Trick or Treat?

Application of Neural
Networks in Insurance
January 10th, 2019

Dr Ben Flood, bflood@kpmg.com, https://www.linkedin.com/in/drbenflood/

Jan Brunckhorst, jbrunckhorst@kpmg.com, https://www.linkedin.com/in/jbrunckhorst/
Mathias Leppmeier, mleppmeier@kpmg.com, https://www.linkedin.com/in/mleppmeier/
Zeno Schneider, zschneider@kpmg.com, https://www.linkedin.com/in/zenoschneider/
1 Introduction.................................................................................................................. 1
1.1 Purpose of this document ........................................................................................ 1
1.2 About the authors ................................................................................................... 1
1.3 What is a neural network?........................................................................................ 1
1.4 What type of people build neural networks?............................................................... 1
1.5 Where we learn about neural networks ..................................................................... 2
2 Applying neural networks ............................................................................................... 2
2.1 What is a neural network used for? ........................................................................... 2
2.2 Steps to set up a neural network ............................................................................... 4
3 Future of risk & regulatory .............................................................................................. 5
3.1 Verification with a traditional model .......................................................................... 5
3.2 Ethics of letting a machine making decisions ............................................................... 5
3.3 Going beyond best estimates.................................................................................... 5
3.4 Individualised Pricing & Reserving ............................................................................. 6
4 Technical ...................................................................................................................... 6
4.1 Architecture of a neural network............................................................................... 6
4.2 How do neural networks learn? ................................................................................ 7
4.3 Architecture engineering is the new feature engineering .............................................. 8
5 Tools............................................................................................................................ 8
5.1 Libraries ................................................................................................................ 8
5.2 Programming Language ........................................................................................... 9
6 Discussion..................................................................................................................... 9

1 Introduction
1.1 Purpose of this document
We have written this document to share our
excitement and our experience with neural
networks. We give an overview of this new
technology, including some examples and
details to help you dive in to this rapidly-
evolving area.
This is not an academic paper, and opinions
therein are only our own. Our view is
captured by the following three points.
1 Neural networks perform one trick,
matching output to input, really well.
2 Lots of business processes can be seen as
performing that trick.
3 The barrier to entry for applying neutral
networks is low.
1.2 About the authors
The authors work in consulting in the CFRO
department of KPMG in Munich, in the areas
of actuarial science and risk management.
1.3 What is a neural network?
A neural network picks the best output from a
list of choices, given an input. If a business
process can be expressed as picking an output
from a list of choices, and you want to
automate that, then a neural network is
probably the way to go. There have long
existed other methods to perform the same
task – the key innovation, we think, is that a
neural network is really good at this task.
A neural network is a machine learning
technique. It falls under the label artificial
intelligence (AI), because it can replace tasks
where a human would be expected to make a
decision; it is sometimes treated as
synonymous with AI, but the field of AI is
much broader. The idea of a neural network is
simple, but has many applications, and is
changing the way we work.
1
Neural networks can operate directly on raw
data, and need little to no encoding to
descriptive variables by humans. This means
image and speech files can be used directly as
input. This is the innovation that allows
Google Translate to understand our speech,
and Amazon’s Alexa to understand our voice
commands, and allows social media and
photo tools on our phones to identify the
people in a photo.
The mathematical basis of a neural network is
not hard to understand, but it can be very
difficult to understand how the parts
combine.
Importantly, with the available software
libraries, the mathematics do not need to be
understood to use neural networks.
Nevertheless, training and debugging models
is easier with the mathematical basis.
1.4 What type of people build neural networks?
Machine learning experts and data scientists
typically train neural networks. A machine
learning expert is expected to be able to
optimize the algorithms, and a data scientist is
expected to know more about testing
hypotheses, as a general rule.
More recently, the software is so practical
that people from other fields are training their
own neural networks. Increasingly the tools
are used by actuaries, risk managers,
underwriters, and more. National actuarial
organizations are actively launching data
science initiatives in many countries.
There is no formal definition of a data
scientist. A panel discussion on registering
data scientist as a protected profession, at the
German Data Science Days conference in
Munich in 2018, showed the idea as very
unpopular with practitioners.
In our experience in the actuarial and risk
area, it is often easier to train people with
mathematical qualifications and an affinity for
coding and databases than to directly find
data scientists. The computing part involves a

