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An Actuarial Vision for Homeland Security and 'Societal Risk Management'

An Actuarial Vision for Homeland Security and "Societal Risk Management"
by Sim Segal

Throughout most of human history, people have been highly vulnerable to risks impacting their health, lives and property. For example, up until 1747 when Benjamin Franklin invented the lightning rod, every electrical storm that rolled in brought with it the routine fear of houses and neighborhoods burning down. However, relatively recently, particularly over this past century, we have significantly enhanced our ability to mitigate basic risk exposures, primarily through medical and other technological developments. Gradually, society began to feel like it was gaining the upper hand over its environment.

However, the recent rash of events–SARS, terrorism, tsunamis, hurricanes and floods–has made us feel more vulnerable again. In the past, society has typically managed risk in a reactive event–specific manner. An event occurs, there is public outcry, government allocates funding and a real or perceived solution is implemented to mitigate the event. In addition, separate departments, or silos, are established to handle different types of risks (e.g., fire, police, EMS, Coast Guard, etc.).

However, today we may be witnessing a sea of change in society's approach to managing risk. The U.S. Department of Homeland Security (DHS), with its myriad collection of departments, was charged with the task of protecting America from a wide variety of risks. In the wake of Hurricane Katrina, the outcry from citizens underscored this responsibility. The questions about the choices and priorities being made by the DHS and specifically the Federal Emergency Management Agency (FEMA) seemed to make this accountability "real" for the first time. The role of the DHS represents an evolution towards a central department to manage all sources of risk. This approach– which may be called Societal Risk Management (SRM)–is analogous to Enterprise Risk Management (ERM), but applied to a society rather than an enterprise.

Similar to an ERM process, SRM establishes a central entity to proactively identify all risks to society, assess and prioritize the risks, respond to manage/mitigate the risks, communicate internally and report back to its citizens about the risks, the level of preparedness and the vulnerabilities. In ERM, a corporate department coordinates the effort to manage risks to the company in protection of stakeholders, primarily shareholders (for public companies); in SRM, a governmental department coordinates the effort to manage risks to society in protection of stakeholders, primarily citizens. Like traditional ERM, one of the key advantages is the comprehensive, consistent and integrated assessment of all risks to prioritize focus and make choices among mitigation options.

While SRM is certainly a daunting effort involving input from a wide range of professions, there is a need for actuarial expertise, perhaps even more so than for traditional ERM efforts. Like ERM, SRM involves the measuring and managing of risks, which is the central expertise of actuaries; this includes quantifying risks, translating this into credible information and using it in management decision–making to weigh risk–to–value trade–offs. However, further actuarial input is needed due to the additional complexity of the SRM metrics themselves–the set of uniform metrics for assessing the risks facing society. For ERM, most would agree that a primary ERM metric is shareholder value (at least for public companies). However, for SRM, several metrics must be considered, many of which involve the following actuarial contingencies:

Life
Clearly, a "life metric" should be the first metric considered. Our society's paramount value is protecting the lives of its citizens. Most people would say the metric should be the number of lives saved. Actuaries might improve upon this by using expected future life years saved, which involves life contingencies.

Quality of Life
While we highly value life in our society, it is not our only value, and so the life metric cannot be our only metric. The quality of life must also be addressed. For example, we value living in freedom, and so are willing to sacrifice the lives of the few to preserve the liberties of the many. Another example of this value is the desire to avoid living in pain. Actuaries might incorporate this metric as a utility function in the life metric.

Health
Some risk events result in an impact to health alone, rather than a life–and–death situation. A health metric is needed to capture the financial impact, which is an increase in healthcare costs. This metric requires the expertise of health actuaries. The non–financial impact–any decrease in health impacting life expectancy–is captured separately in the life metric.

Property
A metric is also needed to capture damages to property, both public and private. Whether this is from natural or man–made risks, this is clearly under the purview of property–casualty actuaries.

Financial
A financial metric is also needed to capture the economic impact of risk events on business income and litigation costs. Losses to businesses and liability exposure are both risks that are routinely evaluated by property–casualty actuaries. This metric is also critical for budgeting purposes/weighing cost–to–benefit trade–offs in evaluating since we must prioritize mitigation actions due to limited resources.

While this is just a cursory glance at SRM, and there are doubtless other metrics and factors to consider, it suggests that actuaries can play a significant role in SRM. In fact, several years ago, a related suggestion was implied in a television program on ABC News. On a program called 20/20, investigative reporter John Stossel discussed how applying the discipline of actuarial science might change society's priorities towards more effectively managing health risks to the public. The two examples that I can recall involved prioritizing funding between different types of cancer research and changing legislation on travel safety devices. Each example made the point that current allocations and choices were suboptimal when compared to those indicated by actuarial science.

If you have some thoughts on this topic, or if this sparks an idea for other non–traditional applications of actuarial techniques, please e–mail me at simsegal@deloitte.com. To expand as a profession, and to broaden our impact on society, we must continue to scan the environment and identify potential applications of actuarial science.