Shane Whelan, L527

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Asset-Liability Management for Actuaries

• Shane Whelan, L527

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Chapter 2

• The Actuarial Control Cycle

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Actuarial Control Cycle
Specifying the Problem
Developing a Solution
Monitoring the Experience
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Actuarial Control Cycle
Context of Business/Economic/Commercial
Environment
Specifying the Problem
Professional Considerations
Developing a Solution
Monitoring the Experience
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Actuarial Control Cycle
Analyse the Risk Assess Clients
Situation Consider high-level options
Specifying the Problem
Developing a Solution
Monitoring the Experience
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Actuarial Control Cycle
Analyse the Risk Assess Clients
Situation Consider high-level options
Specifying the Problem
Monitoring the Experience
Developing a Solution
Built model and discuss assumptions Calculate and
intepret results Determine solution proposed and
main alternatives identified Formal
proposal/report
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Actuarial Control Cycle
Analyse the Risk Assess Clients
Situation Consider high-level options
Specifying the Problem
Compare with model Review model Review business
context Identify scope for improvement
Monitoring the Experience
Developing a Solution
Built model and discuss assumptions Calculate and
intepret results Determine solution proposed and
main alternatives identified Formal
proposal/report
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Actuarial Control Cycle

• Actuarial Control Cycle is a schema based on a
  scientific approach to problem solving
• first, specify the problem,
• second design and implement a solution,
• third monitor the effectiveness of the solution
• But it does not end here
• Typically, revision is necessary hence the loop
  or cycle.
• The Actuarial Control Cycle must of course be
  considered in the context of the economic and
  commercial environment (e.g. legislation,
  taxation, business ethics).
• Also, as professionals, actuaries must adhere to
  requirements of professionalism.
• Taking each stage in turn

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Specifying the problem

• Identifying and specifying the problem can often
  take a surprisingly large part of the total
  exercise.
• It also provides an analysis of the high-level
  options available.
• e.g., one product design over another
• e.g., one investment objective over another
• The focus is on the risks - to recognise,
  measure, analyse and manage them.
• This is what makes the cycle actuarial to
  solve the problem draws on the tool-kit and
  professionalism of an actuary.
• Finally, at this stage, the strategic courses of
  action that could be used to handle the
  particular risks in question might be debated.

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Developing a Solution

• An examination of the major (actuarial) models
  currently in use and how they may be adjusted for
  the particular problem to be solved.
• Selection of the most appropriate model to use
  for the problem, or construction of a new model.
• Consideration and selection of the parameters to
  be used in the model.
• The parameters used in a model are critical and
  it is necessary to have a good understanding of
  their sensitivities.
• Interpretation of the results of the modelling
  process.
• Consideration of the implications of the model
  results on the overall problem.
• Consideration of the implications of the results
  for all stakeholders.
• Determining a proposed solution to the problem.
• Consideration of alternative solutions and their
  effects on the problem.
• Formalising a proposal.

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Monitoring the experience

• It is critical that the models are updated to
  reflect current experience.
• This stage deals with the monitoring of
  experience and its feedback into the problem
  specification and solution development stages of
  the control cycle, i.e. updating the
  investigation.
• An important part of this monitoring will be the
  identification of the causes of any systemic
  departure from the targeted outcome from the
  model and a consideration as to whether such
  departures are likely to recur.
• Hence identify new problem and around the cycle
  again.
• A cycle can take any length of time a day,
  month, quarter, year or multiple years.

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Extended Actuarial Control Cycle
Context of Business/Economic/Commercial
Environment
Specifying the Problem
Professional Considerations
Developing a Solution
Monitoring the Experience
Investment Proccess
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Question

• Is the Actuarial Control Cycle not just the
  scientific method applied in the actuarial domain
  model, test, use results to build better model?

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Critique of the Actuarial Control Cycle

• The Actuarial Control Cycle, while it is useful
  as an educational framework, would seem to be the
  epitome of an abstraction which has been emptied
  of content.
• Bellis, C. S. (2000), Professions in Society,
  British Actuarial Journal, 6, II, 317-344. Quote
  is from Section 10.3.17.
• In Section 10 the author reveals the true nature
  of the emperors new clothes the Actuarial
  Control Cycle is not actuarial at allThe
  Actuarial Control Cycle, so valued around the
  world, is a content-free zone.
• Hardy, M.R. (2000) Discussion of above paper, in
  BAJ, 6, II, p. 353.

