The use of statistical tools to calculate the probability of the likelihood of an event.
Actuarial Analysis Details
Institutions that deal with the probability of future events, such as insurance companies, need to know the likelihood of that event happening and when it might happen. With this information on hand, an actuarial analyst can calculate whether or not the institution has enough assets to pay for future liabilities. Companies, like insurance companies, can use this information to establish premiums for policyholders.
An actuarial analyst is a highly trained statistician specializing in using sophisticated statistical models to make predictions about future events. Various institutions such as banks, businesses, government agencies, and insurance companies all use actuarial analysts. Of course, the future is uncertain, but experts use the tools of actuarial analysis to minimize future risk.
Actuarial analysis can only ever be an educated guess. But applied over a large number of potential policyholders, the analysis is surprisingly accurate.
Actuarial Analysis Example
Ben and Simon have decided to take out ten-year term life insurance policies. They ask various insurers for quotes and discover that the premiums they will pay differ significantly from company to company. This difference occurs because insurance underwriters assess risks differently. They will all use actuarial analysis to calculate those risks, however. Insurance companies will assess Ben and Simon's premiums based on the perceived risk that they represent to the insurer.
Ben is thirty years old. He does not smoke and avoids fatty foods. He works in an office and exercises regularly. The possibility that Ben will survive to reach forty years old and not claim on his policy is high. In other words, he represents a good risk for the insurance company. The relatively low premiums the company will ask him to pay reflects his standing as a low-risk policyholder.
Simon is ten years older. As a test driver, he has a stressful job, smokes very heavily, and relaxes by spending his nights in bars with his friends. He avoids any form of physical exertion. In assessing Simon's premium, an actuarial analyst will look at the statistical probability of Ben suffering a heart attack, the number of smokers in his age range who contract cancer, and the fatality rates amongst test drivers. The analyst decides that there is a very significant chance that Simon will not celebrate his fiftieth birthday, and his premiums will be correspondingly high.
Significance of an Actuarial Analysis
Once an analyst has calculated the potential risk of an event occurring within a given time, the institution can ascertain whether it has, or will have, sufficient assets to cover this future liability. This information helps different institutions in different ways:
- Insurance companies can calculate premiums on such products as life insurance, using statistical probability as a guide.
- Governments can ensure that they have enough funds, equipment, and personnel available to deal with future emergencies.
- Pension plan providers can tailor their investments across various risk levels to optimize returns and ensure that they pay beneficiaries.