With the increasing use of complex quantitative models in applications throughout the financial world, model risk has become a major concern. Such risk is generated by the potential inaccuracy and inappropriate use of models in business applications, which can lead to substantial financial losses and reputational damage. In this paper, we deal with the management and measurement of model risk. First, a model risk framework is developed, adapting concepts such as risk appetite, monitoring, and mitigation to the particular case of model risk. The usefulness of such a framework for preventing losses associated with model risk is demonstrated through case studies. Second, we investigate the ways in which different ways of using and perceiving models within an organisation both lead to different model risks. We identify four distinct model cultures and argue that in conditions of deep model uncertainty, each of those cultures makes a valuable contribution to model risk governance. Thus, the space of legitimate challenges to models is expanded, such that, in addition to a technical critique, operational and commercial concerns are also addressed. Third, we discuss through the examples of proxy modelling, longevity risk, and investment advice, common methods and challenges for quantifying model risk. Difficulties arise in mapping model errors to actual financial impact. In the case of irreducible model uncertainty, it is necessary to employ a variety of measurement approaches, based on statistical inference, fitting multiple models, and stress and scenario analysis.

When deriving a demographic basis from experience data it is useful to know (i) what uncertainty surrounds that basis, and (ii) the financial impact of that uncertainty. Under the Solvency II regime in the EU, insurers must hold capital against a number of risks. One of these is mis-estimation risk, i.e. the uncertainty over the current rates of mortality and other biometric risks experienced by a portfolio. We propose a general method for assessing mis-estimation risk, and by way of illustration we look at how mis-estimation risk can be assessed for a portfolio of pensions in payment from a UK pension scheme. We find that the impact of mis-estimation risk varies according to the risk factors included in a model, and that the inclusion of some necessary risk factors increases the financial impact of mis-estimation risk. In particular, the inclusion of risk factors which improve the model’s fit and financial applicability can lead to an increase in the mis-estimation risk. We also find that a full-portfolio valuation is preferable to using model points when assessing mis-estimation risk.

This abstract relates to the following paper: RichardsS. J.Mis-estimation risk: measurement and impact ‐ Abstract of the Edinburgh Discussion. British Actuarial Journal, doi: 10.1017/S1357321716000040.

This study is a subjective synthesis of the work of many academics, supervisors and practitioners on the topic of liquidity and many of its multiple aspects. It borrows heavily and freely from those works in the pursuit of coherence, as this subject can be both confused and confusing. Although many hypotheses, both established and speculative, are referred to, none is proposed in this paper. In order to be of possible use to a range of readers, it roams from the most basic and elementary to some of the most recent and advanced. In pursuit of brevity and readability, in many instances it can do little more than introduce a particular feature and leave further investigation to the reader. Liquidity is clearly a topic with much unfinished business. Our ambition in writing this paper is threefold: first, to raise awareness amongst actuaries of the wide-ranging implications for actuarial work of liquidity; second, to bring some coherence to the manifold measures and uses of the concept of liquidity by attempting to synthesise some of the key elements of knowledge today; finally, to highlight some of the more high profile and open questions relevant for actuarial work. This paper makes many references to behaviour during the crisis and its aftermath; however, it is not intended to be a forensic analysis of the crisis attributing causality. The crisis has simply served as an experiment during which many things became observable.

This abstract relates to the following paper: AggarwalA., BeckM. B., CannM., FordT., GeorgescuD., MorjariaN.,SmithA., TaylorY., TsanakasA., WittsL., YeI. Model risk – daring to open up the black box by the model risk working party ‐ Abstract of the London Discussion. British Actuarial Journal, doi: 10.1017/S1357321715000276.

Expert judgement has been used since the actuarial profession was founded. In the past, there has often been a lack of transparency regarding the use of expert judgement, even though those judgements could have a very significant impact on the outputs of calculations and the decisions made by organisations. The lack of transparency has a number of dimensions, including the nature of the underlying judgements, as well as the process used to derive those judgements. This paper aims to provide a practical framework regarding expert judgement processes, and how those processes may be validated. It includes a worked example illustrating how the process could be used for setting a particular assumption. It concludes with some suggested tools for use within expert judgement. Although primarily focussed on the insurance sector, the proposed process framework could be applied more widely without the need for significant changes.

This abstract relates to the following paper: KeatingC., HatchettJ., SmithA., WaltonJ. and ZhaoT.Liquidity: essence, risk, institutions, markets and regulation ‐ Abstract of the London DiscussionBritish Actuarial Journal, doi:10.1017/S1357321715000100

