ROLE OF ACTUARY IN INSURANCE By ROHITKRISHNAN VISHWANATH Third Year Banking & In !

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INSURANCE
Insurance is the equitable transfer of the risk of a loss, from one entity to another in exchange for payment. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. An insurer, or insurance carrier, is a company selling the insurance; the insured, or policyholder, is the person or entity buying the insurance policy. The amount to be charged for a certain amount of insurance coverage is called the premium. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice. The transaction involves the insured assuming a guaranteed and kno n relatively small loss in the form of payment to the insurer in exchange for the insurer!s promise to compensate "indemnify# the insured in the case of a financial "personal# loss. The insured receives a contract, called the insurance policy, hich details the conditions and circumstances under hich the insured ill be financially compensated. Thus, basically, Insurance is a contract bet een the insurer and the insured herein against

receipt of certain amount, called premium, the insurer agrees to make good any financial loss that may be suffered by the insured, due to the operation of an insured peril on the sub$ect matter of insurance. Insurance involves pooling funds from many insured entities "kno n as exposures# to pay for the losses that some may incur. The insured entities are therefore protected from risk for a fee, ith the fee being dependent upon the frequency and severity of the event occurring. In order to be insurable, the risk insured against must meet certain characteristics in order to be an insurable risk. Insurance is a commercial enterprise and a ma$or part of the financial services industry, but individual entities can also self%insure through saving money for possible future losses.

INSURABILITY
Insurability can mean either hether a particular type of loss "risk# can be insured in theory, or hether a particular client is insurable for by a particular company because of particular circumstance and the quality assigned by an insurance provider pertaining to the risk that a given client ould have. An individual company ith very lo insurability may be said to be uninsurable, and an insurance ith ould be uninsurable for term life

ill refuse to issue a policy to such an applicant. &or example, an individual

a terminal illness and a life expectancy of ' months of the insurance, that he(she company. A similar, insurance in )alifornia.

insurance. This is because the probability is so high for the individual to die ithin the term ould present much too high a liability for the insurance and stereotypical, example ould be earthquake

Insurability is sometimes an issue in case la of torts and contracts. It also comes up in issues involving tontines and other insurance fraud schemes. In real property la and real estate, insurability of title means the realty is marketable. The characteristics of insurable risks are * +arge number of similar exposure units. ,efinite loss. Accidental loss. +arge loss. Affordable premium. )alculable loss.

 +imited risk of catastrophically large losses.

NEE# FOR INSURANCE

The basic requirements of communal interests gave rise to risk sharing since the da n of civili-ation. &or example, people fire, hich ho lived their entire lives in a camp had the risk of ithout shelter. After basic exchange came ould leave their band or family

into existence, more complex forms developed beyond a basic barter economy, and ne forms of risk manifested. .erchants embarking on trade $ourneys bore the risk of losing goods entrusted to them, their o n possessions, or even their lives. Intermediaries developed to arehouse and trade goods, and they often suffered

from financial risk. The primary providers in any extended families or household al ays ran the risk of premature death, disability or infirmity, leaving their dependents to starve. )redit procurement as difficult if the lender orried about repayment in the event of the borro er!s death or infirmity. Alternatively, people sometimes lived too long from a financial perspective, exhausting their savings, if any, or becoming a burden on others in the extended family or society. ,ifferent assets are exposed to different types of risks like a car has a risk of theft or meeting an accident, a house is exposed to risk of catching fire, a human is exposed to risk of death(accident. Insurance is needed because of follo ing reasons* /ocial security tool * Insurance acts as an important tool providing a sense of security to the society on a medical care, standard of living necessary for his personal and family!s hole.

It is the right of every human%being to have basic amenities like food, clothing, housing, ell being, and right to security in case of unemployment, disability, sickness or any other circumstances

hich is not under control. In case the bread earner of a family dies, the family suffers from direct financial loss as family!s income ceases. As a result, family!s economic condition gets affected unless there are other arrangements to rescue the family from this situation. +ife insurance is one alternate arrangement that offers some respite to the family from financial distress. 0ther ise this family ould have been pushed into the lo er strata of the society, at par si-e hich ould be an additional cost to the society. This is because subsidies ould have to be given to the family so as to enable it to survive and en$oy the basic rights ith other people. .oreover, a poor family is generally seen to have a large family ith family members being illiterate. This on a hole affects the society and is a cost

to the society. Therefore, insurance compliments the state in social management efforts. 1ncertainty * The basic need of insurance arises as risks are uncertain and unpredictable in nature. 2etting insurance for an asset does not mean that the asset is protected against risks or its exposure to risk is reduced, but it actually implies that in case the asset suffers any loss in value due to such risk, the insurance company bears the loss and compensates the insured by making payment to him. 3conomic ,evelopment * The premium paid by people to the insurance companies is a part of their savings. Insurance, thus, acts as a useful instrument in promoting savings and investments, particularly ithin the lo er%income and middle%income families. These savings are ultimately used as investments fuelling economic gro th.

