Contingencies Online - January/February 2013

Commentary CONTINUED

Policyholders may not act rationally and sometimes are not paying
attention. But the agent is and will motivate the insured to take action
because doing so earns money for the agent.

Actuaries are sometimes placed in similar circumstances, such as when they are asked to opine on the adequacy of assets to fund future liability cash flows. That is a binary event. Either they are adequate or they are not adequate.

Auspices and auguries never thought about running scenarios. But actuaries do. When asked to opine on the adequacy of assets, actuaries can say that they are adequate 95 percent—or 99 percent—of the time, depending on how much capital is available and the range of scenarios studied. Actuaries do this by running thousands of scenarios modeling future economic conditions and then factoring in a company’s behavior to economic conditions and, ultimately, factoring policyholder behavior to both economic conditions and company reactions.

Looking at possible future results using the current methodology does not deter the actuary and management from making decisions based on a multitude of assumptions. One major problem, however, is that the assumptions are often not founded on a good analytical system for extracting experience, especially as it is linked to agents. Very few data warehouse applications are designed to support financial-based analytics that relate to the agents who write the business. Certainly, policyholder behavior is modeled. But no one seems to consider agent behavior, and this is a flaw in actuarial analysis.

Agent Ingenuity

Agents are some of the most astute peo-
ple in the world when it comes to guiding
their clients. They usually always work
in the interest of the customer, particu-
larly if it means remuneration to them.
If a policyholder has a deferred annuity
earning 4 percent and another company
is paying 5 percent, the agent will be
aware of this and move to get the better
rate. Policyholders may not act rationally
and sometimes are not paying attention.
But the agent is and will motivate the
insured to take action because doing so
earns money for the agent.

Tracking Agent Experience

Companies that have installed the ability to track experience by agent have learned some interesting facts. And they have saved considerable amounts of money by learning that some of their agents’ lapse or morbidity experience is significantly different from what was used in the pricing assumptions. Checking for fraud, one company tracked experience by producing agent and compared it with expected experience. After probing investigations, the company concluded that even though there was no fraud involved, the target population of certain agents was generating claims experience that was materially worse than the pricing assumptions. These companies have either fired those agents or renegotiated contracts to bring their compensation in line with expectations.

The art of prediction has moved well beyond the time in which pondering sheep’s livers or the flight of birds was useful in divining the future. In some respects, however, actuaries continue to base financial expectations on indicators that ignore the control that agents have on blocks of business. Actuaries need to look at their analytical systems and focus on agent experience. This would help improve their ability to predict the future.

ROBERT J. LaLONDE, a fellow of the society of actuaries, is vice president and senior account manager for Insight Decision solutions Inc.

This article is solely the opinion of its author. It does not express the official policy of the American Academy of Actuaries; nor does it necessarily reflect the opinions of the Academy’s individual officers, members, or staff.