Actuary

An actuary is a professional who applies probability, statistics and financial mathematics to problems where the amount and timing of future payments are uncertain: how much a book of insurance policies will pay out, how much a pension plan must hold today against benefits promised for decades, how long a population will live, and how much money a program needs to stay solvent. The National Association of Insurance Commissioners, the standard-setting body for state insurance regulators, defines an actuary in its glossary as a "business professional who analyzes probabilities of risk and risk management including calculation of premiums, dividends and other applicable insurance industry standards."

The word by itself describes a discipline, not a credential, and that is worth saying plainly because several of the actuarial roles a reader will meet are legal designations with statutory definitions attached. "Enrolled actuary" is a federal designation under the Employee Retirement Income Security Act. "Qualified actuary" is defined by insurance regulators for the purpose of signing statements of actuarial opinion. Neither is a synonym for the general word, and someone can be an actuary without holding either.

What the work actually consists of. Three tasks recur across every setting. Pricing asks what a promise should cost before it is sold, which means estimating how often a covered event will happen and how expensive it will be when it does. Reserving asks how much of the money already collected must be held against claims that have happened but are not yet settled, and against claims that have happened but have not yet been reported. Valuation asks what a stream of long-dated obligations is worth today, which turns on a discount rate and on assumptions about mortality, disability, retirement age, salary growth and turnover. The first is the one people picture; the second and third are where most actuaries spend their careers.

The enrolled actuary is a federal creature, and the statute is short and specific. ERISA directed the Secretary of Labor and the Secretary of the Treasury to establish a Joint Board for the Enrollment of Actuaries, at 29 U.S.C. 1241. Section 1242 then directs the Joint Board to set "reasonable standards and qualifications for persons performing actuarial services" with respect to covered plans, and to enroll an applicant who meets them. For anyone applying since 1976 those standards must include education and training in actuarial mathematics and methodology, evidenced by a degree in actuarial mathematics or its equivalent, by passing an examination given by the Joint Board, or by passing other actuarial examinations the Board deems adequate, plus "an appropriate period of responsible actuarial experience." The Joint Board may suspend or terminate an enrollment after notice and a hearing.

What the enrollment is for is the more interesting half. ERISA section 103(a)(4), at 29 U.S.C. 1023(a)(4), requires a defined benefit pension plan subject to the annual reporting requirement to "engage, on behalf of all plan participants, an enrolled actuary who shall be responsible for the preparation of the materials comprising the actuarial statement." The statute goes further than requiring a signature: the enrolled actuary must use assumptions and techniques that let them form an opinion on whether the reported matters "are in the aggregate reasonably related to the experience of the plan and to reasonable expectations" and "represent his best estimate of anticipated experience under the plan." Note the phrase "on behalf of all plan participants." The plan sponsor pays the actuary, and the statute nonetheless states whose interest the engagement runs to. The same section lets the plan's independent accountant rely on any actuarial matter the enrolled actuary has certified, provided the accountant says so.

On the insurance side the parallel role is the actuary who signs an opinion. NAIC defines a "qualified actuary" as a person who meets the basic education, experience and continuing education requirements of the specific qualification standard for statements of actuarial opinion in the NAIC property and casualty annual statement, as set out in the qualification standards promulgated by the American Academy of Actuaries, and who is in good standing with that body and approved for signing casualty loss reserve opinions. NAIC separately defines the "actuarial report" that accompanies such an opinion as a formal document conveying the actuary's professional conclusions and recommendations to the state regulatory authority and the board of directors, and recording the methods and procedures used. The structure is the same one ERISA uses in a different industry: a named professional, held to published standards, signing a document a regulator reads.

Government actuaries are the third setting and the least visible. Social Security's Chief Actuary is created by statute at 42 U.S.C. 902(c): the office is filled by appointment of the Commissioner from individuals who have demonstrated "superior expertise in the actuarial sciences," the appointee serves as the agency's chief actuarial officer "in accordance with professional standards of actuarial independence," and may be removed only for cause. Those three features together, statutory office, independence standard and for-cause removal, are how Congress tried to insulate a set of projections from the political consequences of what they say.

The consumer-facing point is about assumptions rather than arithmetic. A long-dated liability is almost entirely a function of the assumptions chosen to value it, and reasonable professionals choose differently. That is why the statutes above regulate the choice of assumptions rather than the calculation, and why a change in a discount rate or a mortality table can move a reported liability further in one year than a decade of actual experience does.

A valuation begins with the promise: who is owed what, and when. The actuary then attaches probabilities to the timing, using mortality, turnover, disability and retirement assumptions, and discounts the resulting expected payments back to today at a chosen rate. The result is a present value, which becomes the liability on the balance sheet, the funding target the sponsor contributes toward, or the reserve the insurer must hold. Each assumption is documented, and in the settings described above the actuary must be able to say that the set of them, taken together, is a best estimate of anticipated experience rather than a convenient one.

A hypothetical, to show why the assumption does the work. Suppose a plan owes a single lump sum of $100,000 to be paid in twenty years. Discounted at 5% a year, the amount needed today is $100,000 divided by 1.05 to the twentieth power. That divisor is about 2.6533, so the present value is about $37,689. Change the discount rate to 6% and the divisor becomes about 3.2071, giving a present value of about $31,180. Nothing about the promise changed, no participant did anything differently, and the measured liability fell by about $6,508, roughly 17%. Run that across thousands of participants and decades of payments and it is clear why the choice of rate is the regulated decision. The figures are invented for the arithmetic.

The same logic runs in reverse when an insurer prices a policy. The probability that the covered event happens in a given year, the expected cost when it does, and the length of time the insurer will hold the money before paying it all feed one estimate, and small differences in any of them compound over a long contract.

Pros of the way the role is regulated

• Naming an individual professional and holding them to published standards gives a regulator someone to hold answerable for a number, rather than a corporate entity.
• ERISA's requirement that a defined benefit plan engage an enrolled actuary "on behalf of all plan participants" states whose interest the work serves, even though the sponsor pays for it.
• Requiring an opinion on whether assumptions are reasonable, rather than merely requiring a calculation, targets the part of the exercise where the discretion actually sits.
• A statutory office with an independence standard and for-cause removal, as Social Security's Chief Actuary has, protects long-range projections from the reaction to them.

Cons and limits

• An estimate of something decades away is an estimate. Being produced by a credentialed professional makes it disciplined, not certain.
• The sponsor or insurer selects and pays the actuary in most settings, which is a structural tension the qualification standards manage rather than remove.
• Assumption changes can move a reported liability more than real experience does, which makes year-over-year comparisons harder to read than they look.
• Because several actuarial designations are defined separately by different bodies, the single word "actuary" on a document tells a reader less than they might assume about what standard applies.