ACTUARY
Actuaries are professionals ho apply mathematics to financial problems. They evaluate the financial implications of contingent events, in other ords, events that are not certain to occur. They are often involved in managing the risks that can arise from undesirable contingent events. Actuaries evaluate the likelihood of future events. They also design ays to reduce the financial impact of undesirable events that do occur. To do their understand the nature of insurance, the risks inherent in different types of assets, the in ork, ays actuaries must have a high level of technical kno ledge. &or example, they need to hich statistical models can be used, and the legal and regulatory constraints that apply ork often affects many stakeholders,

to the business. They must also have good business sense, problem solving skills, and the ability to communicate effectively ith others. Their doing so. Although the actuarial profession has existed for many years, it is not a large profession and, therefore, is not countries in ell kno n by members of the general public. In fact, there are many orked primarily in the ell here those industries are hich no actuaries reside. Actuaries have traditionally so they must be able to balance different interests and observe high ethical standards in

insurance and pension industries, and mostly in countries

established. In the insurance industry, actuaries can be involved in all types of insurance* life or nonlife; and direct insurance or reinsurance. Although actuaries are often employed by insurers, many are employed by consulting firms and provide services to more than one insurer. /ome insurance actuaries actuaries ork for supervisory authorities, as either employees or ide range of positions. .any consultants. 4ithin these organi-ations, actuaries can fill a

ork in technical roles, applying their skills to tasks such as designing ne

insurance products, forecasting expected rates of loss, setting premium rates, or calculating the liabilities of an insurer to its policyholders. 0thers apply their kno ledge and experience in management positions, ith responsibilities ranging from technical or operational departments, to product line management, to senior executive roles.

#ISCI$LINES
Actuaries! insurance disciplines management, social and reinsurance. +ife, health, and pension actuaries deal ith mortality risk, morbidity, and consumer choice regarding the ongoing utili-ation of drugs and medical services risk, and investment risk. 5roducts prominent in their insurance, ork short include life and long elfare include life, health, pensions, annuities, and asset programs, property, casualty, general insurance,

insurance, annuities, pensions, mortgage and credit

term disability, and medical, dental, health savings accounts and long term care insurance. In addition to these risks, social insurance programs are greatly influenced by public opinion, politics, budget constraints, changing demographics and other factors such as medical technology, inflation and cost of living considerations. )asualty actuaries, also kno n as non%life or general insurance actuaries, deal 5roducts prominent in their commercial property ith risks

that can occur to people or property other than risks related to the life or health of a person. ork include auto insurance, homeo ners insurance, insurance, orkers6 compensation, title

insurance, malpractice insurance, products liability insurance,directors and officers liability insurance, environmental and marine insurance, terrorism insurance and other types of liability insurance. Reinsurance products have to accommodate all of the previously mentioned products, and in addition have to reflect properly the increasing long term risks associated ith climate change, cultural litigiousness, acts of ar, terrorism and politics.

7oth ma$or classes of actuaries are also called upon for their expertise in enterprise risk management "7ureau of +abor /tatistics 899:#. This can involve dynamic financial analysis, stress testing, the formulation of corporate risk policy, and the setting up and running of corporate risk departments "Institute and &aculty of Actuaries 89;;b#. Actuaries are also involved in other areas of the financial services industry, and can be involved in managing corporate credit, company evaluations, and tool development.

BASIC ACTUARIAL CONCE$TS

The ork of an actuary can be extremely complex and challenging. <o ever, reduced to its basics, it often involves the application of probabilities and the time value of money through models that are designed to reasonably represent reality and assist in analy-ing a particular situation. A brief introduction to these concepts can provide the context for better understanding the particular areas of sector. $ROBABILITIES Insurance is a business that is built on probabilities. .ost insurance policies protect the policyholder from the financial consequences of undesirable contingent events, such as death, fire, or accidents. <o ever, life annuities protect against the adverse financial consequences of a desirable situation, exactly hich is the possibility that a person ill run out of money because of living longer than expected. In either case, it is impossible to predict hat ill happen ith respect to a particular policyholder. <o ever, as the number ith an increasing level of confidence. This predictability enables insurers of policyholders ith similar risk characteristics increases, the outcome for them as a group can be predicted to take on risks that are individually highly unpredictable, and spread the financial consequences across many policyholders through the premiums charged. ork in hich actuaries are involved in the insurance

Actuaries measure the risks that are insured against to determine their probabilities of occurrence, sometimes referred to as frequency, and use these probabilities in a detailed in a mortality table, ide range of calculations. &or example, the probabilities of persons dying at particular ages can be hich can be used in calculating life insurance premiums and the liabilities to policyholders. &or some types of insurance, it is not enough to kno

probability of an event occurring, because the financial consequences of the event could depend on its severity. &or example, one motor vehicle accident might require only minor repairs to the vehicle, hile another might totally destroy the vehicle and severely in$ure its occupants. Therefore, actuaries need to understand the costs that might be involved if an event occurs. This understanding of severity might be limited to kno ing the average cost of an event or, more usefully, by estimating the probabilities that the cost of an event ould exceed various levels. The simplest approach to using probabilities is called deterministic. In this approach, the most likely frequency and severity probabilities applicable in a particular situation are used in the calculations. &or example, a mortality table may indicate that the mortality rate at a particular age is 9.998=, and this rate is used in calculating the premium rate to be charged to policyholders of that age. The deterministic approach typically produces a single ans er in a particular situation. <o ever, even ith a large number of policyholders of the same age, the actual mortality rate at that age can vary from year to year. In fact, the mortality rates sho n in a mortality table are not certainties, but merely the averages of probability distributions of mortality rates. The stochastic approach to using probabilities recogni-es these underlying probability distributions and uses them in the calculations. This is usually done by using the probability distributions to generate many alternative scenarios of hat might happen and repeating the calculations for each scenario. The stochastic approach produces a range of ans ers, ith different probabilities attached to them. The above discussion has focused on the probabilities directly related to the events that lead to insurance claims. <o ever, there are many other factors that can affect the cost of an insurance policy and for hich probability analysis can be useful, or even essential.

/ome of these relate to the behavior of policyholders. &or example, a policyholder may decide to pay a premium on the policy rene al date or let the policy lapse, or a policy may provide a range of options from hich a policyholder may choose at specific dates. 0ther factors are economic in nature, such as the investment returns that might be earned by an insurer, the expenses involved in the administration of insurance policies, and the rates at hich various types of expenses might increase over time because of inflation or changes in operating efficiency.