Once seen as a role for number-crunching geeks, today’s actuaries find themselves at the heart of insurance operations

The role of the actuary has not historically been at the cut and thrust of daily business activities. While the profession has always attracted technically bright individuals, the traditional actuarial role within non-life insurance and reinsurance companies was mostly a back-office function. Now, with a growing emphasis on modelling and technical pricing in the industry, they are becoming an indispensable part of these companies’ functioning.

In the past, an actuary job was not seen as a particularly sexy or interesting role. But that has all changed, says AM Best vice-president Ed Easop. “My son is a freshman in college and I should tell him it’s a good idea to think about being an actuary.

“Maybe 10 years ago the role of the actuary was seen as highly specialised, focusing on the quantitative and mathematical aspects of building insurance policies and setting prices and establishing reserves. But between Solvency II, enterprise risk management and the capital models, more and more of what companies do is to try to figure out: ‘What are my risks? What are the things that keep me up at night? Let me try to find a way to quantify that so I can measure and model it.’ So there has been a significant increase in the demand for actuaries.”

Drivers of change

The drivers behind the growing demand for actuarial expertise are regulatory changes – Solvency II in Europe, Individual Capital Adequacy Standards (ICAS) in the UK – as well as rating agency and accounting requirements. All these reporting requirements need actuaries to be on the payroll and at the centre of decision making.

The role of the actuary is spelled out in the new Solvency II regime, set to come into force in October 2012. According to Article 47: “The actuarial function shall be carried out by persons who have knowledge of actuarial and financial mathematics, commensurate with the nature, scale and complexity of the risks inherent in the business of the insurance or reinsurance undertaking, and who are able to demonstrate their relevant experience with applicable professional and other standards.”

Solvency II brings together much of the current thinking on calculating risk-based capital and follows other initiatives that have encouraged reinsurers to calculate their own capital requirements based on their risk profile.

The regime is intended to strengthen EU-wide requirements on capital adequacy and risk management for insurers, with the aim of reducing insurer failure. Under Pillar 1, reinsurers will be required to demonstrate adequate financial resources and calculate solvency capital requirements and minimum capital requirements.

Under Pillar 2, they are required to have an effective risk management system and prospective risk identification through the Own Risk and Solvency Assessment (ORSA). Part of this is the ‘use test’ (Article 118), which requires firms to prove their internal capital models are widely and regularly used within the organisation and play an important role in governance, risk management systems, decision making and the ORSA.

While insurers and reinsurers are busy ensuring their actuarial teams are ready for the new regime, demand is also growing from the various European regulators. The internal model approval process will put pressure on regulators as they prepare to process numerous submissions. This, among other things, will ensure there is a steady stream of graduates moving into actuarial.

The model masters

The increasing use of dynamic financial analysis has been a key driver behind the evolution of the actuary, says technical management director for Europe at software supplier Ultimate Risk Solutions, Patrick Grealy. “The actuarial role has evolved rather than changed in the past 20 years. Now computing power and availability of detailed modelling platforms have allowed actuaries to create and adapt capital models, which give a great insight into management of the dynamics of their business profiles and potential strategies.?For example, the efficiency of different reinsurance structures can be measured based on their reduction in capital required as compared to the cost of the reinsurance. ??

“Solvency II has helped accelerate the process, primarily in that it is a mechanism for rewarding capital-efficient choices regarding diversification within your business and reinsurance purchasing. No such reward was available under Solvency I. This has required that actuaries become more capital literate so as to be able to advise their employers and clients.”

An actuary’s role has traditionally been straightforward, says global actuarial and insurance management solutions partner at PricewaterhouseCoopers, Bryan Joseph. “When I was a young actuary, actuaries were primarily engaged in reserving and they spent a lot of time calculating reserves. It’s an important function because when you look at a company’s balance sheet the technical reserves are the largest number, so ensuring they are reasonable is vital.”

This vital but uninspiring role began to evolve in the 1990s when technical pricing models were applied more widely. This was partly due to improvements in data, while increased computational power meant that running the numbers through a pricing model was not the onerous task it had once been. As a result, underwriting became less of an art and more of a science.

In the reinsurance industry, hurricanes Hugo (1989) and Andrew (1992) were a big driver towards more technical pricing, as well as the impetus behind the development of vendor catastrophe models. The rating agencies began to ask for insurers’ maximum probable loss and to factor these into their capital adequacy assessments. As their role within capital and pricing grew, actuaries began to work more closely with underwriters and decision makers. “Company management started to discover that actuaries are actually quite technically bright and able to hold their own in terms of discussions around business issues,” Joseph says.

