Actuaries Make Mistakes

Actuaries Make Mistakes

Actuaries Make Mistakes

I noticed a typo in your spreadsheet, you’re fired!

Ok, ok, settle down there. No one is going to (or should we say “no one should”) fire you over a silly mistake. But what happens when the mistake is not silly and ends up costing the company real money or opportunity cost?

 

Imagine the following simple scenario. You are in charge of calculating the reserve discount rate that your company uses to compute its local solvency required reserve capital. You use the yield of the assets backing the reserves to compute this. You inherit a spreadsheet from your predecessor and go about updating it.

The way your company calculates the reserve discount rate is:

  1. Take the weighted average of the yields on the bonds backing your shareholder reserves = X%;
  2. Take a regulatory margin off the resulting amount = X% – 0.5% = Y%.

You have no problems updating the assets, but since the company added a few bonds to the portfolio, you miss the fact that your weighted average formula does not pick them up. The mistake is that you simply forget to expand the domain of the formula!!! Trivial, isn’t it?

The resulting wrong weighted average is smaller than the real one, resulting in your reserves being higher than necessary. You end up overstating the reserves by about $5m.

 

Assuming you discover your error a week after the reserves figures have been submitted, you have two options:

  1. Hush up the mistake and wait for the next quarter for the problem to correct itself; or
  2. Admit the mistake was made and correct it.

Naturally, people hate to admit they make mistakes. However, making mistakes is natural, it is common, it is the cost of doing business. People make mistakes, whether you chose to believe it or not.

 

Actuaries are no exception. There are some managers that do not accept that their employees make mistakes and therefore punish them for it. We certainly believe that this is overkill and it creates a culture of hush-ups, where people are afraid of admitting they screwed up.

Let’s see what the outcomes of the two options above could be:

Hushing up the mistake

  • The problem may just correct itself.
  • Things may blow up in your face after your manager discovers your mistake and realises that you are either incompetent or a coward.

Admitting the mistake

  • You follow the steps we outline below and as a result grow in the eyes of your manager, who realises that you are a responsible employee.
  • Financial statements may need to be restated via a journal entry.

 

Obviously, there are more possibilities, but the point we are after is that you can turn a mistake into an opportunity, to paraphrase the SOA’s motto.

 

Here is a checklist you should follow once you find a mistake:

  1. Identify the mistake and its scope;
  2. Quantify the impact of the mistake across all business lines;
  3. Determine a way to fix the mistake and the timeline for the fix;
  4. Implement checks in the process to avoid making this mistake in the future; and finally
  5. Approach your manager with the discovery and the proposed steps and timeline to fix it.

Still don’t believe us? Take it from this Reddit thread and note the advice of the responders.

We hope you have a mistake-free day!

 

Image Source: We manufactured this example on our own Excel spreadsheet!

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