Life insurance surfaced as a business at the end of the eighteenth century. It's popularity was based upon the then fashionable hobby of European Monarchs with declining fortunes and rapacious mistresses to promote Royal Lotteries. It was a business described by Ambrose Bierce in his Devil's Dictionary as
" An ingenious modern game of chance in which the player is permitted to enjoy the comfortable conviction that he is beating the man who runs the table"That there was an equivalence in the public mind between Lotteris and Insurance was of the class of simple mathematical delusions such as the European Emissions Trading scheme and Carbon Credits.
Lotteries are based upon a fixed basis - the odds are transparent and calculable if miniscule. The first companies claimed that the forecasting of human longevity could be calculated on much the same principles.
A Unitarian MinisterThomas Bayes led a quiet but busy life attempting to follow the first attempts to determine a way of calculating probability and in a sense it's twin - randomness. Laplace had determined what he called inverse probability - from which Bayes developed a calculus that entitles the user to assign a defineable numerical value to the credibility of our judgements about antecedent eventson the basis of past (and present) observations.
His thoughts were posthumously published in a memoir to the Royal Society in 1763 taken from a scholium found amongst his papers.
This was communicated by another Unitarian Minister. Dr. Price. Dr. Pprice was the first actuary of the Equitable - whose blue blooded members made the most massive losses of any such funds in the last ten years.
It is said that actuaries are people who find acountancy too exciting. Their role and function is decribed by the American Society of Actuaries at their website
An actuary is a business professional who analyzes the financial consequences of risk. Actuaries use mathematics, statistics and financial theory to study uncertain future events, especially those of concern to insurance and pension programs. ......This really is pious bollocks - their motto says more - and well may they trade mark it. Risk is opportunity.
Their work requires a combination of strong analytical skills, business knowledge and understanding of human behavior to design and manage programs that control risk.
Here is a true tale of a Pilgrim who struggled in the Slough of Actuaries in the City of London and discovered what a lying bunch of fucks they are.
A graduate of Oxford, a skilled, lauded mathematician was successful in obtaining a post- graduate position at one of the major and renowned City of London Actuaries whose name is known and revered and respected.
Companies who have pension schemes have to regularly demonstrate that the funds in the scheme cover the calculated and accruing liabilities of the members. The members will vary with new staff, new mensioners, deaths of pensioners etc., which with income in the period is a relatively simple task to perform, but laborious.
This - (I speak 13/14 years ago) did not benefit greatly from use of desk top PC's , spreadsheets and was undertaken in a mechanical fashion on paper as inherited from it's earliest exponents. The "Partners" really did not take to these new fangles computer thingy's.
The next stage was to calculate the liabilities on the fund, current members in benefit, members who would qualify before the next review etc., and further calculations over different time horizons.
To do this there are essentially 3 variables to determine
1) Members in benefit and their benefits
2) Forecasts of income required as members retired and drew benefit which involved determining length of life expectation - which relied heavily on the Bayesian assumptions - which were as good as the past (and present) observations.(Life tables)
3) Income from funds invested, which may be in a variety of froms, land, agricultural holdings, shares, bonds etc.,
As a back office toiler our eager entrant would prepare these calculations which were essentially simple and iterative and were a grade of high level clerking. The final result would a be a report to present to the Board of the company involved stating what funds were required to maintain it's liquidity.
This would be borne (at considerable cost the Board of the Company) to their Directors who would look at it and say -- "aaah £120 Mn, that seems rather a lot Jonathan (or Torquil, or Robin) the Board think it should be along the lines of ... what shall we say ... £50Mn .. we realise of course this will require extra work, and costs, but of course ... anyway perhaps you will be joining us at Ascot next week and will have it done by then."
Our tyro would then have to recast the figures , the liabilities were essentially (unless a mistake was made) were fixed, it depended upon the income... Perhaps if we look at the rise in the value of agricultural land - the return on equities .... the partner might suggest .... and tap a port red rich nose.
A report would be prepared and presented and passed.
Which allowed the company to declare profits boosted by the sums (sometimes it was zero)not paid into the pensions, the shares rose, the Directors share options would be happily timed(and coincidentally) to ride the crest of the wave ... until next year. On a constantly rising equities market everyone was happy.
Our toiling calculatrix got fed up and suggested that it would save him a great deal of time, energy and frustration if they just asked the board what they wanted to pay and prepare a report accordingly. How could they arrive at such fundamentally unsound and variable assumptions between clients all investing in the same market - he enquired. If Company X expected equities to return 6.2 % why did Company Y expect a 9% return ?
Torquil (or Robin or Jasper) called in our graduate and explained that really he didn't think he fitted in there, he didn't really seem to understand the service the company offered. He explained that he understoon only too well what the service was - spurious valuations of pension funds and their liabilities.
Torquil (or Robin or Jasper) suggested that the company could offer him 3 months salary if he would sign a non - disclosure agreement and leave instantly. He hung on for 6 months pay. Got it. .. and left. He now holds a global position with a US$54Mn pharmaceutical company.
Essentially in the early 90's two frauds were perpetrated by Actuaries - one they persisted in using out of date (and known to be out of date) life tables. It was claimed this was an aid to "consistency" - indeed it was .... consistently wrong. People were simply living healthier and longer so the demands on the funds had a more extensive life that they were calculating. This REDUCED the expected liabilities, now and over time.
To augment this basic fallacy the gradual growth in the numbers of women in senior positions which again distorted longevity assumptions.
Improvident and unproveable assumptions were made about returns on funds, which as the income was repeatedly cut, inadequate cover for incorrectly calculated labilities grew exponentially until the shortfalls in funding were exposed when reality kicked in and the dot.com bubble simultaneously popped.
New life tables were introduced and greater honesty was to be found, regulations was improved, irate, well fed educated judges , barristers ansd stocbrokers in Equitable exposed the huge under fundings , which "emerged" - - a grammatical inexactitude - they were always there, artfully concealed in the confidential Actuarial reports which were limited in circulation to the Trustees of the Fund (s) who would keep bumping into each other at Boodle's, Ascot, Wimbledon, the Masters' Gaudy Night at Christ Church kept the secrets well hidden in a jumble of figures and false assmptions.
So when the Chancellor made his raid on the pension funds in 1997 it was difficult to see or hear any cries from the leaders of the FTSE 100 companies (check) . They had been raiding them for long enough - there is after all, Honour among thieves.
The accumulated underfunding on pension funds was at one time calculated in the 10's of Billions 60/70/80/90 Billion, who knows ? Gordon's £4Mn a year by removing tax relief is hardly , as they say in the curious world of Accountancy practised in the City - Material.