The roots of modern day actuarial science can be found in ancient shipping transactions. A ship would leave ancient Greece laden with wine, olives or pottery bound for Africa, expecting to return with valuable and exotic spices, metals, or wood. Wealthy individuals funded these voyages and agreed not to seek repayment if the cargo was lost, but required repayment of their investment with a high rate of interest if the ship returned with cargo intact. The interest rate compensated the investor for both the time value of the money and the risk associated with the transaction. As world trade expanded, traditional investors became unwilling to assume the risk, giving rise to the marine insurance industry in the mid-1300’s.
The Roots of Actuarial Science
By the late 1500’s, marine insurance was being regulated in Britain. Life insurance soon followed, mainly consisting of short-term policies meant to protect a lender until a borrower had repaid a loan.
Managing a lender’s risk by insuring either loan collateral or the life or earning ability of the borrower, a mainstay of modern consumer finance companies, arose out of these ancient concepts. The concept of a pension existed in ancient times as well. One of the surviving speeches of Lysias, a speech writer in ancient Greece, is “On the Refusal of a Pension” dating from around 400 BC, wherein he argues his continued eligibility for a pension.
These twin concepts – payment upon a death, and payments continuing until a death – require a similar ability to predict the timing of a death in order to ascertain the amount of the premium (for the insurance) or payment (for the pension). Failing that ability in the individual case, what would suffice is the ability to estimate the timing of a death based on a statistical sampling of a population similar to the insured. This became possible in the late 1600’s. First, Christian Huygens published the seminal work on probability theory in 1657. Then, in 1693, Edmond Halley, more well-known as the namesake of Halley’s comet, published an article on life mortality based on age-at-death data from the city of Breslau. And thus, the field of actuarial science was born.
Actuarial science encompasses several interrelated subjects such as mathematics, probability theory, statistics, finance, and economics. The increase in computing power in the last few decades has also caused revolutionary changes in the field.
In many countries, the practitioners of actuarial science, actuaries, are required to maintain credentials in order to perform certain public actuarial functions such as valuing insurance or pension liabilities. These credentials also serve as a measure of competence in various actuarial-related disciplines. In the United States, to become credentialed, actuaries must pass a series of exams administered by one of the actuarial professional societies, and to maintain the credentials, must meet annual continuing education requirements.
Advancement of Actuarial Science
Actuarial science has advanced in tandem with, and sometimes in response to developments in accounting practice and regulations. For example, recent adoption of amendments to the accounting standard regulating the amount and presentation of insurance liabilities in public companies’ financial statements will require actuaries to rely more heavily on cash flow models in setting insurance liabilities. In turn, it seems likely that actuarial practice around the use of models, model governance, and setting assumptions will improve.
Similarly, actuarial science has responded to external forces in the financial services industry. While actuaries have been required to opine on the adequacy of insurance liabilities for many decades, before the adoption of the Actuarial Opinion and Memorandum Regulation, life insurance actuaries were not required to consider the actual assets held by their company when issuing such opinions. After several high profile insurer insolvencies in the 1980’s were traced back to the quality of investments held by the companies, regulations were changed so that the value of the liabilities was not considered in a vacuum, but rather the value of liabilities must be determined by considering the quality of the assets held by the company and in particular the likelihood of future cash flows from those assets. Actuarial practice by necessity developed to include the modeling and analysis of asset cash flows, and not just insurance cash flows.
The range of applications relying on actuarial work has expanded greatly from the twin concepts of pension and life insurance. While many actuaries still work in these areas, actuaries also work in health insurance, property and casualty insurance, investments and asset management.
From ancient trade routes to modern securities trading, and for many financial service fields in between, actuarial science has developed to help measure and manage the financial risks inherent in our lives. Whether evaluating the financial burden of losing an income or evaluating the financial burden of outliving our savings, many of us rely on the work of actuaries for financial stability even if we are not active participants in the financial market. As new areas emerge that require the quantitative analysis of risk, the practice of actuarial science will evolve to meet the demand for knowledgeable and skilled risk evaluators.