SOA - A Higher Level of Abstraction

A Higher Level of Abstraction
by Sim Segal

We are often told that, as actuaries, we excel in technical skills and ethical behavior. SOA member surveys confirm that we believe this to be true. We have also been told that we often demonstrate a lack of business savvy, and in particular, we have difficulty seeing "the big picture." The same SOA surveys indicate that we know this to be true as well.

So, we need to think in terms of a higher level of abstraction–to see issues from a higher perspective, a higher level of thought (maybe not always at the 30,000-foot level, but certainly higher than our own shoes). But, how do we do that?

The first step (and often the most challenging one), in any such effort, is to identify when the problem arises–finding the opportunities to improve. Each of us must work individually to find our own instances of when we may be too narrowly approaching an issue. However, it may be helpful to share some observations of where we see this occurring in practice. For what it's worth, here are a few examples that highlight a shift from an insular focus to a broader perspective, and the potential benefits of doing so.

Example: Stakeholder Bias
During the Clinton administration, there was an attempt to push through legislation on national healthcare. At that time, there was an SOA exam on the subject, and there were many technical study notes with all sorts of fascinating financial analysis relating to all stakeholders–government agencies, individuals, employers, medical professionals, etc. But one article in particular stands out in my mind. It was written by a well-known think tank. Their key observation went something like this:

Forget all the numbers. National healthcare is never going to happen in the United States because of the American Medical Association (AMA). The AMA is a monopoly and they will never allow it to happen.Whether or not I agreed with the think tank's opinion, this struck me as a refreshing example of looking at an issue from a higher level of abstraction. They addressed (what they thought to be) an over–riding political driver of a key stakeholder, rather than focusing narrowly on the financial puzzle. In any leadership exercise–getting people to change their direction–we need to consider the broader perspective, including realities such as stakeholder bias.

Example: Sub–Optimal Process
In 1990, most of the actuarial education on pricing was purely technical, focusing exclusively on the actuarial mathematics. However, one SOA study note expanded the discussion to include the pricing process itself. Shane Chalke's Macro Pricing note was renowned for stating that only cash flows marginal to a decision should be included in the evaluation of alternatives; this often meant ignoring overhead expense allocations for certain decisions. However, in that famous note, Shane Chalke also demonstrated a higher level of thinking about pricing, identifying a problem with the process: A political battle is often waged between Marketing (pushing for lower price) and Actuarial (wanting a higher price), resulting in a delayed, iterative process and, ultimately, a price that is sub–optimal.

The Macro Pricing approach suggested a redesign of the pricing process that eliminated iterations and offered a better division–of–labor. Rather than iteratively re–pricing each time Marketing pushed for a lower price, Actuarial would calculate, in advance, multiple projections based on a range of volume/price pair combinations. Actuarial would present Marketing with the viable options–those volume/price pairs with an expected return above the hurdle rate. Marketing would then select the volume/price pair to which they would commit, based on their judgment of the demand curve (i.e., how much they could sell at a given price level). Each area could then be held accountable: Marketing for achieving their production goals and Actuarial for the accuracy of their projections.

Example: Executive Perspective
Most of us approach our job with an eye towards continual improvement, focusing on the tasks at hand and finding ways to do it better and faster. However, periodically, it is also important to re–examine our role from a higher perspective, to see how it connects to company goals. This should already be part of a company's planning process, but it is often helpful to take this a bit further. This exercise gives us an executive's perspective of how we fit into the organization. It can also provide a better motivational connection to the organization for you and your team. Finally, it often leads to opportunities to improve productivity.

How is this done? Begin by mapping your activities upwards, e.g., to the goals of your unit, line of business, and ultimately to the goals of the enterprise. Then, identify which goal(s) each activity supports, and consider ways to improve. Also, identify things you may be doing that do not support the goals, and consider shifting resources elsewhere. Finally, identify additional higher level goals that are not supported by your current activities, but might be within your purview, and consider what projects you might propose.

Example: Customer Perspective
For several years, our industry has been aware of the large and growing needs of consumers nearing or at retirement. Up until now, this market has been served by various professionals, for example:

  • Financial planners recommend an asset allocation among investment products (e.g., 30 percent stocks; 60 percent bonds; 10 percent cash) based on a retiree's risk tolerance.
  • Health insurers offer long–term care.
  • Life insurers attempt to address a retiree's longevity risk with life annuities.

Unfortunately, these disparate efforts have not been fully successful in making retirees more financially secure. Retirees rarely have their risks fully and appropriately covered, due to gaps or overlap in coverage, sub–optimal allocations or poor prioritization of resources. Rarer still is finding a retiree that feels secure in their financial plan; they commonly express a lack of confidence in understanding their situation.

However, some actuaries have recently begun addressing this issue from a much broader perspective. They recognized that retirees need a single, unbiased view of all of their risks–investment, mortality, morbidity, longevity, etc., and an integrated recommendation on allocations across a comprehensive financial product set–both investment products (stocks, bonds, cash) and insurance products (life insurance, health insurance, annuities, etc.). Though this approach does involve a technical component–a stochastic retirement model that incorporates investment and life contingencies–the insight that led to this solution was elevating the thinking to a higher level of abstraction.

Non–Insurance Example: Practicality and Marketability
A recent article in The New Yorker magazine discussed a sea change that occurred in the field of obstetrics in the 1950s. At the time, 1–in–30 babies were stillborn. This was partly due to the poor care of newborns deemed "too sick to live" that were just put out of sight and allowed to die; these included babies that were malformed or of poor color and breathing.

In 1953, Virginia Apgar, the daughter of an insurance executive, introduced a scoring method for newborn health, in an attempt to improve the mortality rate. The Apgar score was a zero–to–10 scale: two points for pink all over, two for crying, two for good breathing, two for limb movement and two for a heart rate over 100. A ridiculously simplistic metric that could not possibly capture a baby's viability, you say? This couldn't possibly improve results, could it? Actually, the Apgar score is widely credited with revolutionizing child delivery and leading to dramatically improved results.

How could this be? The simplicity of the Apgar score led to its success. It was practical. It was easy to calculate. It was easy to compare. Availability and comparisons led to competition to obtain better scores. This led to standardized improvements.

This is another example of seeing the bigger picture. Rather than staying mired in multiple technical pieces of medical information, Apgar realized that a less accurate, more widely adopted metric could get people to improve. The bigger picture here is that people need practical metrics that are easy to calculate, easy to understand and easy to use in practice.

The lesson for actuaries is clear: Rather than focusing on perfecting models and/or making them increasingly complex, if we recognize the larger issue–the practical needs of business people–and simplify our work, we have much to gain. When we actuaries are invited to the business table, we need to bring more than our stochastic forks and knives. We need to build practical, marketable solutions that will catch on. We sometimes may need to down–shift our intellectual capabilities to get traction. It is often a choice between business people either employing our crude tool or ignoring our hyper–accurate, much–too–complex tool. It's like the old adage, "don't let the perfect be the enemy of the good."

As part of improving our business savvy, lifting our eyes to see the bigger picture can help us reap bigger rewards. Whether it is recognizing stakeholder bias, a sub–optimal process, the executive perspective, the customer perspective, practicality and marketability, or other factors, addressing issues from a higher level of abstraction can make us more effective in everything that we do. It will also get us more frequent invitations to the table for strategic business discussions.

Recognizing the opportunities to raise our level of thinking may help us take the first step towards improving. Hopefully, the few examples above help shed a little light on this. If you have examples you would like to share, please send them to me at