Raney Baumgardner

May 4, 2020

Mini-Essay

Actual Actuarial Accuracy: Should It Exist?

Much like gravity, risk is an inevitable, inescapable part of life. However, 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. Actuarial accuracy is treated with a certainty that, in most

contexts, it does not quite deserve. This raises the question: is the idea of actuarial accuracy a valid

assumption? Should it be a valid assumption? After all, how accurate can theory be within the realm of

practical application?

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 most commonly as

probabilities that represent the expected losses of certain policyholders in the event of adverse

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

serves to establish what could be adequate, fair premiums.” (p. 520) So it is essential that these

probabilities be calculated with grave precision. But is this viable? To answer this, you must first

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

probability for the individual. The powerhouse of predictive modeling is most dependent upon a

mathematical principle called the Law of Large Numbers, which simply states that the larger the sample

size of the statistical study, the less variability will be present within the results. Meaning, these results
are more holistically reflective of the population of interest. The Law of Large Numbers substantiates the

idea that 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. No matter what the individual is unable to be

truly representative. Is this fair? Should it be?

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

within strata that are 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. Risk classes essentially pool the

risks of the policyholders in each classification 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, but

never the individual. This violates the definition of a “fair” insurance premium, and the possibility of the

individual being compromised rises.

Similar conclusions can be made within the context of a lesser-known branch of practical

application within the actuarial sciences: criminal justice. For a number of years, actuarial methods, such

as Actuarial Risk Assessment Instruments (ARAIs), have been used to try and predict violent and

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

determined on an individual basis, and thus 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. In particularly polarizing circumstances, this “educated guesses” often

have a hand in administering the death penalty. (Cooke, Hart, 2013)

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

reliance on results that might not necessarily be reflective. Time and time again, we use the data that
faithfully represents a group, in order to make weighted decisions for the individual. More often then we

care to believe, the foundation of a decision is comprised of support beams made out of the hypothetical.

Therefore, we must once again ask ourselves: is this fair? And if it is, should it be?
 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.