces that affect the product, service or scheme on which an actuary is working. These forces are external in the sense that they are usually outside the actuary's control or sphere of influence.

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In a dynamic world the forces change over time. Such changes can create downside risk (threats) or upside risk (opportunities).

5.1.3 Context is Not Static 

The iterative nature of the Actuarial Control Cycle reminds us that the context is never fixed. The context changes over time.

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Changes in the context generate new problems and challenges for actuaries. Such changes can bring upside or downside risk. They can generate new kinds of risk requiring new approaches to analysis quantification and management.

5.2 Components of the Context Broad Category

Components

Professional Context

                          

Regulatory Environment Government Judicial Context

and

Physical Environment

Economic and Social Environment

Industry and Business Environment

Code of conduct Practice standards Laws of the country and/or province Supervisory authorities Regulations Government policy Taxation Social assistance and insurance Judicial decisions Climate and Natural Hazards (e.g storms, earthquakes) Pandemics Man-made disasters Technological developments Economic structure, conditions and trends Demographic structure and trends Work and employment patterns Social factors and trends Industrial (labour union) issues Range of products and services offered. Convergence of financial institutions Product distribution and Intermediaries Accounting standards and practices Competition Industry associations Stakeholders Corporate culture Globalisation

5.3 Two Special Components

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In most countries an actuary is recognized as a professional, with special privileges and responsibilities. The implications of this for an actuary's approach to and conduct of his/her work is very important.

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Governments often regulate financial institutions and their activities. Regulation may be imposed through a combination of legislation (laws passed by parliament) and supervision by statutory bodies known as supervisory authorities, or regulations

5.4 Government and Judicial Context 5.4.1 Government 

Changes to laws can often be anticipated because they tend to flow directly from the policies of the government of the day. Being aware of government policy as it ev...