October 2011

Labs in Actuarial Science, Finance and Risk Management

By Tim Cardinal

Do a) none, b) some, or c) all of the classes in your actuarial science, finance and risk management programs have labs? (I do not consider exam question prep software labs).

Anyone that has taken a science class in high school or college—physics, biology, chemistry, psychology, computer science—will have fond or not so fond memories of labs. College TV promos during football and basketball halftimes always show students doing cool and exciting science and computer experiments. Science classes show videos, and TV channels have popular entertaining shows explaining science.

A quick Amazon search on physics experiment yielded 16,024 results and on physics lab yielded 7,778 results. However, actuarial science experiment and actuarial science labyielded eight results, all of which were clearly non-applicable.

Where are all the cool actuarial science experiments? Classes, TV-shows, or videos?

In this article, I will consider the importance of actuarial science, finance and risk management labs and experiments. I will use MLC (life contingencies) for most examples only due to a lack of print space. Examples and possibilities abound for any topic related to actuarial science, finance and risk management.

The Necessity of Labs

In addition to “missing” experiments, students, either in college or still taking exams while employed, often develop a single-minded focus on credentialing exams—actuarial or otherwise. Although topics covered early in one’s career are vast, they are by-and-large highly technical—one formula after another. Understanding concepts and developing technical fortitude is the desired route, but candidates can plod through via formula mechanics, memorization, and sheer persistence. Developing business acumen and intuition do not receive the same focus, are hard to squeeze in with so much technical content to cover, or are deferred until after finishing exams.

For example, can your actuarial students answer basic questions on the life insurance business, such as:

  • Why is level term rather than annual renewable term predominant in the term life market?
  • Why have U.S. term reserve requirements resulted in companies forming special purpose vehicles to finance reserves?

Do your finance students have a feel for the change in net present value from changing parameters such as discount rates, growth rates, dividend rates, or tax rates? Or the risk exposure resulting from mismatching an investment portfolio? Or the change in an option’s value (e.g., Black-Scholes) from a change in volatility?

Some students get lost in the minutiae. They see each of 100 problems as a new and separate challenge to be conquered. Those that mastered a topic, e.g., financial mathematics, will see that the 100s of exam problems are simply variations on a few themes. They know the pertinent definitions and understand the concepts. Thus, their path to covering material and solving problems is faster. Labs accelerate learning and bridge the gap between book knowledge and real-world practice.

Means or Ends

Consider an analogy I used in “Reinventing the Actuary,” (The Actuary June/July 2016). 1X-ray technicians are experts at using the machine. With the help of other technicians, they deliver accurate, useful intelligence regarding the patient to the doctor. But a technician is limited in creating value or helping the patient. The doctor uses multiple tools and multiple sources of intelligence to interpret and diagnose the patient’s condition, to consider alternatives, to make recommendations, to gain the patient’s acceptance, and to implement a solution. Patients in need of services go the doctor, not the technician.

Risk manager and actuaries’ roles should be analogous to the role of doctors. We are not mere technicians.

Second, I explored John Keegan’s stages of making intelligence useful in “ERM, Lessons from WWII Codebreakers,” (Contingencies March/April 2011).The five stages are:

  1. Acquisition
  2. Delivery
  3. Acceptance
  4. Interpreta
  5. Implementation

How do risk managers, actuaries and finance majors fare in this process of making intelligence useful? Exams help actuaries develop solid technical skills in the acquisition of intelligence, namely calculating things (NPVs, reserves, losses, durations, VaR, values, etc.). Actuaries also learn to use computer software models to calculate and project things as well as produce tremendous amounts of output data. But in this glut of assumptions and data, someone still needs to think critically; look at the right data; and analyze, interpret, and understand drivers to make the connections. Our path to personal growth—and the path to take business leadership roles in any industry—is via developing stage 4 (interpretation) and stage 5 (implementation) skill sets which include “soft skills.” One such skill set is being able to analyze ambiguous data and gain insights into the big picture by recognizing patterns or connecting the dots and being able to persuade and influence. However, during an actuary’s formative stages, the vast majority of time is devoted to stage 1 (acquisition) versus the latter stages.

Developing technical expertise is intense and takes considerable time. Does one need to have all the technical know-how first before applying it like a doctor to an actuarial or business context? Can one develop intuition and critical thinking skills about how underlying factors will impact reserves or durations of investments before or concurrent to being exposed to formulas and technical matter? Can one develop interpretive and communication skills regarding proposed alternatives to product designs and investment strategies?

Einstein opposed formative teaching focused on specialized knowledge and said, “The development of general ability for independent thinking and judgment should always be placed foremost.” 3 A smartphone can be used without knowing all the science and technology to design and build one. Likewise, one can learn about risk management, insurance, finance, and investments without performing technical calculations. Labs are fundamental in science to experiment, make observations, interpret data, and develop critical thinking and communication skills.


If X changes (mortality, interest, gross premiums, product features, etc.),

what is the impact on Y (reserves, earnings, capital, IRR, etc.)?

On Z (product design, product performance, risk profiles, etc.)?

Students that have taken actuarial mathematics (MLC) may be able to calculate modified net premium level reserves and those who have taken financial mathematics may be able to calculate duration, but likely lack the experience to understand relationships, drivers, and implications. Solving a formula in a textbook or exam problem falls short of providing insights into how prices or reserve behave or why. If X changes what is the impact on reserves, earnings, capital, and Internal Rate of Return (IRR)? Or the impact on product design, performance and risks?

Figure 1: Basic Reserve Questions

What is the impact of changing gross premiums on modified net level premium reserves (e.g., traditional CRVM or GAAP FAS 60 life reserves)?

On segmented modified net level premium reserves? (e.g., VM-20 Term NPR)

After year one, are earnings higher using net level premium reserves or modified net premium reserves? Which has the higher IRR?

How much will a five percent decrease in valuation mortality affect profit margin? IRR?

Does increasing valuation base mortality increase or decrease accidental death benefit reserves?

Will increasing the valuation interest rate increase or decrease reserves for a mortgage credit life product (assume a 30-year 6% mortgage)?

Do your students understand the questions in Figure 1? Are CRVM, FAS 60, VM-20 familiar or is the reaction, “what!?” Students might be dismayed to find out that after years of study and even passing all the ASA exams, it is possible they have yet to study the actual reserves held by U.S. life insurers or have little understanding as to how reserves behave and the business implications. Or that although they took Accounting 101, it didn’t cover accounting pertinent to insurers or banks.

A Remedy – Labs & Experiments

Determining answers to Figure 1 questions does not require calculations or knowing reserve formulas with actuarial notation. Nor does it require any actuarial prerequisites. The ability to answer does require experience and the development of critical thinking skills applied to the questions’ subject matter. These and other skills can be developed through experiments. Anyone with basic math can develop the necessary skills, not in years, but within weeks through labs. The same is true for financial/investment mathematics and corporate finance.

Tim Cardinal, FSA, MAAA, CERA, is principal at Actuarial Compass in Cincinnati. He can be reached at tcardinal@actuarialcompass.com.

[1] Cardinal, T. “Reinventing The Actuary” The Actuary, June/July 2016.

[2] Cardinal, T. and Li, J. “ERM, Lessons From WWII Codebreakers” Contingencies, March/April 2011.

[3] Einstein, A. 1954. Ideas and Opinions. New York: Crown Publishers. Pp. 64.