We are actuaries – Life Insurance

By Kasun Amarasuriya

In a previous article written by my colleague, she introduced what an actuary is and what they do (with a focus on the General Insurance industry). To recap, her article defined ourselves as problem solvers and strategic thinkers, we use our mathematical training to evaluate the risk associated with future events. 

I prefer to take a slightly different approach when introducing myself. “I model for a living”. That usually gets an interesting reaction from the person at the other end. I don’t model fashion, I model the probabilistic outcomes of uncertain future events (much less interesting, to some). 

We are a very versatile bunch and the extensive training we undertake as part of our qualification means we tend to approach problems from first principles. This means that we are generally able to tackle a variety of problems that relate to probability and uncertain outcomes. A good example is an interview question used by my team: ‘How much is spent on coffee in X city on a given day’. This is the type of question that gets a mathematical brain excited because we can make a number of assumptions and estimate an answer. We would start off by making an assumption about the population of the city (or source it from available statistics) then we need to make an assumptions about the portion of the population that works, how many work from home vs go into the city, what portion of the population would drink coffee, how many cups of coffee would an individual drink per day, how much is the average cup of coffee and so on. 

The Actuarial Association of Sri Lanka (AASL) is the representative body for the profession in Sri Lanka. The Association is a bit more than just a meeting place for Sri Lankan actuaries to gather around, sip tea and try to calculate the amount spent on coffee. A key area of focus for the Association is the development of the profession, in particular how we train up the local talent to address the needs of our market. As my colleague discussed in her article, and as we will discuss in this, and upcoming articles, the profession plays an important role in the financial services industry. While looking out for the best interests of our members, we also need to consider the best interests of the insurance policyholders and other stakeholders who rely on actuaries conducting their duties in a professional manner applying the utmost skills. 

The Actuarial profession can trace back its roots to John Graunt who pioneered demographic analysis. He concluded that there were predictable patterns of longevity and death in a group of people of the same age. In other words, while we cannot predict the time of death for an individual person, if we group a few thousand people together, we can predict the number of people from that group who will die in within a given period of time. Edmond Halley (whom the Halley’s Comet is named after) built on Graunt’s work and created the first life table in 1693. These two mathematicians formed the basis on which the modern actuarial profession is built upon. 

While life insurance type products existing since Roman times in the form of mutual aid society (or benevolent societies), these were not properly priced. That meant that most societies became insolvent over time because they were paying out more benefits than they were collecting in the form of contributions. Granut and Halley’s work enabled the formation of Life Assurance societies which could calculate the contribution (or ‘premium’) required from each member in order to provide death benefits in a sustainable way. These premiums were calculated on the basis of the member’s age and allowed for the probability that the society will need to make a benefit payment over a period of time. 

Taking a simple example, assume we have a group of 1,000 individuals all of whom are aged 30. We can use the life table to estimate how many of these individuals will die within the next 12 months (based on the Sri Lankan population mortality table, we would estimate about 8). Now let’s assume these individuals were insured for a sum of Rs. 100,000 upon death. The expected amount each individual needs to contribute into the fund is calculated using the expected total payout (8 deaths x Rs. 100,000 paid on death = Rs. 800,000) divided by the number of individuals (1,000) which gives us a minimum contribution of Rs. 800 per individual. 

Over time, the life insurance industry has developed into an integral part of the financial services industry. Today the sector plays an important role in most economies both in terms of providing a safety net to families at some of their darkest moments and as a form of savings for individuals. The products offered by life insurers have evolved from the simple death benefit that was offered in the 17th century to more modern covers such as the ‘Critical Illness Cover’ which pays a benefit when a policyholder receives a life altering diagnosis. 

Broadly, there are two types of life insurance, risk insurance and savings. The risk insurance covers are benefits paid to policyholders (or their beneficiaries) when a certain event occurs. This could be the death, total and permanent disability (i.e., the insured person is unable to ever return to gainful employment), diagnosis of a critical illness (such as a heart attack or a cancer). The savings type products tend to include an element of risk insurance plus a lump sum paid at the end of the policy term. 

In Sri Lanka, most life insurance companies tend to have at least a few members in the actuarial team. These teams perform a range of tasks supporting the management of the life insurance business. The tasks range from the calculation of liabilities for financial reporting and regulatory reporting purposes to designing and pricing new products to supporting the risk management function. Using our example of a 1,000 individuals from above, the actuary will estimate the premiums that each individual has to pay (we estimated Rs. 800 in our example). The actuary would need to consider things like the risk of some individuals being unhealthy and therefore representing a higher risk, or the need for the life insurer to cover expenses and make a profit. Therefore, the minimum premium of Rs. 800 would need to include loadings to allow for expenses and profit margins. The actuary would also need to calculate how much money the insurer should set aside for the claims expected to be paid in the future, these are referred to as reserves. 

At the moment in addition to their day to day roles, the actuarial teams are also consumed by the implementation of the new accounting standard for insurance contracts (SLFRS 17 which is also known as IFRS 17 globally). Transition to the new accounting standard was a massive challenge to most insurers around the world as they worked through the complex calculations required for the new standards. 

To summarise, life insurance is essentially a promise, a promise made by the life insurance company that, in exchange for the premium paid, the policyholder or their beneficiaries will receive a certain amount of money if an unexpected event occurs. A policyholder would only pay the premium if they are able to trust that the insurance company will honour the promise when the time comes. Many life insurance policies are sold for a long duration (potentially 40 years or more). Therefore, the life insurance policy is a long-term commitment made by the insurer. It is the fundamental role of the actuary to make sure that the insurance company is able to meet those commitments to policyholders for the entire duration of all the policies (promises) that they have sold.