lot of failure and debugging, and the need to
learn never stops. The affinity for computing
appears to be particularly important to
success in data science.
We have seen several companies very
successfully roll out data science training for
their existing staff. Anecdotally, the key, as
shared in the community, is that there needs
to be at least some initial resource, who
understands the techniques and technology,
to guide training and recruiting the team.
While new graduates often have a very high
level of technical skill, framing business
problems such that they can be solved by
machine learning or statistical methods is
often a hurdle. Hires with these skills are hard
to find, and harder to evaluate.
1.5 Where we learn about neural networks
The field of machine learning moves fast.
Quoting a postdoctoral researcher from a
seminar at a recent Datageeks meetup in
Munich, if you miss the last two or three
papers in reinforcement learning, you are
already behind. Keeping up with
developments is an ongoing process and relies
on several changing sources. Find a good data
scientist, and you have probably found
someone who enjoys learning new things.
Meetups
There are most likely multiple data scientist
meetups in your city – findable via a search
engine. Practitioners love to meet up and
share their expertise. These are usually quite
informal events (think pizza and beer).
Datageeks and the Insurtech & Fintech
meetups are particularly established in
Munich. Events with a commercial focus are
less likely to attract practitioners.
Virtual Courses
We have used Coursera and Datacamp, but
there are many other options available for
online courses, including IBM, Udemy, Google,
Amazon Web Services, etc.
2
Forums
Hacker News (news.ycombinator.com) is a
great source for community submitted links
on machine learning, computer science and
startups. GitHub repositories often have lots
of detail and explanations.
Workshops
We have hosted and taken part in workshops,
both internally and externally, on technology
and use cases for machine learning in the
insurance industry. A workshop in which
participants present their own use cases, and
then brainstorm, is usually a very efficient way
to share knowledge and generate projects.
Graduates
Hiring new graduates is a good source of
information. While only two or three years
ago it was nigh on impossible to recruit
graduates who had studied machine learning
or data science, the numbers of courses and
interested students has exploded. These
graduates often have a good network within
which information is shared.
2 Applying neural networks
2.1 What is a neural network used for?
Since a neural network picks an output from a
list of choices, given an input, a neural
network will only work on aspects of the
business problem that can be described in this
simple way. Fortunately, many business
problems can be described in this way.
Insurance
For example, many health insurers face the
business problem of trying to improve their
net promoter score. This does not obviously
generalize to picking an output from a list. It
has, however, been identified that higher net
promoter scores can be achieved by paying
claims faster. Also that many claims were
obviously payable. This aspect of the overall
business goal does generalise to picking a
value from a list. A neural network is used to
pick whether a claim is instantly payable
 3

without review. This speeds up the claims Other Fields

payment process for many (one example is
25% of claims payable within 3 seconds). This
process has been applied by many insurers
internationally.
Another application is the decision to accept
an application for life insurance automatically,
without a medical underwriter needing to
review the requirements for medical
assessments. One company we know already
can approve 70% of applications
automatically.
A major insurer issued a data science
competition to identify the driver of a car
based on telematics data.
Further, neural networks are being used by
many insurers and reinsurers to predict
claims, for pricing or reserving. This has been
considered for both frequency and severity of
claims and for loss triangles.
Finance
Portfolio managers, hedge funds, and hedging
departments are testing neural networks to
maximize returns subject to a given risk
appetite, or minimize risk subject to given
returns.
Call centres and robo advisors are using
neural networks to decide based on live call
monitoring whether to pass the call to a
human or not.
Neural networks are particularly effective for
problems involving speech recognition and
image recognition. Speech recognition is
picking which word has been said, given
waveforms as input. Image recognition is
picking which object is in a picture given pixels
as input. Instead of painstakingly deriving
features from waveforms and images, and
algorithms to analyse them, neural networks
are used to do the hard work.
An international energy company, using the
wind as the input, and the settings of a wind
turbine as output, has increased its energy
output from its windfarms by 1% a year using
neural networks.
Using the inputs from a wide range of sensors
on a car, the major car companies are
producing the output of the action a car
should take next, and this builds the
foundation of autonomous driving. Training
data is being gathered by real and virtual trials
(amusingly, in some cases the training data is
created using computer games about driving,
including grand theft auto).

