WATERLOO MAGAZINE – Spring 2011
How Waterloo actuarial scientists saved Canada
Text: Karen Kawawada
Photography: Jonathan Bielaski

Faster than a speeding actuarial calculator. More powerful than a supercomputer performing regression modelling.

Admittedly, it doesn't have quite the same ring as Superman's tagline. And Waterloo's actuarial scientists don't typically wear capes.

There is still evidence that in their Clark Kentish way, they helped save Canada's economy — or at least, that they helped save the Canada Pension Plan from bankruptcy, helped prevent Canadian financial institutions from failing during the recent financial crisis, and are now helping save private pensions and insurance in a world where people are living longer than anyone used to expect.

Waterloo is home to one of the largest actuarial science programs in the world — some say the largest.

"We're known as the largest program in the world. We're also known as probably the largest producer of actuarial research in the world," says recently retired professor Rob Brown.

"I think it's fair to say we're probably the top program in the world," says Gordon Willmot, currently the most senior actuarial professor in the Department of Statistics and Actuarial Science.

It's an impressive reputation for a program that, in Brown's words, "started as a speck on somebody's radar screen," and not that long ago.

The roots of the actuarial science program go back to 1960, three years after the founding of the university, when actuary Ian McIntosh of the Equitable Life Insurance Company was recruited to teach in the then-department — now faculty — of math. It was a natural fit for a university in a city that had long been a centre for the Canadian insurance industry.

"There has always been a collective spirit in Waterloo County — this goes back to the Mennonite philosophy, where you're all part of a community and you help your neighbour," says Brown.

That same collective spirit was evident in 1962, when three local insurance companies urged the university to expand the co-op program to math. The university agreed, and when the plan was announced to the public, 29 companies signed up to participate. So many students applied that, instead of starting with 40 as planned, the department decided to allow 100 students into the program, which started in 1964.

Brown enrolled as a first-year math student in 1967, the year before a degree program in actuarial science was established. He didn't leave until 43 years later, as a much-lauded professor and author of seven textbooks. In his time at Waterloo, he saw enormous changes.

Some of those changes have been within the program. Brown's graduating class consisted of just seven actuarial students, and it was the largest to date.

Now there are 767 undergraduate students. There are two master's programs — a research stream and a new professional stream, introduced in 2009 — with a total enrolment of 47. There are 13 PhD students, three postdoctoral fellows, and 14 faculty members. In total, more than 200 people a year graduate with the words "actuarial science" in their degree.

There have been major changes in the financial services world in the last few decades, say Brown and other professors.

There are fewer but bigger insurance companies. Banks have moved into insurance and insurance companies have moved into investing. Mathematical models have improved and computers have become more powerful. New, more complex financial products have proliferated.

The financial industry has also had to respond to major shifts in the world's economy, demography, politics, and even environment."The world's a much more dangerous and complicated place than it used to be," says Gordon Willmot, who holds the title Munich Re Professor of Insurance.

Munich Re is a German reinsurance company — a company that insures insurance companies. It funds Willmot's research chair, and is a perfect example of how the financial industry can be exposed to global-scale risks as big as any dreamed up by Clark Kent's archnemesis Lex Luthor.

"The World Trade Center was heavily insured by Munich Re so they took quite a hit on that," says Willmot. "That was a real eye-opener — 9-11 — that in addition to all the other risks, we're facing the risk of terrorist attacks."

Canadian financial institutions weathered the recession better than their counterparts in many other countries, in large part because of regulations that forced them to have significant resources set aside for just such a rainy day — regulations Waterloo helped shape.

Before the crisis, "CEOs of banks and insurance companies were all pestering the regulators to ease up, and they often used the argument that they needed to compete with their counterparts in the United States, and that the United States was not as heavily regulated," says Brown. "But I'll tell you, today we're all very thankful that we had the Canadian regulations and the Canadian regulators, capable people who knew what they were doing."

Some work by a Waterloo professor, on a new and popular type of mutual fund with guaranteed minimum returns, had an influence on the Canadian regulator of banks and insurance companies, says Brown.

"Mary Hardy wrote a very influential paper pointing out that the reserves [financial institutions] were carrying for the risk in these securities was not large enough — The industry fought that, but at the end of the day, she was right."

Building on that work, some of which was done with her husband, Waterloo professor emeritus Phelim Boyle, Hardy got involved with a task force that was instrumental in setting regulations on capital requirements about a decade ago.

