Raney Baumgardner

February 27, 2020

Mini-Essay

Actual Actuarial Accuracy: Does It Exist?

Much like gravity, risk is an inevitable, inescapable part of life, but gravity can be measured and

quantified by a numerical constant. Can risk? Actuarial science exists to answer this question. An

actuary’s purpose is to take the uncertainty that is integral to the human experience and characterize it

numerically so that decisions, whether it be setting insurance premiums or setting pension rates, can be

made readily, accurately, and with efficiency. Unfortunately, actuarial science’s predictive power relies

heavily upon a foundation of the theoretical that is expected and assumed to perfectly encapsulate the

practicalities of real life. This raises the question: is this a valid assumption? How accurate can theory be?

Actuarial accuracy is treated with a certainty that, in most contexts, it does not quite deserve.

The environment that artfully demonstrates this issue is the one most associated with actuarial

science: the insurance industry. Within this context, actuarial accuracy is defined as probabilities, which

are the expected losses of certain policyholders in the event of adverse circumstances, that are calculated

with precision. According to Landes (2015), “In the insurance industry, the concept of actuarial fairness

serves to establish what could be adequate, fair premiums.” (p. 520) Is this viable? To answer this, you

must first acknowledge a simple, statistical truth. As of right now, there is no possible way to calculate a

probability for the individual. The power of predictive modeling within statistics is mostly derived from

what is called the Law of Large Numbers. The Law of Large Numbers simply states that the larger the

sample size of the statistical study, the less variability will be present within the results, and these results

are then more holistically reflective of the population of interest. Meaning, there is no way to calculate an

individual’s expected losses, as the sample size would be one and the variability alone would result in

unreliable inaccuracy.
 This is how the issue manifests, as within the realm of insurance, it is universally acknowledged

that a “fair premium” is constituted as a premium in which a policy holder pays for their expected losses

and their expected losses, alone. However, because risk cannot be calculated on an individualistic basis,

actuarial accuracy takes a more general approach using a more generic way of classifying policyholders

called, “risk classes.” Each risk class is a group of like-minded policyholders that exhibit the same levels

of potential risk, as well as risk-averse behaviors, essentially pooling the risks of the policyholders in each

risk class together. By doing so, the sample size is increased, the Law of Large Numbers is

acknowledged, and accurate predictions for the group can be determined. This is helpful but violates the

definition of a “fair” insurance premium, and the possibility of the individual being compromised rises.

Likewise, similar conclusions can be made within the context of a lesser-known branch of

practical application of actuarial science: criminal justice. For a number of years, actuarial methods, such

as the use of Actuarial Risk Assessment Instruments (ARAIs), have been used to try and predict violence

and criminal behavior. However, similar to the insurance industry, these statistics simply cannot be

determined on an individual basis, and these tests have no validity on predicting the violent behavior of

an individual. Yet, they impact the fate of the individual all the same. In fact, within the context of

criminal persecution, the future forecasting of these actuarial methods often has a hand in determining

civil or criminal commitment, and in particularly polarizing circumstances, administering the death

penalty. (Cooke, Hart, 2013)

To put it plainly, the large issue within actuarial science isn’t necessarily inaccuracy, but a heavy

reliance on results that might not necessarily be reflective of the reality around us to make weighted

decisions that impact not just a single individual, but many individuals. Therefore, we must ask ourselves:

is a guess, even an educated one, good enough?

 Sources:

Hart, S. D., & Cooke, D. J. (2013). Another Look at the (Im-)Precision of Individual Risk Estimates

Made Using Actuarial Risk Assessment Instruments. Behavioral Sciences & the Law, 31(1), 81–

102. https://doi.org/10.1002/bsl.2049

Landes, Xavier. (2015). How Fair Is Actuarial Fairness? Journal of Business Ethics, 128(3), 519.