Actuarial work is exhilarating, and reserving, especially so. But let’s not pretend that insurance loss forecasting inspires excitement in everybody. In fact, when compared with pricing or data science, the reserving function comes across as staid, more … reserved.
Why is that? Well, unlike other actuarial practice areas that are more commonly perceived to foster experimentation and innovation, reserving teams are weighed down by the need to understand not just the current state of a company’s financials but also how those financials have changed over the past quarter and why. This is not dissimilar to the way that luxury watch brands view time-tested designs of the past with all the benefits of modern technology. Rolex’s contemporary Submariner timepiece, for example, is almost indistinguishable in design from its 1953 predecessor, yet the demand is just as high. Its value is in its appearance rather than the inner workings, which are more state-of-the-art. For actuarial teams, this demand for consistency in models and approaches imposes a similar inertia that appears — at first glance — to inhibit genuine innovation.
This is not to say that stability isn’t important: Insurers are not looking for their financials to be disrupted on a constant basis, and some stability in a world of uncertainty is appreciated. But using judgment to gloss over what data is saying is potentially worse than pretending something isn’t happening — it’s hiding it.
The reality, obviously, is far more nuanced. Some signals should be ignored as the noise that they are, but trends such as the potential impact of inflation and rising costs, or sudden changes in policyholder behavior, which are likely to shape or impact the future of the insurance industry, cannot be ignored in the reserving process. It is these trends that we need to address by channeling our most important resource: our judgment. Equally as important is the need for transparency in how that judgment has been applied and why.
Further weighing down the speed of innovation is the need to report clearly, not just on the results but also on the bones of an analysis to an audience of non-technical stakeholders. Any enthusiasm to use elegant but complicated models based on vast sets of individual claims data can be dampened somewhat when actuaries are asked to “print the analysis on letter-sized paper.”
A false dichotomy
We often talk of the actuarial field — and specifically reserving — as a balance between science and art. The science is contained in the data and the models used to extract the signal from that data, and the art is our ability to tame or control the signals from the data with the expectations derived from our knowledge of the line of business concerned, insight into policyholder behavior, or the market in general.
When we talk about a changing balance of science and art, this often is taken to mean a dynamic change in the balance of two static qualities. An example of this is manifested in the perceived fear that robot automation is coming to take over the work of reserving analysts.
This is not the case. Both sides of the science and art equilibrium should be and are improving. It is not art versus science, rather it is art and science working in tandem. As we increase the amount of data that is available and when technological innovations afford us the ability to improve the science, we become better informed and have more analyzing capacity. We also have better, more advanced tools to impose and communicate our judgment.
Why technology is important
The current environment provides an excellent case study in the challenges and why the rising tide of technological innovation is important. A confluence of fast-emerging and overlapping trends makes it very difficult to identify homogenous and voluminous groups of data to study. These include the fast-changing dynamics of the pandemic and its varying impact on commercial and personal behavior, recent high levels of inflation and supply-chain challenges, underlying trends in “social inflation” and sociopolitical factors such as global conflicts or institutional prioritization of environmental, social and governance goals. While these recent trends suggest an increased reliance on external insight and judgment, it is technology that enables such insights, providing the tools to analyze and communicate with clarity.
Making space for creativity
A conspicuous area of opportunity is the use of process automation technology to make space for deep analysis by reducing the time that high-value resources, such as actuaries and database administrators, spend performing low-value tasks such as data management and manipulation. Ostensibly the value here is in reducing costs, but most insurers overwhelmingly prioritize increased value rather than lower costs when looking to increase their use of automation. Manual processes are accelerated, and key indicators are delivered as soon as data is available. This enables actuaries to quickly orient where their attention is best deployed and focus on the appropriate analysis. The better the information and the earlier it is obtained, the more time there is to react appropriately to that information.
Taking an innovative look
Technology-empowered techniques such as machine learning can be used to reassess the data cohorts used in analyses. What were once homogenous data groups are now groups being affected by changing factors — where the historical mix of business has become more volatile. Machine-led techniques can identify the underlying loss drivers within a data set to isolate those elements that demonstrate consistency. These pockets of stability can then be analyzed using traditional techniques. In other words, applying innovative techniques during the data processing stage allows us to do fewer complex things during the analysis phase, while still improving our forecasting ability. This has a corollary benefit of simplifying the reporting element of the reserving process, which can often be onerous.
Using communication
Another often overlooked area is how technical results are communicated back to the business.
The work of a reserving team is to forecast. While they are never going to be 100% right in their analysis and results, they can reduce the noise, become more transparent in their underlying assumptions and communicate them in easy-to-understand everyday language. They should be shrewd not just in how they complete the analysis but also in knowing who they are sharing the results with, how they will receive the information and anticipating how they will react to that information. There are two potential pitfalls that often cause stumbles: producing an overwhelming volume of information, thereby running the risk of burying the most important message or spending too long focusing on something that simply isn’t material. Data visualization tools can be very powerful in building a narrative through a complex set of diagnostics to identify and communicate the key driving trend, while also providing the context within the wider business.
The vision for an ideal team
It is crucial to develop and maintain a strong vision of how an actuarial team should be performing in the future but at the same time be strategic in how innovations can be incorporated so that a clear line through the financials is maintained. Companies need to take a larger view of what they want to do in the next two to five years. They need to imagine their ideal operating model and make incremental improvements to get there.
Companies need to balance the science and the art, elevating both. As a result, companies’ most valuable resources — their teams — will be stretching themselves to do more value-added analysis and critical thinking. Just like James Bond’s Omega Seamaster watch, beneath the traditional facade lies a world of innovation and technology.
Jamie Mackay is San Diego-based director and reserving proposition leader for the Americas at Willis Towers Watson PLC. He can be contacted at [email protected]