"The insurance companies wanted not to put money to one side for liability, but our task force said they should, and the regulator, OSFI, the Office of the Superintendent of Financial Institutions Canada... picked up the task force work and insisted that the insurance companies make significant provisions," says Hardy, who is CIBC Chair in Financial Risk Management.

Today, "insurers are hurting a little bit, but if the regulator hadn't insisted 10 years ago on a big cushion of assets, things would be worse."

Indirectly, Waterloo influences the regulator on a daily basis. A former faculty member and a number of former students are "very senior people" there, says Brown. "I think we somehow made the world a safer place by having our program."

Though he didn't have to rip open his shirt in a phone booth before leaping into action, Brown was part of a major effort that made Canada a safer place for older people.

In the mid-1990s, the Canada Pension Plan (CPP) was in crisis. With rising costs and decreasing revenue, the plan's chief actuary released a report saying the fund would be exhausted within 20 years unless changes were made, and quickly.

The Canadian Institute of Actuaries, however, urged calm. Brown, as past president, was involved in preparing several key reports and travelled the country speaking about the issues.

"I went out of my way to speak at the same forums as people like [representatives from] the C.D. Howe Institute, who wanted to change the Canada Pension Plan into, effectively, individual RRSPs, which I totally disagree with," says Brown.

"I don't know why I would want to pay somebody to manage my tiny little bank account if I could put it in the Canada Pension Plan and have the investment board invest it all over the world and do it for less than one per cent of cash flow."

In his book Fixing the Future, economic journalist Bruce Little says Brown "figured prominently in the CPP debate." The book quotes him explaining how several "relatively small but important modifications" could stabilize the plan.

In the end, governments agreed to a series of subtle fixes that had the necessary effects without some of the massive changes that had been discussed, such as effectively privatizing the plan, raising the retirement age, or raising mandatory contribution rates well into the double digits.

Despite the reforms, there is still a common perception, fuelled by the media, that the Canada Pension Plan is in trouble. It's not, says Brown.

The Canada Pension Plan is actually "in good shape," he says. "It's just had an actuarial valuation that looks ahead 75 years and, according to the assumptions in the actuarial valuation, it will be here 75 years from now."

Of course, it's not just the Canada Pension Plan that faces pressures as baby boomers move into their golden years. The private-sector financial industry is facing what Mary Hardy calls "a good-bad problem" — that people are living longer than ever before.
Increased life expectancy is a challenge for financial institutions, because when people live longer than expected, they get more pension and health insurance payouts and, in some cases, life insurance payouts. That means increased liability for insurance companies and pension plans.

That's not just an issue for financial services companies, because if they were to go bust, ordinary people would lose out on money they're counting on receiving in their old age.

One of the rising stars of the department is assistant professor Johnny Li, who holds the Fairfax Chair in Risk Management. With former PhD supervisors Hardy and Ken Seng Tan, he works on longevity risk modelling.

Life expectancy has been steadily rising for as long as there's been reliable data, which for Canada means since the 1920s, says Li. "On average, human life expectancy increases by 0.2 to 0.3 years, every year...

"Twenty years ago, people expected there would be a limit to [how long] people can live... they expected human longevity is going to stop improving at some point in time or at least slow down. But it turns out it hasn't."

In the past, when insurance companies sold people policies, they underestimated the longevity improvement and set prices accordingly. Even a slight underestimation can have a big impact, says Li.

"If you manage a pension plan and you have, say, 10,000 retirees, and every year you have to pay a pension of, say, $20,000 per retiree... if people are living one year longer than expected, your plan has to pay $200 million additionally."

Through papers and conference presentations, Li and his colleagues are working to create awareness within the financial industry about longevity risk. "It's important for the industry to understand that this risk is real, and it's coming," says Tan.

The industry has been listening. One way companies are coping is by passing off some of the risk to reinsurance companies. Another, newer method is trading securities that will pay more if people live longer than expected and less if the opposite occurs.

Though it's still hard to predict how long people will live in the future, methods such as these should help people's pension and insurance plans to survive in an increasingly long-lived world, says Li.

And so, despite their mild-mannered reputations, Waterloo actuarial scientists are still doing their part to save the economy, acting as the real superheroes of the financial world.

This country is safe again, Clark Kent, thanks to you.