Table 1 Sample of Applications

Item Input Output Goal

Claims Payment Claim Data Automatically approve Reduce time it takes to
payment pay a claim
Customer Churn / Customer data, interactions, Lapse in the next period Minimise Lapse
Lapse products, etc. or not
Next Best Offer Customer data, interactions, Which product to sell Maximise Sales
channel, products, etc.
Medical Customer application data Automatically approve Maximise conversion
Assessment application rate
Portfolio Market Data, Financial A permitted portfolio Maximum Return
Management Reports, Social Media Feeds allocation
Wind Turbine Winds Turbine settings Maximise Energy Output
Speech Recognition Audio waveform Words Automate processes
Call Centre Waveform, or text of the call Pass the call to a human Automate processes
operator or not
Image Recognition Pixels Object Automate processes

2.2 Steps to set up a neural network
Frame the problem
The first, and often hardest, step is to frame
the business problem as a machine learning
problem. This does not mean changing the
business problem – just describing the
business problem in a way such that a neural
network can handle it.
This is always a cross-disciplinary effort.
Neural network specialists are usually not
good at identifying the business problems,
and business specialists often have difficulty
generalizing their business problem to a
problem that can be solved by machine
learning.
In the workshops we have been part of, we
have sometimes seen machine learning
specialists try to shoehorn everything into
using the latest algorithm, when a simpler
solution suits better. On the other hand, if you
don’t let your techies play with the newest
algorithms, they will quit and go work
somewhere else. This needs to be balanced.
Framing the problem involves engaging
business owners. Engaging business owners to
help identify data science projects is always a
challenge. They need to be incentivised to
support the project with their time and
expertise, and the fear that they or their staff
will be replaced by a computer needs to be
managed carefully. Anecdotally, many of the
applications we see in insurance are to
support overworked staff in claims handling
and reporting, or replace retiring staff. We see
often more engagement where business
owners are made part of the data analytics
team.
Get the training data
Collecting enough training data is the next big
challenge. To train the network, you need to
have a data set consisting of inputs and the
corresponding outputs. For getting data in the
insurance industry, data privacy and data
quality are key issues. In comparison with
internet firms, for example, there is often
4
more difficulty accessing databases across
departments, and data from legacy systems.
For example, for training neural networks to
predict the next best offer for cross-selling,
multiple product databases need to be joined,
and this is often a showstopper for a whole
project.
Data is always a problem and it is safe to
assume that getting clean data will take
longer than expected. Back a few years ago
when ‘big data’ was the key buzzword, many
newly established data science departments
contacted the business owners with the
message, “Give us your data, and we will find
great insights.” From the business owners’
perspective, creating data queries and
cleaning data is hard work, and it is not clear
who is going to get the credit for the insights.
This needs to be managed sensitively for
cooperation to be successful.
Train a neural network
We often hear of new data scientists that
want to build their software from scratch.
While it might be a useful academic exercise
to implement your own neural network
trainer for a simple example, we prefer to use
one of the libraries available. The developers
of open source libraries have already faced
and solved an abundance of tricky technical
problems, the majority of which are probably
not relevant to the business problem you are
solving.
Neural networks can be trained on your
laptop. For larger applications, Amazon,
Microsoft, Google, and others provide pre-
built operating system images in the cloud
with many software configurations already
installed. Libraries provide support for
alternative processors, such as graphics
processors, which allow speed-up through
better parallelization and other properties.
Training a complicated neural network can
take hours or days, and it is advisable to get
into the habit of carefully documenting each
experiment. Fitting mathematical models

