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Exercise 19.

1
We comment above that the actuary would approach the work in a professional way. Reviewing
Chapter 3, what do you think this sentence means?
Solution
To start with, the actuary would establish with the client the scope of the work. This was a major piece of
work, so it would be appropriate to have a written agreement on the work to be done, the timeline and the
basis for charging. The consultant would not take on the job unless certain of having the necessary
expertise, time and other resources. The work in progress would be well managed, with due attention to
good housekeeping procedures such as documentation, creating backups and protecting clients
confidential data. There were several stakeholders, so the actuary needed to be aware of potential
conflicting interests. Everyone should be clear about who is the actuarys client, but the actuary would
also take into account that other parties might be relying on any report. Communication on an ongoing
basis was important, so that the client could provide input into the modeling and to make sure that the
client fully understood the issues and could use the actuarial advice to make an informed decision.

Exercise 19.2
(a)

What were the contrasting objectives of the various stakeholders in the project?

(b)

What are the sources of risk in the project?

Solution
(a)

The client and its equity partners wanted to be able to supply cable capacity at a profit, without
adding debt to their balance sheets. The banks financing the project wanted a secure, debt-type
investment. The banks wanted to see a business structure which locked in known revenue, as long
as that comfortably covered servicing the debt. They had nothing to gain from upside risk. The
equity owners on the other hand didnt want to lock in low guaranteed revenue, as they stood to
gain from the upside. The customers wanted low prices, and possibly to lock in a guaranteed
price. An added complication was that some equity partners might also be customers.

(b)

Risks arose from the potential for problems with laying cable, and uncertainty about future
growth in demand and future supply from competitors.

Exercise 19.3
Projects to lay fiber optic cables under the Pacific Ocean dont come along every day. Can you think of
other sorts of projects that raise similar issues to this example?
Solution
Any major investment project. Consider for example the toll road example also described by Tony
Coleman, or any partnership to develop infrastructure, housing etc. Actuaries have been involved in
advising on such projects for decades.

Exercise 19.4
Of the three phases of the Actuarial Control Cycle, which will provide the greatest challenge to an
actuary working on non-traditional problems?
Solution
The first phase, understanding the problem, will be the greatest challenge. When working in a new area, it
is necessary to do considerable preparation in order to understand the context. It is especially important to
listen to all the involved parties so their actual goals are understood. Both client and actuary need a firm
grasp of the problem to avoid implementing a pre-conceived solution.

Exercise 19.5
In the interview above, Samuel J Keller stresses the importance of understanding the cause-and-effect
relationship between management actions, market movements and the ultimate riskiness of a companys
financial position. Give examples of such relationships.
Solution
There is no single correct solution but you may have come up with examples similar to the following:
Example 1 Management of an insurance company may decide that guarantees provided with some of
their policies have no cost because they will never be in the money. When an extreme market
movement takes place the risk becomes apparent. Because the situation was viewed as being without risk,
no risk mitigation was done.
Example 2 An automobile manufacturer assesses the savings of a shortcut in manufacturing against
possible liability payments from accidents and deaths. The market for liability awards increases rapidly,
leading to significantly more payments than anticipated, not to mention future losses due to decreased
reputation.
Example 3 Management of an airline anticipates that fuel costs will rise and elects to secure forward
agreements for purchasing jet fuel. When prices increase dramatically, the company profits but risk (as
in uncertainty) was reduced regardless of the outcome.

Exercise 19.6
The football tipping example involves relatively frequent decisions, with short deadlines. Another area
where actuaries have had to cope with rapidly changing information is in the energy markets. On the CD,
you will find two articles describing such applications.
Can you think of some examples, outside financial services (and energy), where quick but accurate
decisions are required? What about decisions which require much more time but must be made with more
precision?
Solution
The following illustrates the type of example that you may have thought of:
Driving a car requires accurate processing of key data and quick decisions whether to brake or swerve,
for example. Similarly, sailing a boat or flying a plane can present situations where a quick decision must
be made.
On the other hand, planning a long journey can take considerable time and, in the case of a commercial
flight or an expedition into the desert, will require meticulous attention to detail.
As an alternative, consider the engineering decisions that have to be made when rescuing victims from a
collapsed building (perhaps following an earthquake) and compare them with the decisions involved in
the design and construction of the building in the first place.
In all cases, an understanding of implications (a characteristic both of experience and of judgment) helps
to improve the decision, even when that decision is being made quickly and before all the facts can be
fully assessed. Models can help to fill the gaps in experience by showing what outcomes are possible.
Scenario tests have a key role here.
Note that scenario tests do not always require computer models. Soldiers have exercises (war games),
sporting teams have training sessions and astronauts prepare for all kinds of possible eventualities.