Oct 31, 2009

The first Actuary

As the story goes, insurance began around 1688 at a coffeehouse in London called Lloyds, where shipman discussed and divided their risks.

That 'explains' the birth of non life insurance.

But what about life insurance?

Who developed the first life table?

The answer to this question depends on who you ask...
  • Definitely Graunt in 1662 (statistical analyzes of data)
  • Surely De Witt in 1671 (life insurance tables)
  • Undoubtedly Halley: 1693 (life insurance tables)

Depending on what you define as a life table, answering this question often leads to a never ending semantic discussion.

Don't worry, there's help... In his Google-book, "A history of probability and statistics and their applications before 1750", Anders Hald explains the origin and development of life tables.

First Life Tables
An indeed, the 'first' life tables, based on more or less empiric data and interest rates were developed at the end of the 17th century.
The first actuary....
However, already in the 3rd century the Roman jurist Ulpian devised a table for the legal conversion of a life annuity to an annuity certain.
It was pointed out by Greenwood that the valuation (duration) of the annuities was deliberately chosen to high, in order to protect the interests of the legal heir.

This would implie that Ulpian not only did a tremendous job by estimating life annuities, but also developed and applied the first primitive 'Solvency Zero' principles...

With his 'simple table', Ulpian was more than ahead of his time.

So, we may rightfully conclude that the one and only first actuary was a jurist: Domitius Ulpianus, alias Ulpian

Strange that it took more than 1500 years to develop more sophisticated life- and annuity tables.

Related links & Sources:

Oct 24, 2009

Pension Fund Market Valuation ParaDox

Is Market Valuation (MV) the right tool for pension funds?

Mid 2009, the new appointed ABP chairman Nijpels and - previously - the ABP CFO ten Damme (picture on the right), stated that the relatively new method of MV is inadequate for pension funds.

Both think that valuation of pension funds could be better based on a (seven year) moving average interest rate.
Nijpels en Ten Damme are supported in their view by Albert Röell, Chairman of KAS BANK, who advises the Dutch regulator DNB to reassess its policy.

Nevertheless DNB doesn't seem to respond.
Neither Roëll nor the world's third-biggest pension fund gets an answer. Is ABP crying over spilt milk?

Why MV?
At first sight, there seems nothing wrong in calculating the value of a pension fund, on MV basis. Market (consistent) valuation implies that the value of an asset or liability is defined by it's market price. If the market is too thin, a mark-to-model approach can be used....

Clearly MV increased the transparency and accountability of pension funds. However, 2008/2009 show that MV, based on the actual term structure of interest rates, leads to excessive volatility in funding ratios.

Is MV the best method?
Of course MV can be a best practice method in helping to define the pension fund value in case of a merger, a takeover or with regard to managing assets. But is MV also the best method for managing the pension fund as a whole, from a board, regulator or 'pension fund member' perspective?
  • Future certainty
    The first fundamental question is :

    can we define the value of long-term
    ( 60 years or more) cash flows at all?

    The answer is: No, we can't!. Just take a look at an average CFO, who's proud to present his next quarterly company result with 60% certainty. What would be the certainty of the long-term company result of - let's say - 20 years ahead. Exactly: Almost zero.

    It's impossible for anyone, no Nostradamus Actuary included, to predict the compound and correlated long term effects of interest rate, stock market, derivates, inflation, salary increases, mortality, disability, longevity and costs. Therefore, if it's not possible....., don't pretent you can.

  • Pension fund: Not for Sale
    Second important subject for consideration is that a pension fund (in general) is not listed on the stock market. Also, in general, it is not for sale on the market. Therefore, the hourly, daily or monthly calculated MV is only of limited interest with regard to the pension fund's strategy, policy or control.

    Neither is MV the right base for monthly adjusting of the contribution rates, funding rates or indexation capacity.

Simply stated, it's important that a pension fund:
  1. can meet its obligations "on the long-term"
  2. is sufficiently liquid to pay his annuities "on the short-term"

Moving average
The first statement implies that if you take the funding ratio as steering/testing parameter (there are more!), there is - given the mentioned long term uncertainty - no other option than to base the valuation on a more (term dependent) 'moving average' of interest rates in combination with the moving average value development of other asset classes. The choice of the moving average period is critical.

