An Insurance Buying Question Mary Frances Miller, FCAS, MAAA, FCA, CPCU University of Illinois October 27, 2005

What is an Actuary? An expert in the evaluation and management of the financial impact of uncertain future events A member of a small, highly respected profession that is essential to maintaining a strong economy A math techie who also succeeds in business Someone who really wanted to be an accountant - but it was too exciting

What’s the value of an uncertain future event? Start with a certain event –What’s the value today of a dollar tomorrow? –That’s the magic of compound interest Now add uncertainty –What’s the value today of a dollar tomorrow if you’re dead? That’s life insurance –What’s the value today of a dollar tomorrow if you’re still alive? That’s a pension! –What’s the value today to replace your car if you crash it next month? That’s casualty insurance!

What kinds of problems do actuaries work on? Insurance –What’s a fair price for auto insurance in Illinois? –If the legislature increases workers compensation benefits, how much will that cost employers? Pensions –How much does an employer need to contribute each year to fund retiree benefits? –How much is my pension worth? Private industry –Should a large company buy insurance or manage risk internally? –How likely is it that a new capital project will yield a return greater than the cost of capital? Social questions –Is Social Security really bust? –How much is the new Medicare drug benefit going to cost?

When should you buy insurance? Should you insure your car? –Let’s say you are an exceptionally good driver Your accident risk is low Insurance is expensive –But – can you afford to replace the car if it does get totaled? –What if you kill somebody in an accident? Should you (or your parents) insure your house? –The probability of your house burning down is very, very small –But would you take that risk?

A less clear example You are the Risk Manager for a large manufacturing company, with 1000’s of employees Your employees have on the job injuries –Despite the best safety efforts, accidents happen! –The employer is responsible for the costs under workers compensation laws –Costs can include lifetime medical costs and lost wages Should you buy insurance, or just budget for the workers comp costs?

Your choices Average annual losses are $55,000,000 Option 1: Insure it all –Pay an insurance premium of $65,000,000 Option 2: Only insure for the big claims –Pay an insurance premium of $18,000,000 to cover claims over $500,000 –Budget $45,000,000 for the other losses Option 3: Only insure for the really big claims –Pay an insurance premium of $3,000,000 to cover claims over $1,000,000 –Budget $50,000,000 for the other losses

Average Costs On average, your costs for the three options would be: Full Insurance - $65,000,000 Some Insurance - $63,000,000 Little Insurance - $60,000,000 No Insurance - $55,000,000

What else do you need to know? If the losses were totally predictable, you’d just budget the $55,000,000. How likely is it that the losses will be more than $55,000,000? –Or $65,000,000? –How much more? Can the company afford to cover the difference if the results are bad? –Are there enough assets? –Would you lose your job?

What is the distribution of possible results?

“Distributions” The average is $55,000,000 (we already knew that) About 1/2 of the time, losses are less than $45,000,000 About 10% of the time, losses are more than $90,000,000

What is the distribution of possible results?

Full Insurance

Full Insurance vs No Insurance

Maybe I can take some risk?

Can I take some risk? Savings Losses Break Even

Can I take some risk? Save money more often than not Biggest potential loss is around $10,000,000 Biggest potential savings is around $15,000,000 Average savings is $2,000,000 Decision: Go for it

How about some more risk? Savings Losses Break Even

How about some more risk? Savings Losses Break Even

Can I take some more risk? Cheaper about 85% of the time Biggest potential additional loss is around $20,000,000 Biggest potential additional savings is around $15,000,000 Average savings is $3,000,000 Decision: How much risk can my company take on?

How do the options compare?

Where do actuaries work? Insurance companies Consulting firms Accounting firms Banks & investment companies Large corporations Government Colleges & Universities

What do actuaries make? $40,000 to $50,000 to start $65,000 to $90,000 with 5 exams and 5 years of experience $100,000+ for new Associates (7 out of 9 exams) $125,000+ for new Fellows $150,000 - $500,000 for experienced Fellows DW Simpson & Company, PC

What does it take to become an actuary? There are two organizations that qualify actuaries in North America –Society of Actuaries for life, health, pension & investments actuaries –Casualty Actuarial Society for property & casualty and health actuaries Both require demonstration of mastery of a wide range of knowledge

What does it take to become an actuary? Prerequisites (not tested) –Calculus –Linear algebra –Introductory accounting –Basic statistics (SoA only) –Business law (SoA only)

What does it take to become an actuary? Required Courses –Econ – 2 university courses or equivalent –Finance – 2 university courses or equivalent –Time series & regression – university courses or equivalent

What does it take to become an actuary? Preliminary exams –Probability –Financial Math (interest) –Actuarial Models and Statistics –Actuarial Modeling

What does it take to become an actuary? Advanced topics –Actuarial Practice –Law & Regulation –Advanced Finance –Professionalism

How long does it take? Average “travel time” for FCAS is about 8 years Similar times for FSA Exams are currently offered twice a year –Once a year for some of the upper exams Most people are also working full time –But most people also get some time at work to study

What does it take? Most employers look for 2 exams –Or more for actuarial science majors –But not all employers require exams –Varies by geographic area Exams and GPA trade off –Less than 3.5 – you may need 2 exams –More than 3.8 – you may find jobs requiring no exams

How do I get a job as an actuary if I’m from a liberal arts college? Get a degree in math or a related field and try to have as high a GPA as you can, especially in math Take econ and finance Pass the first actuarial exam Try for a summer internship Be more than just a math nerd –Hone your writing skills –Take something challenging outside your major You can get a listing of actuaries in your area at (click on “members”)

Where do I go for more information? (Casualty Actuarial Society) (Society of Actuaries) –I’m happy to help

Questions?Questions?