“And as capital became recognised as an issue of greater importance to management teams, actuaries started to get involved in these discussions, because the calculation and discussion of capital and risk is one of the core training processes of actuaries.

“As we move to a market-consistent form of reporting, which will include Solvency II and IFRS 4, company managers require actuaries to perform the calculations and then analyse

and report on many aspects of a company’s operations. As a consequence, actuaries are being engaged much more in the heartbeat of how insurance companies operate in the property and casualty arena.”

Central communicators

As more is being asked of actuaries, their skillsets are broadening. The ability to communicate model output effectively with others – particularly with colleagues or clients who are less technically adept – requires patience, good communication skills and the ability to put highly complex information into layman’s terms.

“Being technically brilliant in any profession is never enough,” Joseph says. “If you cannot communicate properly the ideas, the concepts, the discussion points you’re dealing with, then realistically your technical brilliance is best kept in a box. I can come up with the best way of calculating capital requirements, but until I speak to a board of directors or communicate with a client, these passages of technical brilliance will remain only that.”

As actuaries’ roles have grown in the non-life insurance sector, the traditional career path has altered. “Actuaries provide a different perspective to some of the more traditional, less quantitative ways that insurance and reinsurers have worked in the past,” Willis Re chief actuary Ian Cook says. “It’s not necessarily the fact that someone is an actuary per se that makes them useful in a wider context, it’s the fact that the actuarial skill set is part of it.”

Many actuaries have moved into other key roles, becoming underwriters, chief risk officers, chief financial officers and even chief executive officers. The risk management function within the organisation has become so entwined with the actuarial function that in some organisations the risk manager reports to the chief actuary.

“One of the challenges when we’re hiring is finding people who can interact on a technical and non-technical level with a range of people,” Cook says. “Having to deal day to day with underwriters, chief financial officers, brokers, reinsurers and buyers and external accounts and actuaries, they need to be able to explain what they’re doing in appropriate language to different types of audiences. Increasingly, for those actuaries who are in the more front-exposed roles, that communication is fundamental.

“The internal?model approval process in Solvency II is going to affect that as well, because up to now to some extent actuarial models have been seen by a lot of companies as a little bit of a black box. But Solvency II is saying that?to?use?these models??for assessing capital requirements, they have got to be?validated,?used?more, understood by a wider?range of?people, properly documented,?with?all?data and with all assumptions?used?justified.

“The actuaries building these models are going to be under more pressure over the next few of years explain what they’ve done, how?they?work and what the?limitations are.”

Rising to the challenge

As insurance companies seek better ways to manage and mitigate their risks, actuaries have become a vital role. They increasingly bridge the gap between the technical side of the business and the point at which decisions are made. From helping underwriters set pricing and manage accumulations to aiding the chief executive and board with capital allocation decisions, they are the people who translate highly complex actuarial analysis into risk and opportunity.

“Over the past 10 or 15 years, actuaries have grown in prominence within insurance companies and have moved from almost exclusively operating in the reserving end of the insurance lifecycle right up to the front end of that cycle, assisting with technical pricing and

other more business-related decisions,” non-executive director of Ultimate Risk Solutions and former chief executive of BMS Group, John Spencer, says. “That’s quite relevant in terms of the new roles they’re taking on in the Solvency II and ERM setting.”

Actuaries also have an essential role in communicating potential weaknesses in internal models, so that more informed decisions can be made. “Actuaries do have to be much better communicators and what we’re seeing under Solvency II is the need to take the whole process out of the backroom and into the boardroom,” Spencer says. “Boards and management teams now need to have a much greater understanding of the moving parts in any kind of capital analysis.”

The challenge for the actuarial profession is how to respond to the evolving role of actuaries within the non-life market. While once the preserve of graduates in mathematics, the vocation is now drawing talent from a wider range of degree paths. Many of the next generation of actuaries could come from countries such as India, which is gaining a reputation for its business schools and highly trained graduates.

Training for tomorrow’s actuaries must also be in line with their shifting responsibilities. The International Actuarial Association has recently created a professional designation to respond to the growing demands of ERM and Solvency II. The Chartered Enterprise Risk Analyst is aimed at actuaries involved in designing and working with risk-based capital models.

“The development of ERM across the board is providing an impetus for change within the profession,” Joseph says. “It will be [the actuarial profession’s] choice to grasp the nettle of change and expand into different areas of work and show how they can make a difference to the understanding of business issues.” GR