Dead Money
Even more, if the pension fund is forced to act on basis of MV, it has to keep extra (non-volatile) buffers to withstand the possible effects of non-relevant short-term market fluctuations. On top of this many pension funds tried to downplay their indexation ambition.

The consequence of all this is that MV generates a substantial amount of structural "dead" capital into the balance sheet. "Dead" capital that - besides - is withdrawn from the national economy and therefore weakens the pension fund's country position in the international level playing field.

Paradoxical measures
In case - due to market developments - the MV goes down , short-term prudential constraints (as enforced or stimulated by the regulator) will moreover endanger the long-term objectives of pension funds. Consequently leading pension funds from the frying-pan into the fire.

There's another interesting aspect that pleads against MV. In general (Dutch) pension funds cannot go bankrupt, as they are allowed to cut back on the participants’ entitlements in extreme (emergency) situations. So the key question is what kind of minimum security level we enforce upon ourselves. Just an example to illustrate this:

What would you prefer:
  1. 100% of the yearly pension that you have been promised, on basis of a 125% funding ratio
  2. 125% of the yearly pension that you have been originally promised, at a 100% funding ratio target

Remember there is no ultimate warranty whatsoever in either situation.

The only difference is that in scenario A the chance that your entitlements will be cut down is slightly smaller than in scenario B. But this last situation is as hypothetic as it can be, as contributions will be raised first, before any cut down scenarios will be considered.

So its better to use the funding ratio surplus for legalized controlled indexation and pension benefits improvement than as 'dead' money.

A final argument in the war against MV for pension funds is the next illustration .....

Let's take a look at a company called ParaDox.... ParaDox produces parasols (sunshades) for the high season.

In winter, ParaDox produces at full speed in order to achieve a top level inventory at the start of the summer.

In winter, however, hardly any parasols are sold. During this cold season the price of the parasols on the market (in the shops) drops to about 50% of the summer price. Even more, parasols sales go 80% down in winter (cf. long-term investment market).

If ParaDox would apply MV based techniques, it would have to depreciate their current stock to 50% of the (summer)value. Surely ParaDox would go bankrupt. No, every sensible human being, including actuaries, would decide that in this situation it's best to value the stock of ParaDox on basis of the 'moving average' (realized) sales price over one or more recent years.
N.B. Even if ParaDox would have one or two 'bad summers', deprecation would not be considered.

If in this ParaDox case it's clear that market valuation (i.c. deprecation) is unwise, the more it must be clear that in a company with long-term obligations and high uncertainties , like a pension fund is, it's naive to operate and steer on basis of MV.

Moving Average Period
Now that's illustrated that the Moving Average Method (MAM) is preferable above the MV method (MVM) for pension funds, there's still one thing to decide: the 'MAM period'.

If the MAM period is chosen too short, it will suffer the same disadvantages as the MVM.

If it's chosen too long, there's the risk of not being able to adapt fast enough to realistic contribution levels, if needed. In this situation there's also the risk of unintentional intergenerational financial effects. However, these effects can be yearly calculated and translated into a sound policy.

From this perspective it seems reasonable to fix the MAM periode to the average duration of nominal pension liabilities, which is (in The Netherlands) about fifteen years (in real terms, it is even longer).

Let's trust that DNB listens to ABP and KAS BANK, so that 'pension funds' and 'pension fun' become one again!

Related links:
- P&I/Watson Wyatt World 300 Largest Pension Funds
- Market-consistent valuation of pension liabilities (must read!)

Oct 22, 2009


If you want something to chew on, something that challenges your actuarial brain and associative power, try to solve the next Actuagram.
This actuarial brain teaser is a mix of an actuarial crossword puzzle and a cryptogram.

How to play the puzzle:
  1. Click on the word you would like to solve.
  2. Fill in your suggestion, click on OK
  3. Only if you do not know the answer, click on the 'solve button'

Can you manage, without using the 'solve button' ?

Congratulations! Actuaries, have fun!

[ If your browser doesn't allow you to play here, click on this link]


by Joshua Maggid
EclipseCrossword © 2000-2007

This interactive crossword puzzle requires JavaScript and a reasonably recent web browser, such as Internet Explorer 5.5
or later, Netscape 7, Mozilla, Firefox, or Safari. If you have disabled web page scripting, please re-enable it and refresh
the page. If this web page is saved to your computer, you may need to click the yellow Information Bar at the top of
the page to allow the puzzle to load.

