An actuary writes:
“Please be fair Eumaeus team. Most actuaries working in life/GI today encounter market consistent and risk neutral concepts on an everyday basis. The fact that some prominent valuations have not been performed in a reasonable manner by some actuaries does not mean that you should criticize the whole profession. I for one was astonished to read on this excellent blog about what has been done in the market for NNEG valuation and agree with the views mentioned here.”
To clarify, we have had extensive discussion with actuaries, from which it is clear to us that some understand these valuation issues and others do not. Unfortunately, those who do understand tend not to speak out in public, and those who do speak out, including those speaking on behalf of the IFoA, often make mistaken claims about valuation, especially when it comes to equity release or Matching Adjustment. These mistaken claims, especially when made with the authority of an IFoA imprimatur, inevitably cast a shadow over the profession.
“Most actuaries working in life/GI today encounter market consistent and risk neutral concepts on an everyday basis.” I’m sure they do, but I never came across many who had a firm grasp of them. Let’s take the actuarial fallacy that I discussed in an earlier post, namely the fallacy that the forward price that we input to Black76 is the future asset price, i.e. the price that the asset will have (future tense) in the future, rather than the price that a forward contract has (present tense) now, in the present. Pricing the option off the forward does not involve any kind of prediction of future asset prices, yet the Institute of Actuaries seems to think it does. This is an egregious valuation error.
“The fact that some prominent valuations have not been performed in a reasonable manner by some actuaries does not mean that you should criticize the whole profession.” My emphasis. In my experience (I worked closely with many actuaries in my time as an insurance regulator) actuaries fall into two types: Boy Scout and Naughty Boy. (Read both terms in the gender-neutral sense: I include Girl Guides too.)
Boy Scouts have a perfect but imaginary view of the world which they truly believe in, with no difficult reality to darken their vision. There exist difficult realities, to be sure, but these are brushed aside with various perversions of logic. My favourite was ‘negative time value’. The NNEG valuations performed on any reasonable basis gave results that were out of whack with any economic reality, so the discrepancy was explained by the underlying put option have negative time value. Never mind that the option value is a value times a probability, and a probability is always positive, but never mind. The world must be a perfect place.
Naughty Boys, by contrast, know exactly what is going on, they recognise that the “unreasonable valuations” are economically and morally wrong, and they understand the world is far from perfect, but they profess that there is nothing they can do about it. My favourite was the lawyer who told me that none of these firms were solvent in any rational sense of the world ‘solvent’, but in the same breath said that our benchmark was EU rules transposed into UK law. If the law says that the firm is solvent, then it is solvent, whether solvent in a rational sense or not (and probably not). Only obeying orders!
Another, a partner at one of the accounting firms, told me that ‘no one made any money by telling the truth’. Which sounds cynical, but actually he cared deeply about the wrongness of it all, but felt there was nothing he could do about it. I have heard the same from many others: they privately admit that some actuarial valuations are completely wrong, and would like to speak out about it, but they have families to feed – and private school fees to pay. It would be financial suicide to speak up.
Why actuaries? What about bankers, tax avoidance consultants, creative accountants, reputation management City lawyers (we have had some trouble from some of them) and the rest of the evil crew? Well them too. But the problem with actuaries is that whereas public perception of bankers (and tax avoidance schemes and of course lawyers) is pretty much on the mark, the perception of actuaries is of slightly dull people who diligently, but honestly, work out longevity tables and mortality rates, and who occupy a slightly more exalted space than typical high street accountants.
To put it bluntly, the question is whether the profession as a whole, and especially its professional association, is doing as much as they could be doing to live up to its still somewhat exalted public image.
For our part, we want the profession to enjoy a well-deserved public image.