The history of actuarial science has its roots in ancient times, when insurance was used to manage shipping risk. Today, actuarial science encompasses many fields such as probability theory, finance, and statistics. Actuaries work in the insurance and other industries to measure and manage financial risk.
What is an Actuary?
You may have seen actuary on a list of best jobs. Or you may have heard about it as a good career choice for a math major. But you may have wondered, what is an actuary and what do they do? In this article, we will explain the history of actuarial science and the types of work that modern actuaries engage in.
Key components of actuarial work are measuring and managing risk. To get more specific, actuaries measure and manage financial risk. Since most people manage their financial risk through insurance, you might think that actuaries work in the insurance industry. That is certainly true, although actuaries work in other industries as well. But to understand what actuaries do, and actuarial science in general, we can start with the origins of insurance as a way to manage risk.
The Early Insurance Industry
To understand the history of actuarial science, we have to start with the history of insurance. The beginning of the modern day insurance industry can be found in ancient shipping transactions. A ship would leave ancient Greece laden with wine, olives or pottery bound for Africa. It would 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. However, they 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. By the mid-1300's, professional risk-takers, or insurers, had filled the gap.
This earliest type of insurance is known as marine insurance. It covered the loss or damage of a ship and its cargo. Other types of insurance that focused on managing a lender's risk soon followed. For example, early life insurance was designed to pay off a loan if the borrower died before paying it off.
Another early type of insurance is a pension. A pension provides income to someone who is no longer able to work. This is insurance against the risk of outliving one's savings. We have evidence this concept existed in ancient Greece from a surviving speech of the professional speech writer Lysias. In a speech written in about 400 BC, he defends himself against the accusation that he is no longer eligible for a pension.
The Roots of Actuarial Science
These twin concepts – payment upon a death, and payments continuing until a death – are key to many types of insurance. They require a similar ability to predict the timing of a death in order to ascertain the cost of the insurance. Of course, it is nearly impossible to predict the death of one individual. However, mathematical advances in the 1600's made insurance pricing practicable by allowing predictions on a group of people.
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. For the first time, it was possible to estimate the timing of death for a group of individuals.
Advancement of Actuarial Science
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.
External forces in the financial services industry have influenced the development of actuarial science. Insurance regulations require actuaries to opine that an insurance company has enough assets to pay their outstanding liabilities. In prior decades, this was a static evaluation comparing the two amounts. But regulations changed after several high-profile insurer bankruptcies. Actuaries are now required to opine that the companies' assets are enough to pay the outstanding liabilities under a range of possible scenarios. Actuarial practice by necessity developed to include the modeling and analysis of both asset and liability cash flows.
Similarly, actuarial science has advanced in tandem with developments in accounting practice and regulations. For example, publicly traded insurance companies in the United States must follow standard accounting practices. Actuaries who work in financial reporting for public insurance companies follow these guidelines when determining the outstanding liability of the company.
Recently adopted amendments to the accounting standard regulating the amount and presentation of insurance liabilities 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.
The increase in computing power in the last few decades has also caused revolutionary changes in the field. For example, actuaries can now use predictive analytics to price health and property insurance.
Working as an Actuary
In many countries, actuaries must 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. To maintain the credentials, actuaries must meet annual continuing education requirements.
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. As the history of actuarial science shows, the field will continue to progress.