Actuarial Principles

Brief History of the Actuarial Profession

The actuarial profession in North America has celebrated its centennial in 1989, though actuarial science has earlier beginnings in Europe. The formal founding of the profession in North America occurred in 1889, with the formation of a professional organization then known as the Actuarial Society of America. The Conference of Actuaries in Public Practice was formed in 1950 to meet the needs of consulting actuaries and others employed outside of the insurance industry.

 In 1979, IAI was admitted to the International Actuarial Association as a member. On 14th December 1982, it was formally registered under Registration of Literary, Scientific and Charitable Societies Act XXI of 1960. A certificate of registration of the IAI under section XII AA of Income Tax Act was received on the 14th March 1984. IAI is also registered under Public Charitable Trust Act 1950.

 An actuary is a financial expert who applies mathematical and statistical methods to the assessment of financial and other risks relating to various contingent events and the scientific valuation of financial products in the fields of insurance, retirement and other various benefits, investment and other related areas.

 Actuarial science is an applied science based on concepts and observations distilled from the experience of practitioners and from other sciences. The principles underlying actuarial science are extracted from this experience and from related fields such as mathematics, statistics, economics, and finance.

The objective of Principles Underlying Actuarial Science is to articulate the current understanding of the significant principles that form the scientific framework underlying all areas of actuarial practice. Actuarial science is concerned with the study of consequences of events that involve risk and uncertainty. Actuarial practice identifies, analyzes and assists in the management of the outcomes, including costs and benefits, associated with events that involve risk and uncertainty. Understanding the principles underlying actuarial science enables actuaries to develop models of such events and other techniques in order to solve practical problems. Actuaries solve business problems in which the mitigation of negative consequences and the exploitation of positive consequences of risk play major roles. Thus, actuaries must be familiar with the principles of the management of fields in which they work including insurance, healthcare, and retirement systems, investment portfolios and the risks facing individuals. Actuarial models can be developed to solve virtually any problem requiring an analysis of the consequences of risk and uncertainty.

 One of the main objective of actuarial science is to arrive at the premium. Factors that affect premium are
Rate of mortality Rate of interest Operational expenses Loading for such things as profit margin, contingencies etc

Principles underlying actuarial Science

When actuaries use historical observations to make inferences, certain insights derived from probability and statistics are used.

Statistical Framework
Begin with standard definitions of experiments, stochastic phenomena, probability, random variables, and estimators. Recognize uncertainty, which can be quantified (and variance need not be the only measure).

 Phenomena are occurrences that can be observed. An experiment is an observation of a given phenomenon under specified conditions. The result of an experiment is called an outcome; an event is a set of one or more possible outcomes. A stochastic phenomenon is a phenomenon for which an associated experiment has more than one possible outcome. An event associated with a stochastic phenomenon is said to be contingent.

 PRINCIPLE (Statistical Regularity). Phenomena exist such that, if a sequence of independent experiments is conducted under conditions that are substantially similar to a set of specified conditions, the proportion of occurrences of a given event converges as the number of experiments becomes large.

 Statistical Regularity Law of probability Law of large numbers. (Representation) Enough observations will enable one to understand the probabilities and other measures. Does not reject subjective approach to probability.

Law of probability
Useful in estimating the likelihood of future events Deductive reasoning complete knowledge of all the causes for the previous experience Inductive reasoning assumption is made that what has happened in the past will happen again if the same conditions are present.

Mortality Statistics
Law of Probability Law of Large numbers The above two can be applied to mortality data

 PRINCIPLE (Basis for Model Construction). A model of a specific stochastic phenomenon can be based on the
outcomes of experiments performed on that phenomenon, (e.g., mortality study) on observations of related phenomena, ( use census data) on knowledge related to the phenomenon itself, or on a combination of all three.

 Principle of Credibility A weighted average of several estimators may be more accurate than any of the component estimators. Need a way to measure accuracy of a model.

Economic and Behavioral Framework

Need to explain behavior in terms of quantifiable incentives and disincentives. These principles are less specific because they describe human behavior An economic system consists of (i) a group of persons, called participants, (ii) a set of items, called economic goods (goods), each of which belongs, at a given time, to one of the participants, and (iii) a mechanism, called a market, through which participants may exchange the economic goods they currently hold for other economic goods.

 PRINCIPLE (Preference or Indifference). At a given time, for almost all pairs of economic goods, a participant either prefers one economic good to the other or is indifferent between them. PRINCIPLE (Time Preference). Most people prefer to receive something sooner than to receive the same thing later. Participants tend to prefer shorter deferral periods for otherwise identical economic assets and longer deferral periods for otherwise identical economic liabilities. PRINCIPLE (Risk Aversion). For a given measure of the degree of uncertainty, when choosing between two wagers with the same expected payoff, participants tend to prefer the wager with the lower degree of uncertainty. Faced with two uncertain futures with equal expected values but different measures of uncertainty, people tend to choose the future with lower uncertainty.

 PRINCIPLE (Existence of Money). In many economic systems, there is a commodity such that, at a given time, for most desirable economic goods and for most participants, there is an amount of the commodity such that each participant is indifferent between the economic good and that amount of the commodity. Present Value PRINCIPLE (Enlightened Self-interest). The parties to an economic transaction act in accordance with their preferences, subject to the knowledge each has about the environment and about the other parties. PRINCIPLE (Law of One Price). In most financial markets, two portfolios that have the same net cash flows under all possible scenarios will trade at the same price.