The Staple Inn Actuarial Society

MODERN VALUATION TECHNIQUES

06 February 2001
Jarvis, Stuart; Southall, Frances; Varnell, Elliot

Synopsis

This paper sets out to explain the application of deflators as a model for valuing actuarial liabilities.

For the uninitiated, deflators come from the financial economists' toolkit and are a way of valuing uncertain liabilities stochastically to produce market-consistent values. In particular, they offer an objective route to a risk-adjusted discount rate, something the profession continues to struggle towards. The paper suggests applications across the range of pensions, life, and general insurance problems.

As ever, the discussion showed the gulf in detailed mathematical understanding between the rocket scientist few and the rest of the profession. Many of the contributors to the debate asserted that this was straightforward stuff Ð another helpful contribution to bridging the gap with financial economists and the wider world, etc, etc. Its particular attraction is that it retranslates some of the concepts used in other fields into a language of discount rates with which actuaries are familiar.

The minority expressing concern did so from a position that not everything we deal with has a market value from which model parameters can be deduced. This is perhaps a little harsh - no actuarial techniques are perfect, but they can still add value.

For me the most insightful comments pointed to the need for a greater proportion of practitioners to come to grips with the detail of these concepts and their practical application. The sight of an integral in a document is still enough to send most practising actuaries reaching for a student. While there has been a sea change in opinion in the profession of the importance of financial economics - the majority have now 'got it' in terms of the importance of the concepts - there is still much to be done on communication within the profession and with our paying clients.

Tim Gordon and his colleagues have picked up the challenge of applying this theory to pensions, and their Institute paper on 23 April will make an interesting follow-up. Perhaps, however, it will only be when financial economics starts finding its way into mandatory CPD and guidance notes that the real impact will be felt.