involves mathematics, and some engineering,
to set the computers up. But the bulk of the
work looks more like chemistry: designing
experiments, setting out what you expect to
learn, trying to set up the experiment just
right, waiting, and documenting the results. It
is very easy to waste calendar time by not
being systematic with the experimentation.
Validate the results
Validating neural networks is not much
different than validating models in the
actuarial, risk management, quant, or
statistical world. Validation is still all about
separating training and validation data,
analysing residuals, and producing good
graphics. However, explaining the parameters
fitted by a neural network can be next to
impossible.
Traditional statistical methods and machine
learning usually use cross validation where
the training and testing is done multiple
times. With lots of data, larger neural
networks can take a lot of computing power
to train. Training and validation data is often
defined once, and a test data set is kept aside.
Use it to predict
Once the neural network has been trained,
using it to predict is an almost instantaneous
process. The input is passed to the network,
and the answer comes out.
Decisions about how and when to update the
network are complicated. The only new
consideration versus traditional modelling in
insurance is that computing time might be
expensive.
3 Future of risk & regulatory
3.1 Verification with a traditional model
A neural network is a black box. If it does
something weird, it might be hard to explain
to your stakeholders. It is a good idea to have
a simple, interpretable model as a baseline for
the neural network, where regulated and risky
activities are concerned.
5
One of the main problems, preventing the
wide usage of neural networks in the
insurance industry, is the lack of
interpretability of those models. Research has
shown that there are some mathematical
concepts to increase the interpretability, but
it is early days yet.
We see a ‘trust but verify’ method being used
in practice. Say two models are fitted, a
traditional model and a neural network. The
neural network is assumed to have better
predictive power. The traditional model can
be explained easily. The rule goes: If both
models give a similar answer, use the neural
network. If two materially different answers
are given, investigate.
3.2 Ethics of letting a machine make decisions
In some of the discussions that we have been
part of, the consensus has been that a
machine can act to benefit the customer, but
it cannot take decisions that disadvantage the
customer. This means automating paying a
claim, accepting an application, for example,
but not automatically refusing a claim or
application.
3.3 Going beyond best estimates
The main non-standard work we face using
neural networks for insurance is fitting
probability distributions, which we solve by
estimating conditional density function
parameters.
Standard neural networks provide point
estimates and not estimates for distribution
functions. These neural networks are not able
to compute percentiles or risk measures.
Since Solvency II, and other regulatory risk
frameworks, require metrics like value at risk
to compute the capital requirements, it is
necessary to estimate features of probability
distributions.
This extension requires some extra
programming work.

3.4 Individualised Pricing & Reserving
In non-life pricing, there are cases in which
machine learning cannot be used in pricing for
regulatory reasons, but where the difference
in prices predicted via machine learning and
permitted methods can be used to identify
pricing gaps. Good and bad risks are identified
using this method, and management actions
are taken.
4 Technical deep dive
4.1 Architecture of a neural network
A neural network is composed of layers of
neurons. It is believed that neural networks
with a lot of layers generalize better than
their shallower counter parts, but are harder
to train. Neural networks for image
classification can have hundreds or thousands
of neurons if enough data is available and the
task requires learning very complex, non-
linear relationships.
Google’s natural language processing model
BERT, which was published in November
Figure 1 A neural network
6
2018, consists of 1024 layers with 340 million
parameters. The model was trained on 3.3
billion word corpus. For tasks like the
prediction of house prices or insurance claims,
neural networks with ‘only’ a few layers are
already enough and can over-fit quickly. How
wide and deep a neural network should be
depends mainly on the amount of data
available, and the complexity of relationships.
Neuron
The base element of a neural network is a
neuron. A neuron computes a non-linear
function of a linearly weighted sum of its
input data. The non-linear function is called
the activation function. Training the neural
network means estimating the weights.
Note that the specification of a neuron is
equivalent to a generalized linear model,
where the weights are the coefficients, the
inputs are the independent variables, and the
link function of a GLM corresponds to the
activation function of the neuron. The
activation functions, the same as link
functions, are used to model non-linear
relationships between the output and the
input.