Oct 17, 2009

Actuarial Sustainability Alarm

Recently the European Commission launched the 'Sustainability Report 2009", investigating the long-term (2010-2060)sustainability of public finances.

This report clearly shows the long-term economic effects of the aging society and the continuous increasing life expectancy.

Financing increasing pension and health costs in the next decades, will be a real challenge for almost all European countries. Even more, the current financial crisis and unsure financial outlook urge for severe short term measures in order to prevent much more unpleasant other measures in the next decades.

The report claims that the ability to meet public pensions liabilities is a higher long-term risk for governments than ever before and in most cases reform of member states’ pensions systems is 'must' and can no longer be delayed.

Although the report manly focuses on the increase (the so called delta) of the sustainability gap, I would like to take a look at the development of the aging costs in relation to the debt development of each country.

Development Aging costs
Let's start to take a look at the development of the public pensions liabilities (pension costs) and health costs from a slightly different angle as published in the report:

On average the total aging costs are increasing from 25% in 2010 to about 30% in 2060 on bases of a no-policy-change assumption.But there a countries (BE, EL, LU, SI) that grow way above this average to a level that's even above the current level of countries with high social standards, like Sweden and Finland.

To conquer this development, some member countries are trying to tackling the longevity issue by raising retirement ages.
Not only the pension costs increase, but also the projected long-term increase in healthcare spending is large and constitutes on its own a risk to sustainability.

Countries whose regimes are listed by the report as 'high-risk' in terms of sustainability are: The Czech Republic, Cyprus, Ireland, Greece Spain, Latvia, Lithuania, Malta, the Netherlands, Romania, Slovakia and the UK. In many countries the age-related expenditure is expected to climb quickly against existing financial imbalances.

Development gross debt ratio
As is clear from the next table, the mentioned next decades increase in health and pension costs, in combination with the unhealthy financial situation - due to the credit crisis - cumulates in a clear desperate debt situation for most of the European countries:

The table shows the government gross debt ratio in 2008 and 2009, and the projections for 2010, 2030 and 2060, once the costs of servicing debt and paying for age-related expenditure are taken into account.

As mentioned before, the long-term debt projections have been prepared under a no-policy-change assumption and in partial equilibrium. Given these assumptions, the projections are not robust forecasts and are not meant to be realistic scenarios of what may happen in the future.

The aim of the debt projections is to illustrate the long-term trends and the size of the required remedial action to avoid government debts to enter into an exponentially increasing spiral.

Actuary Involvement
It's clear that the debt and social costs developments are not heading in the right direction..... Actuary involvement to analyze, advice and create new social systems seems necessary.
Actuaries on the bridge, please!

- EC
- Sustainability Report 2009
- Report 2009
- Download: Maggid Excel tables Aging Costs and Debt Development

Oct 15, 2009

Best Pension Country 2009

There's a small country somewhere on this globe, called The Netherlands......

This small country does not only turns out to be the European and (probably) World Health Leader 2009, but - by the way - also happens to be the first Pension World Leader 2009, according to a new global research by Mercer.

You might wonder, who's the leader of that small country near the sea? His name is Mr. Jan Peter Balkenende. He's Prime minister for more than 7 years, is said to have no charisma and has proved to be able to lead a country that's loaded with hair-splitters and complaining people who disagree with each other on every possible subject.

Opposite to other European presidents like Sarkozy (France) or Berlusconi (Italy), who perform strongly on basis of their charisma and seem mainly interested in the fair sex, the Dutch Prime Minister Balkenende - just like the German Prime Minister Angela Merkel - is a modest no-nonsense leader, who walks his talk and gets the job done.

For sure he would be the best European President kandidate, to lead Europe through difficult times ahead on basis of dialog, respect and agreement.

Mercer Global Pension Index
Back to the Mercer Global Pension Index outcome.
The research is a first attempt to objectively compare the retirement income systems of eleven countries spread across the world.

Countries where rated in five grades:

Grade Index value Description
A >80 A first class and robust retirement income system that delivers good benefits, is sustainable and has a high level of integrity
B 65–80 A system that has a sound structure, with many good features, but has some areas for improvement that differentiate it from an A-grade system.
C 50–65 A system that has some good features, but also has major risks and/or shortcomings that should be addressed. Without these improvements, its efficacy and/or long-term sustainability can be questioned.
D 35–50 A system that has some desirable features, but also has major weaknesses and/or omissions that need to be addressed. Without these improvements, its efficacy and sustainability are in doubt.
E <35 A poor system that may be in the early stages of development or a non-existent system.

