To many readers of actuarial reports the language can be quite confusing. This article discusses the notion of an “Estimate” or “Forecast” in the parlance of what has become part of generally accepted actuarial guidelines of communication.
Actuaries often develop projections of losses or loss reserves. These amounts are then considered by the corporate client or insurance company. We used to call these projections “expected values” or “estimates”, but in today’s actuarial world they are referred to as the Actuarial Central Estimate. The basic definition of an Actuarial Central Estimate is “…an estimate that represents an expected value over the range of reasonably possible outcomes…Such a range of reasonably possible outcomes may not include all conceivable outcomes, as, for example, it would not include conceivable extreme events where the contribution of such events to an expected value is not reliably estimable.”
I am sure to you non-actuaries out there, the above definition is as clear as mud! So what does the above mean in ordinary language? Let’s present a simple example:
Actuaries often utilize several methods in the forecasting process.
Suppose the Actuary’s charge is to forecast 2011 worker’s compensation losses for a particular client. He or she uses various methods and comes up with four different results – not unusual. These results are:
Method A = $6,000,000
Method B = 7,000,000
Method C = 8,000,000
Method D = 9,000,000
Assume prior years’ losses after adjusting for inflation and other considerations have largely fallen within the $ 6 – $9 million range. Let us further assume the Actuary believes all methods are equally valid. In this particular instance the Actuarial Central Estimate might be the average of the four numbers or $7,500,000 which is an estimate that represents an expected value over a range of reasonable outcomes. Now, let’s make it a bit more complicated. Suppose Method D results in a value of $12,000,000. The actuary might now say that $12,000,000 seems a bit high, but it is a possible event, so we need to give it some weight, say 10%, with 90% of the weight given to the other Methods. The Central Estimate is still $7,500,000. However, the client may be of the opinion that $12,000,000 is unreasonable and should be excluded from consideration, so the appropriate estimate is the average of $6,000,000 –$8,000,000 or $7,000,000.
The point of the above discussion is to illustrate that Actuaries often need to exercise judgment in their determination of the Actuarial Central Estimate, and clients need to be aware of the underlying assumptions and weights given to the various methodologies.
Feel free to contact AJA ifyou have questions regarding the actuarial methods and processes utilized to arrive at a loss pick or reserve projection.