ROLE OF THE ACTUARY

When evaluating past experience the actuary must also watch for fundamental changes that will alter the underlying probability distributions. For example, when estimating healthcare costs, if new but expensive techniques for treatment are discovered and implemented then the distribution of healthcare costs will shift up to reflect the use of the new techniques.

The frequency and severity distributions are developed from the analysis of the past experience and combined to develop the loss distribution. The claim payment distribution can then be derived by adjusting the loss distribution to reflect the provisions in the policies, such as deductibles and benefit limits.

If the claim payments could be affected by inflation, the actuary will need to estimate future inflation based on past experience and information about the current state of the economy. In the case of insurance coverages where today’s premiums are invested to cover claim payments in the years to come, the actuary will also need to estimate expected investment returns. At this point the actuary has the tools to determine the net premium. The actuary can use similar techniques to estimate a sufficient margin to build into the gross premium in order to cover both the insurer’s expenses and a reasonable level of unanticipated claim payments.