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What’s Certain about Uncertainty?
Session 29

Presenters: Adam J. Reese; Hay Group, Inc.; Alfred O. Weller, Weller Associates, Inc.; Lawrence J. Sher, Buck Consultants, an ACS Company
Recorder: Richard H. Bailey, Mercer

The group discussed various issues around risk and uncertainty, particularly in the area of communicating these issues to clients. The discussion was general and applicable to all practice areas.

Consulting actuaries provide value to their clients by describing risk and uncertainty associated with actuarial estimates. Financial and statutory reporting may be placing too much emphasis on expected values and single point estimates. Using a range when communicating to clients can help express the uncertainty and protect the integrity of the work product.

Gaining client consensus on the assumptions going into a model can be beneficial. Clients that are involved with assumption review have a better understanding of the work product, and likely get more value out of the process. Consultants can benefit from a deeper sense of partnership with clients and have their work product gain enhanced credibility, even if the actual results vary from the assumptions.

Point estimates can be additionally dangerous in situations where the underlying distributions are asymmetric. X% up and X% down may have dramatically different impacts on the financial results under a skewed distribution or formula.

However, there are some considerations for ranges as well. First, the type of range needs to be considered. Should it be range of reasonable estimates or range of actuarial estimates? Next, the range shouldn’t be so wide as to encompass all possible results. Third, ranges must be considered in light of what the client is going to do with the information. The actuary needs to consider the entire enterprise when preparing a range, not just the actuary’s function. Also, it’s acknowledged that financial markets tend to recognize the low end of a range in times of uncertainty, rather than a midpoint. The consequences of this should be considered when producing a range.

Weller described a process of considering all assumptions as a package, rather than individually, which can be helpful in developing a range of results (e.g., the unlikely end of the spectrum for two separate assumptions are even more unlikely to occur together, and some combinations may be offsetting).

There was much discussion among the panel and participants around procedural matters. Participants discussed methods they use to gain client consensus and to communicate risk and variance in their results. Many ASOPs were referenced throughout the session, including 4 (Measuring Pension Obligations), 6 (Measuring Retiree Group Benefit Obligations), 27 (Selection of Economic Assumptions for Measuring Pension Obligations), and 44 (Selection and Use of Asset Valuation Methods for Pension Valuations). A discussion of the difference between the terms “may” and “should” revealed differing opinions about the intent of the ASOPs.

In an informal poll, about ½ of the group said they would support the idea of “best practices” related to uncertainty being promulgated by the CCA. The counterargument to this was that individual firms have developed their own best practices and these become a competitive distinction among them.

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