The overall index value for each country represents the weighted average of the three sub-indices. adequacy, sustainability and Integrity.

Pension Index Outcome 2009
The results of the pension research clearly appoint The Netherlands as the undisputed Pension leader.

Remarkable however, is that none of the participating countries were classified with an A-grade (index value > 80). This can be easily explained by the fact that no one system is strong enough to withstand the challenges of an aging population.

Want to know more? Than listen to to Dr David Knox (WWP Mercer) discussing the Melbourne Mercer Global Pension Index

Or simply download the full report.

Interested in how The Netherlands 'did it'? Just contact Tim Burggraaf, one of the best worldwide consultants of Mercer in The Netherlands. Tim is a Master in Pensions and Life Assurance. No... he's not an actuary... but you wouldn't notice and moreover, he's one of the best interlocutors and speakers you can can get.

Sources :
- Melbourne Mercer Global Pension Index

Oct 13, 2009

Humor: Actuary Solves Credit Crisis

One upon a time there was a small village depending on only one source of income, tourism... the only problem was - due to the 'crisis' - there were no tourists left...

Every villager had to borrow from an other in order to survive.. several months passed .. everyone felt miserable.

One day a cost conscious actuary, visiting a Risk Conference nearby, arrived in the village.

Heading for a cheap overnight stay, he booked a small room in the only available local hotel. He paid in advance with a 100 dollar note and went to his room to prepare for the conference.

Before the actuary could unpack his bags, the hotel owner had already taken the 100 dollar note, heading his way to pay the butcher.. to whom he owed precisely 100 dollar.

The butcher, in his turn, immediately ran off with the 100 dollar to see the local farmer and paid his debt for all the meat he'd been supplied with...

With the same 100 dollar note, the farmer immediately paid the seed salesman who, right at that time, was visiting the farmer to collect the unpaid 100 dollar bill.

Back in his hotel, the seed salesman closed the circle. In order to settle the hotel bill for that night, he dropped the 100 dollar note on the counter. Just at that moment, the actuary - who'd come down to tell the hotel owner that he didn't like his room - arrives at the counter, picks up his 100 dollar and disappears.

Nothing was spent,
nothing was gained,
nothing was lost.
Nonetheless, thanks to the actuary, nobody in the village had any debts!

This story shows why it's important for actuaries to attend Risk Conferences and illustrates how actuaries can actively contribute to solving the credit crisis.

Original Sources: Free after newciv, Dutch source Aardbron

Oct 12, 2009

Health Leadership 2009

The Netherlands win the 2009 Euro Health Consumer Index (EHCI), for the second year in a row.

Nevertheless, Denmark keeps its runner-up position from last year. Besides The Netherlands and Denmark there are other strong performers like Iceland, Austria and Switzerland, leaving the UK in a disappointing 14th position....

Index performance criteria
The EHCI 2009 groups 38 indicators of quality into six categories: Patient rights and information, e-Health, Waiting time for treatment, Outcomes, Range and reach of services provided and Pharmaceuticals.
Each sub-discipline is weighted for importance to provide the overall Index score.

HCP research director, Dr. Arne Bjornberg, states: The Dutch might have found a successful approach that combines competition for funding and provision within a regulated framework.

Effective Health (Actuarial) Principles
In actuarial context, the success of the Dutch health system is based on a few very simple principles:
  • Risk Solidarity
  • Risk Equalization
  • No Risk Selection
  • Free choice of Care Providers & Health Insurer
  • Transparent ranking of Care Providers on bases of cost & quality
  • Worldwide cover

The Dutch Health Care System
An excellent summary of the Dutch Health Care System can be viewed on YouTube:

Health care In the Netherlands

Of course the Dutch system is no panacea, there are also many challenges and disadvantages.

Just to mention some....

Nevertheless, the Dutch system can be an inspiring example for countries like the US and the UK.

Let's conclude with an interesting development. In an 2009 article called A Strategy for Health Care Reform, Michael E. Porter presents the principles for a new health system, based on the idea that the central focus must be on increasing value for patients.

Related downloads/sources: