As an actuary, you seldom have the information required to solve a problem with certainty. Nonetheless, you need to present your best solution. The ability to make decisions based on incomplete information is one of the most important skills an actuary can possess. Depending on your mindset, developing this skill can be intimidating. Much of our academic training leads us to believe that problems have “right” or “wrong” solutions. But this distinction is not so clear in practice. Consider loss reserving as an example. While there are an unlimited number of “wrong” ways to estimate loss reserves, there is no single “right” approach. Making decisions based on incomplete information can be a messy process. In this way, it mirrors life: you have to do the best with what you’ve got. Nonetheless, there are ways to optimize this process. Here two tips to help become comfortable making decisions under uncertain conditions: #1 Sensitivity test assumptions. Suppose you estimate loss reserves at $10 million. What are the assumptions underlying your estimate? How would your estimate change if your assumptions changed by X%? Routinely sensitivity testing assumptions will give you a sense for how much sway they have. Once you have identified the most influential assumptions, refine your focus accordingly. #2 Look at the implications inherent in selected estimates. Once you select an actuarial estimate, you can calculate the assumptions implicit in your selection. For example, what is the implied reported loss development pattern underlying your estimate of IBNR? How does this compare to historical development patterns? By reverse-engineering your own estimates, you can gain a comfort level by comparing the implicit assumptions to comparable benchmarks. What techniques do you use to get comfortable with estimates based on incomplete information?
Don Grimm, FCAS, MAAA, another approach is to look at the period-over-period percentage change to ensure there isn't any large change without an explanation. For example, the Net IBNR estimate for year-end 2022 compared to 2023, assuming there's no change in the reinsurance arrangements.
Great advice! It come to complete focus on each scenarios.
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4moGut check. One of the most frustrating and insightful comments one of my first bosses always had to my analysis was “no, that doesn’t feel right”. While I didn’t have his intuition at the time, the idea to stop and check my assumptions, to think about where it could be wrong, why, and by how much has helped me tremendously.