by Craig Turnbull

Palgrave Macmillan 2016

The reputation of actuaries in the UK has declined precipitously in the last three decades. Once they were among the most powerful decision makers in Britain’s financial sector, albeit semi-invisible. Today their role has been sharply curtailed by regulation and market trends, while their profession struggles to articulate its relevance.

In this context, Craig Turnbull’s book is a valuable contribution. He takes the reader back 300 years to the emergence of probability in the late 17th century, when the pricing of life contracts by the likes of Halley or De Moivre was closely related to gambling.

An actuary himself, Turnbull prices the early contracts using the crude mortality tables available at the time, going beyond most scientific histories of this period. But the book really comes to life when he reaches the mid 18th century, and the foundation of Equitable Life. Here the key figure is Richard Price, the nonconformist clergyman who shepherded Thomas Bayes’ famous probability paper to publication in 1764.

Not only did Price effectively created the UK with-profits life assurance model for calculating premiums and allocating surplus reserves. He also compiled a series of mortality tables that remained in use for over a century, helped by his nephew William Morgan, who was chief actuary of the Equitable until 1830.

Turnbull recounts how actuaries spent the next two hundred years refining mortality models, studying the interplay between interest rate changes and investment policy and how surpluses should affect premiums and bonuses. With access to the archives of the Institute and Faculty of Actuaries, Turnbull provides vivid detail on how the profession debated these topics, highlighting the role of luminaries such as Frank Redington.

But one thing that didn’t change since Price and Morgan’s time was the almost godlike authority of the life office actuary to translate these musings into business decisions that affected thousands of policyholders. With the advantage of hindsight, the weaknesses in this system are now obvious.

Take the ‘cult of equities’ which took hold of actuaries after World War One and saw life office equity allocations increase from 5 to 35 per cent in the space of a few decades.

Now most people agree that equity investments should be part of long-term saving. But if you hold equities within a life company, where bull market returns get baked into policyholder bonus expectations, the company ought to hold capital against the risk of equity returns falling short.

Before the 1980s, British actuaries shunned this modern viewpoint. Instead, they used the intellectual justification that dividend-paying stocks were an inflation hedge that could ‘immunise’ bond-like liabilities.

This view, which looked reasonable in the 1930s when index-linked bonds were not even a pipe dream, became threadbare in the 1970s era of negative real rates. Disastrously, it led pension actuaries to believe that equity returns could be used to calculate scheme liabilities.

Actuaries were also slow to appreciate the threats from institutional and cultural changes in UK finance after World War Two. Life offices began with a tight grip on the long-term savings market but from the 1960s onward faced serious competition from unit trusts and other personal savings products. Increasing empowerment of consumers raised concerns about the opacity of life products.

The life industry responded by handing out market value guarantees, fatally in the case of Equitable Life, and here Turnbull is unstinting in his analysis. He takes a long detour to describe the intellectual development that could have saved actuaries: financial economics.

While actuaries debated in splendid isolation, this new discipline took shape from the 1950s onwards. It challenged a number of ideas that actuaries had taken on board – such as the notion that the shares of companies that reinvested dividends would outperform corporate bonds. Nonsense, retorted Nobel economics laureates Modigliani and Miller, pointing out that the capital structure of firms shouldn’t affect their market value.

Catastrophically for their profession, actuaries resisted these ideas, along with those of Markowitz, Sharpe, Black, Scholes and Merton until almost too late. Turnbull is careful to point out the nuances in this history. As far back as the 1920s, a few heroic actuaries spoke up for market valuation. And some ideas from financial economics, such as Shiller’s dividend discount model, actually supported actuarial thinking that short-term market volatility was ‘too high’.

But when faced with guarantees, and questions of solvency for policyholders, these nuances are irrelevant. As an actuary working at the time for consulting firm Barrie & Hibbert, Turnbull was more than a spectator. He can take some comfort that aside from Equitable, the biggest UK life offices took his firm’s advice and hedged guarantees by buying derivatives from major investment banks.

But the damage to the industry was done and consumers fled. Stripped of their self-regulatory powers by the 2005 Morris Review, life actuaries have licked their wounds ever since. And Turnbull is even more scathing about pension actuaries, who fiercely resisted market valuation even as defined benefit provision in the UK imploded.

His analysis of their failure is instructive. In essence, pension actuaries laboured as glorified bookkeepers funding long-term liabilities with long-term assets, and ignored their real job of protecting scheme members from the risk of sponsor insolvency.

The loss of actuarial prestige may have been deserved, but it doesn’t mean that what replaced the old system is much better. It’s easy to forget that most with-profits policyholders and final salary pension scheme members in the UK received what they expected, while these baby boomer products are unavailable to younger generations.

Bankers have now replaced actuaries at the apex of British finance. And the results haven’t been good, as the 2008 crisis and the mis-selling of swaps to UK small businesses shows. There is a need for experts who can objectively advise younger generations on investments and risk. But whether these people are actuaries remains to be seen.