Neural networks stack potentially hundreds or
thousands of neurons, and, hence, can model
very complicated non-linear relationships. It
has been proved that any mathematical
relationship can be modelled exactly by a
sufficiently complicated neural network.
Activation Function
There is no single activation function that
works best in all cases. Recent research has
shown that a mixture of activation functions
can be better. The choice of activation
functions for your problem affects both
predictive power and time it takes to train the
network.
The rectified linear unit (ReLU) function, or
the ‘rectifier’, f(x) = max(0, x), is currently
favoured by many practitioners, because it
works. The ReLU activation function is quick
to calculate. It also allows neurons to be
switched on and off for different data items,
making it easy to represent multiple
relationships in the same network.
Several modifications to ReLU are available.
Exponential linear units (ELUs) have been
shown to allow higher classification accuracy
than ReLUs. Leaky ReLUs allow a small
positive gradient when the ReLU is not active.
Softplus approximates the ReLU with a
smooth function.
In the early days of neural networks the
sigmoid function, with its S-shaped curve, was
a very popular choice, but it was hard to train.
It compresses the values of the output to the
range between zero and one. The tanh
function became accepted as an alternative to
speed up training, and this is still used in
recurrent neural networks for predicting
sequential data.
The list of activation functions used is
continually growing.
Layers
In a basic neural network, a single layer
usually has the same activation function for
each neuron. Extensions of the basic neural
7
network architecture are used to solve
particular problems.
For sequential data, like text or time series
data, recurrent layers introduce a mechanism
for learning time-dependent relationships.
The neurons receive information not only
from previous layers, but also from previous
rounds in this layer. This means that the order
of the given information is important.
Gated recurrent layers and long short-term
memory (LSTM) layers are used to represent
deeper relationships in sequential data. The
LSTM introduces a memory cell that is able to
forget. LSTMs can learn very complex
sequences and are used for time series
analysis with seasonal effects. They are also
widely used for writing and speech
recognition.
In image classification, convolutional layers
use a sliding window to move across the
image, and calculate a function of groups of
pixels at a time. The results of this function
are then used by the other layers. The
neurons in a convolutional layer are only
connected to local regions of the image.
Pooling layers are also sometimes used to
compress the data in image classification, but
their use is controversial. Quoting Geoffrey
Hinton, pioneer of deep learning, “The
pooling operation used in convolutional
neural networks is a big mistake and the fact
that it works so well is a disaster.”
4.2 How do neural networks learn?
The parameters of a neural network are
trained via gradient descent. Given a
performance measure, the gradients can be
computed with respect to the network
parameters via back propagation. In back
propagation, the chain rule for derivatives is
used recursively starting at the last layer and
passing the gradients backwards through the
neural network. The parameters are then
updated by taking small steps in the opposite
direction of the calculated gradients.

