Actuaries Tune Risk Analysis to Improve Decision Making under Uncertainty

Actuaries are more risk-averse than you and I because they advise insurers and pension funds that have a lot at risk.  So they need to be better at decision making under uncertainty.   When they calculate requirements for pension fund investment, life insurance, or long-term care they try to account not only for the uncertainties–say, growth rates for bonds– but the factors that influence variation in the uncertainties, key economic indices.

A recent research study by noted authorities in actuarial practice Kevin Ahlgrim, Illinois State University, and  Steven D’Arcy and Richard Gorvett of the University of Illinois, Champaign-Urbana, provides a risk analysis model for projecting economic indices such as interest rates, equity price levels, inflation rates, unemployment rates, and real estate price levels.  The researchers undertook the project for the Society of Actuaries and the Casualty Actuary Society.  Their goal was not simply to create a model, but to help bring practicing actuaries up to date on current thinking and techniques for economic modeling and to lay the foundation for future advances. Their model was developed using @RISK, the popular Monte Carlo software for Excel, and if you want to take a look at it, it is available on the website for the Casualty Actuary Society (the model is a link to Appendix D).

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