The Solvency II Directive introduces the idea of a formal Actuarial Function to have responsibility over delivering the requirements of Article 48 of the Directive. Article 48 describes the responsibilities as being concerned with technical provisions, an opinion on reinsurance adequacy, an opinion on underwriting policy and contributing to the risk management system. Considerable documentation has been produced by the Prudential Regulation Authority (PRA), the Institute and Faculty of Actuaries (IFoA) and the European Insurance and Occupational Pensions Authority on the subject, much of it very recent to the publication of this paper. The purpose of this paper is to provide the reader with some practical insights and suggestions around addressing the requirements of Article 48 of the Solvency II Directive in general insurance firms, taking into consideration the publications of the aforementioned regulatory authorities. It is not our intention to give advice, nor to be seen to give advice, but rather to make suggestions and observations that we hope the reader will find useful. The Regulations lay down the tasks of the Actuarial Function, so insurers should consider the need for formal terms of reference, backed up by proportionate governance procedures. The Regulations also require the production of an Actuarial Function Report to document the tasks undertaken by the Actuarial Function and its results. Such a report can be an aggregate report, made up of individual component reports completed at suitable points in the Actuarial Function’s work cycle, so long as it reports on all the required tasks. The technical provisions section should cover at least all the areas laid down in the Delegated Acts. The opinions required covering reinsurance adequacy and underwriting policy are not formal “sign offs”, but contributions to the effective running of the insurer by applying the skills and knowledge of actuaries to areas for which they are not normally responsible. Again, the Delegated Acts mandate the minimum contribution the Actuarial Function should make. The responsibility for delivering the work of the Actuarial Function does not have to be given to a member of the IFoA; however, the PRA is going to require (at least) one person to be designated the “Chief Actuary”, defined as the person responsible for delivering the requirements of Article 48 of the Directive. In response, the IFoA has stated its intention to require its members holding the role of Chief Actuary, as defined by the PRA, to hold a practicing certificate. Any Actuarial Function will need to consider issues of governance, independence and conflicts of interests. The PRA intends to require the Actuarial Function to be independent of an insurer’s revenue-generating functions. In addition, normal good governance requires a degree of separation between those who perform Actuarial Function work and those who review and supervise it. There are numerous stakeholders in the Actuarial Function’s work. Some of these will rely on the output of the Actuarial Function, others will provide inputs to its work. Setting out stakeholder responsibilities clearly and in advance will be of vital importance. Good communication and coordination between these groups will be important to the efficient running of the insurer. Bringing together issues of governance, independence and meeting the Directive and regulators’ requirements will require a suitable organisational structure which will also need to consider practical issues, such as the availability of suitable staff. Many such arrangements may be possible, but all will require trading off advantages and disadvantages. The Actuarial Function is primarily about good practice and getting the most out of the actuarial skills available. For many insurers, meeting the requirements should not be unduly burdensome.

This abstract relates to the following paper: AshcroftM., AustinR., BarnesK., MacDonaldD., MakinS., MorganS., TaylorR. and ScolleyP.. Expert judgement ‐ Abstract of the Edinburgh Discussion. British Actuarial Journal. doi: 10.1017/S1357321715000239.

This abstract relates to the following paper: WilliamsR. L., AnzsarJ., BulmerR., BuntineJ., ByrneM., GedallaB., GoswamyP., GrantJ., HeahW., KeshaniS. & ShahJ.Actuarial Function Working Party ‐ Abstract of the London Discussion. British Actuarial Journal. doi: 10.1017/S1357321716000052.

This abstract relates to the following paper: Expert Judgement by Institute and Faculty of Actuaries-Solvency & Capital Management Working Party, Ashcroft. doi: 1500023.

Expert judgement is frequently used within general insurance. It tends to be a method of last resort and used where data is sparse, non-existent or non-applicable to the problem under consideration. Whilst such judgements can significantly influence the end results, their quality is highly variable. The use of the term “expert judgement” itself can lend a generous impression of credibility to what may be a little more than a guess. Despite the increased emphasis placed on the importance of robust expert judgements in regulation, actuarial research to date has focussed on the more technical or data-driven methods, with less emphasis on how to use and incorporate softer information or how best to elicit judgements from others in a way that reduces cognitive biases. This paper highlights the research that the Getting Better Judgement Working Party has conducted in this area. Specifically, it covers the variable quality of expert judgement, both within and outside the regulatory context, and presents methods that may be applied to improve its formation. The aim of this paper is to arm the insurance practitioner with tools to distinguish between low-quality and high-quality judgements and improve the robustness of judgements accordingly, particularly for highly material circumstances.

The relationship of the chain ladder method to mathematical statistics has long been debated in actuarial science. During the 1990s it became clear that the originally deterministic chain ladder can be seen as an autoregressive time series or as a multiplicative Poisson model. This paper draws on recent research and concludes that chain ladder can be seen as a structured histogram. This gives a direct link between classical aggregate methods and continuous granular methods. When the histogram is replaced by a smooth counterpart, we have a continuous chain ladder model. Re-inventing classical chain ladder via double chain ladder and its extensions introduces statistically solid approaches of combining paid and incurred data with direct link to granular data approaches. This paper goes through some of the extensions of double chain ladder and introduces new approaches to incorporating and modelling incurred data.

This abstract relates to the following paper: TredgerE. R. W., LoJ. T. H., HariaS., LauH. H. K., BonelloN., HlavkaB., ScullionC.Getting better judgement working party: bias, guess and expert judgement, in actuarial work ‐ Abstract of the London Discussion. British Actuarial Journal, doi: 10.1017/S1357321716000155.

We examine the roles of actuaries in UK life offices, along with trends, challenges to and opportunities for actuaries. We carry out an analysis of senior roles in life offices, a questionnaire survey and interviews with relevant senior personnel. We find that actuaries occupy many important roles in life offices and are regarded as having good industry knowledge and technical skills, especially in financial modelling. There are fewer executive directors and more non-executive directors of life offices who are actuaries compared with the position in 1990. A higher proportion of reserved roles is outsourced to consultants than was the case in 1990. Only a small number of Actuarial Function Holders are directors. Actuaries are more siloed than was the case in the past, although actuaries are well represented in the finance and risk functions of many offices. Although actuarial work in connection with the preparation for Solvency II will decline, there will be important ongoing requirements for actuaries following Solvency II implementation. We also see opportunities for actuaries in four areas: in risk management, in financial analysis and management based on Solvency II and international financial reporting standards, in connection with “big data”, and in product development and the customer proposition. There are implications for the examination syllabus, continuing professional development and research.

This abstract relates to the following paper: Prof WilkieDavid, F.F.A., F.I.A.; Dr HareDavid, F.I.A.; SmithAndrew, Hon F.I.A. Celebrating the British Actuarial Journal’s 20th anniversary: looking at the next 20 years of actuarial research ‐ Abstract of the London Discussion. British Actuarial Journal.