The gradients are not usually computed on
the whole training data set at once. A small,
randomly-chosen batch is used to calculate
the gradients and update the model
parameters for each training step. This
process is called mini-batch gradient descent,
and is a variant of stochastic gradient descent.
A training step is a single calculation of the
gradients and parameter update, and an
epoch is a full cycle through all the data.
Neural networks are prone to overfitting, but
methods are available to mitigate this, called
regularization. Dropout regularization
randomly selects neurons that are left out
during a training step. This requires the neural
network to not rely heavily on specific nodes
and is believed to improve generalisation.
Another regularization technique adds the L2-
norm of the neural network weights to the
loss, which also smooths the loss surface and
improves the learning process.
4.3 Architecture engineering is the new feature
engineering
Deep learning allows raw data to be used in
the model, without a human needing to
decide on useful variables.
For example, one of the first algorithms in
computer vision to be successful at identifying
Chinese characters used 5 lines drawn
through each character, and used the number
of times the character crossed each line as the
input data set. Ten or fifteen years ago, a lot
of research was done in evaluating tens of
thousands of automatically calculated
descriptor variables from images, to identify
useful variables.
Now, the first few layers of the neural
network figure out themselves which
properties of the input data are useful for
prediction. This makes neural networks very
generally applicable, but there are still
obstacles to overcome.
8
In theory, training a neural network is pretty
easy. In practice, selecting the hyper-
parameters and network structure is as much
an art as a science. It takes a lot of trial and
error to find a good network architecture and
the experimentation itself is very time
consuming.
5 Tools & toys
Applying mathematical models has long been
possible by choosing the right tools. At a
conference on Bayesian statistics in 2006 in
Lago di Como, the late John Nelder, described
how he had released the GLIM software in the
1970s, so that non-statisticians could apply
generalized linear models. At a seminar at
Google’s office in Munich in 2018, one of the
lead engineers of TensorFlow described how
the software is being developed to enable
non-experts in machine learning to apply
neural networks.
5.1 Libraries
We discuss three popular libraries here, Keras,
with the lowest barrier to entry; and
TensorFlow and PyTorch, more powerful
libraries.
Keras
Keras is the easiest library to get started with.
Several insurers we have spoken to use Keras
in real applications. It is developed to be a
high-level library for neural networks, with a
focus on rapid prototyping. Besides standard
neural networks, it also supports
convolutional and recurrent neural networks,
and has gained favor for its out-of-the-box
solutions.
TensorFlow and PyTorch
TensorFlow and PyTorch are open source
libraries, TensorFlow developed by Google,
and PyTorch developed primarily by
Facebook. TensorFlow is established, and
PyTorch is more recent, but is gaining
momentum in academic papers. The licenses
 9

and the projects’ main sponsors are different, exploratory and statistical work. In
but the functionality is increasingly the same. comparison to R, Python focuses on
productivity and code readability. The choice
All three libraries can be used on a laptop, and
depends on the task, knowledge of the
are supported by cloud platforms. Operating
language and personal preference.
system images with the software pre-installed
are available on most cloud platforms. Packages and Modules
The module repository of Python, called PyPi,
In contrast to Keras, TensorFlow and PyTorch
is by far behind the package repository CRAN
offer low-level as well as high-level
for R for statistical methods, although it’s
application programmers’ interfaces (APIs).
catching up. Statistical libraries like numpy
The low level APIs come with support for
and scikit-learn for Python grow and improve
machine learning generally and offer low level
further, but the focus is on basic functionality
functions, providing much more flexibility
in comparison to readily implemented
than Keras. PyTorch and TensorFlow have
statistical models in R.
frontends for C++, which is intended to enable
research in high performance, low latency C++ Visualization
applications. Python and R both support visualization, but
Python’s support is not built-in. Python
Since TensorFlow’s Estimator Framework and
supports graphical visualization with basic
PyTorch’s Ignite were launched, the
libraries like Matplotlib or advanced ones like
respective high level APIs, it is much easier to
Plot.ly. It requires more effort to achieve basic
get started with neural networks using
results than in R, but you also have more
PyTorch or TensorFlow.
possibilities, like interactive dashboards and
TensorBoard better support of web applications.
TensorBoard is a tool for visualization,
specially developed for TensorFlow, but can
also be used with PyTorch. It visualizes the
6 Discussion
whole training process of your models. Neural networks have suddenly become easy
to train and popular. In insurance, as with
5.2 Programming Language other industries, we are finding a gold rush of
If your team consists only of computer business problems we can apply this new
technology to.
scientists, software engineers, or similar, then
they might want Scala, C++, JavaScript, and Applying neural networks needs a
that’s fine. If, like us, you have a mixed team combination of business and technological
from various backgrounds, either Python or R acumen.
is a better choice.
Our outlook is, if there is a repeated task that
Python & R involves picking an output from a list of
Python and R are high-level languages that choices, it is probably going to be automated
allow application of algorithms, without using neural networks in the near to medium-
having to handle all the ugly details term future.
underneath. The languages frequently
reference the same libraries to do the hard
work.
Both languages are powerful tools for
statistical modeling and both have advantages
and disadvantages. R is primary used for