Who’s Managing the Risk Anyway?

Actuaries, Risk & Risk Management

4,000 with probability .20

3,000 with probability .25

1.

2.

Choose 1. or 2.

2,500 with probability .332,400 with probability .660 with probability .012,400 with certainty

A.

B.

Choose A. or B.

2,500 with probability .330 with probability .67

C.

D.2,400 with probability .340 with probability .66

Choose C. or D.

4,000 with probability .80

3,000 with certainty

X.Y.

75% chance of stopping with nothing25% chance of moving on to Stage 2

Stage 1

Stage 2

Choose X. or Y. prior to Stage 2

A. =

2,500 0.33

2,400 0.66 0 0.01

minus

2,400 0.66

= C.

2,500 0.33 0 0.67

B. =

2,400 1.00

minus

2,400 0.66

= D.

2,400 0.34 0 0.66

1. =

4,000 0.80x 0.25

X. =

4,000 0.20

2. =

3,000 1.00x 0.25

Y. =

3,000 0.25

One of the major biases in risky decision making is optimism. Optimism is a source of high-risk thinking.

(Daniel Kahneman)

Financial Risk

Actuaries as Risk Managers

You only learn who has been swimming naked when the tide goes out.

(Warren Buffet)

Risk is Opportunity!

1. To create rules that require professionals to learn and follow?

2. For professionals that can find ways to take risk, following the rules?

3. To manage risk to make systems sound & sustainable?

Prerequisites for Managing Risk

Risk takers accept being managedRisk managers not conflicted

Very good rules and regulationsor

+

Advocateor

Auditor?

Actuaries as ...

Case study: corporate pensions Plans grew big during 80’s/90’s bull market Original ERISA rules didn’t encourage low

risk Clients not asking for risk management Client advocacy creates conflict for

actuaries No goal of sustainability

Easy to make promises that someone else needs to keep

Few rules Actuarial methods not focused on risk Client advocacy creates conflict for

actuaries No goal of sustainability

Case study: public pensions

Know the assets AND the liabilities

Establish survival and sustainability as objectives

Tilt balance away from advocate toward auditor

Principles-based rather than rules-based

Better Risk Management Comes From . . .

Actuaries as caretakers, working to ensure the

long-term survival of

insurance and pension systems

RULES

or

REASON

But Do Better OUTCOMES Come From . . .

?

1. Psychological biases impact choices

2. Risky positions are not always easy to identify (until the tide goes out)

3. Being an advocate may compromise risk management

4. Know the assets AND the liabilities

5. Think about sustainability of the system

A. Sure gain of $240; orB. 25% chance to gain

$1,000 75% chance to gain $0

C. Sure loss of $750; orD. 75% chance to lose $1,000 25% chance to lose $0

Choice 1.

Choice 2.

Make a decision about both of these choices

AD. 25% chance to win $240 & 75% chance to lose $760

BC. 25% chance to win $250 & 75% chance to lose $750