Taming Uncertainty: The Limits to Quantification

Abstract

Taming the beast of uncertainty has been the grand project to which actuaries have dedicated much of their energy and skill over at least the last 50 years -roughly the time since, in Hans Bühlmann's (1989) famous term, 'Actuaries of the Second Kind' emerged. The collective efforts of actuarial researchers and practitioners have been founded on two premises: -First Premise: Uncertainty is malleable; responsive to quantification skills and management expertise. Yes, actuaries concede, models sometimes fail, as seen in the case of the 2007-9 financial crisis. But, the world is orderly enough, such that one need not despair: the answer lies in using better, more sophisticated models, which will provide a better approximation to the risk environment. -Second Premise: We can neatly separate the quantification of uncertainty -by probabilistic and statistical tools -from the economically motivated (and often normative) principles according to which decisions are taken. Disagreements about the accuracy of quantitative models are distinct from disagreements on how decisions should be taken. Maximising the Return on Capital for a portfolio is one thing; deciding that such a measure of performance should, in fact, be used in portfolio management is quite another.

The Model Ajar: Building Rationality Infrastructures Within Insurance Organizations

“…As they engage in this way with various types of stakeholders, modellers create a model that is 'flexible' enough to be consistent with multiple conceptions of the model and of uncertainty, thus facilitating expansion of model use. Such coexistence of alternative conceptions of the model and of uncertainty is consistent with previous discussions on cultures of model use (Tsanakas et al, 2016;Tsanakas and Cabantous, 2017), to which our study, while different in its framing, gives an empirical underpinning.…”

The Global Financial Crisis – risk transfer, insurance layers, and (lack of?) reinsurance culture

“…In this situation, there are pressures of various kinds pushing you towards the cheaper option. The importance of behavioural issues, in the face of uncertainty, to organisations in general has been recognised for a long time – see, for example, Kahneman and Lovallo (1993) – and lately also by the banking (Pollock, 2018) and the insurance industry (Frankland et al, 2014; Haddrill et al, 2016; Jakhria, 2014; Tredger et al, 2016; Tsanakas et al, 2016; Weick et al, 2012). Many of the issues described in the following appear indeed in more than one of these references.…”

How banks and other financial institutions think

“…Some of our most recent work (see Tsanakas et al ., 2016) has been on model risk . As well as causing something of a stir in the actuarial profession, it won the 2015 IFoA (UK Institute and Faculty of Actuaries) Peter Clark Prize, it has now caught the attention of the BIS (Bank for International Settlements).…”

“… 1 Some of these are of a fairly orthodox academic kind (e.g. Ingram et al ., 2012; Huang et al ., 2014; Tsanakas et al ., 2016) but many are in what could be called “the trade press” (e.g. Ingram & Thompson, 2011; Underwood et al ., 2014; Tsanakas et al ., 2014).…”