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Brief History of the Actuarial Control Cycle

• The holistic approach to actuarial management put
  forward in Goford, J. (1985), The Control Cycle
  Financial Control of a Life Assurance Company.
  Journal of Institute of Actuaries Students
  Society, 28, 94-114.
• Actuaries in Australian Universities (Macquarie,
  University of Melbourne) teach courses on the
  application of general actuarial principles to
  different areas.
• Used solely as educational (not management)
  structure.
• Institute of Actuaries in Australia adopt the
  actuarial control cycle as a subject in 1996.
• Faculty Institute of Actuaries (UK) adopt
  actuarial control cycle as subject, first
  examined in 2005.
• Best text-book on subject Bellis, C., Shepherd,
  J. Lyon, R. (2003), Understanding Actuarial
  Management the actuarial control cycle.
  Institute of Actuaries of Australia. 462 pp.

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Other Control Cycles

• What other control cycles are there?
• Especially those applied in a business context.
• Two-generic types
• Mathematically-assisted decision-making
• Mathematically-inspired decision-making
• The following few slides are adapted from those
  of Dr Maciej Klimek based on a seminar he gave at
  Dublin Institute for Advanced Studies, December
  2004.

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Mathematically assisted decision making
The decision process uses results of computations
only as arguments
Required goals
Separation of tasks!!!
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Mathematically inspired decision making
Highly quantitative and logical approach to
problem solving, with no spurious assumptions
Mathematical-like reasoning is an integral part
of the decision process!
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Real discrete dynamical system
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Characteristics of decision making in the spirit
of dynamical systems

• Modelling of reality as a collection of time
  dependent processes
• That is, modelled as a stochastic process with an
  associated filtration
• Awareness of non-linearity/sensitivity to initial
  conditions
• Adaptability regarded as one of the highest
  values
• Must update model and actions with filtration.
• Reliance on iterative decision loops whenever
  possible
• Embracing change as opportunity for betterment.
  

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Other Decision Loops

• The Six-Sigma Loop (Japanese roots, developed by
  General Electrics and Motorola)
• Define-Measure-Analyze-Improve-Control
• The six-sigma methodology is closely related to
  the Japanese methodologies Lean Thinking and TQM
  (Total Quality Management).
• The common sense PRIME loop
• Planning-Rehersal-Implementation-Maintainance-Evol
  ution
• The Lean Thinking 5S management rule
• SEIRI clear organization without redundant
  elements
• SEITON order, everything has its place
• SEISO absolute cleanliness to avoid errors
• SEIKETSU clarity the result of the first 3S
• SHITSUKE discipline

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John R. Boyd (1927-1997) Strategist and fighter
pilot
What is the aim or purpose of strategy?  To
improve our ability to shape and adapt to
unfolding circumstances, so that we (as
individuals or as groups or as a culture or as a
nation-state) can survive on our own
terms. Boyd The most important thing in life
is to be free to do things. There are only two
ways to insure that freedom you can be rich or
you can you reduce your needs to zero. I will
never be rich, so I have chosen to crank down my
desires. The bureaucracy cannot take anything
from me, because there is nothing to take. Boyd
quoted in Spinney, F.C. (1997) Genghis John,
Proceedings of the U. S. Naval Institute, July,
pp 42-47.
Boyd in 1953
Time is a weapon
For more on Boyd, including all his lectures and
notes on strategy, see www..belisarius.com/boyd.h
tm
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Boyds Loop OODA Observation Orientation
Decision - Action
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Applications/Examples of Actuarial Control Cycle

• Problem It is the 19th century and a mutual
  friendly society approaches you to design a
  simple scheme to provide for funeral expenses of
  members in consideration for a weekly premium of
  P.
• Formulate your proposal and put in place a plan
  to monitor the emerging experience.
• Topics that you will probably treat (however
  briefly) are listed overleaf
• each topic forms a section in this course.

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Actuarial Control Cycle
Meeting Customer Needs Assessing and Managing
Risks on stakeholders Professionalism External
Environment /Investment Environment Capital Market
ing Project planning management Options
Guarantees
Determining Expected Results Reporting Actual
Results Risk Management Asset Management Capital
Management Surplus Management Monitoring
Specifying the Problem
Monitoring the Experience
Developing a Solution
Product Design Methodology and techniques Input
validation Assumption Setting Expenses Cost and
price Provisioning Relationship between assets
and liabilities
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Applications/Examples of Actuarial Control Cycle
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• Problem An established pension fund with
  significant assets wants to design and implement
  a suitable investment strategy.
• See Actuarial Investment Course for outline of
  Investment Advisory Process
• An instance of the actuarial control cycle.

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Investment Advisory Process
Investmentobjectives
Strategicassetallocation
Monitoring Evaluation
Fund managerstructure
Fundmanager selection
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Completes Chapter 2

• The Actuarial Control Cycle

Asset-Liability Management for Actuaries
Shane Whelan, L527