Basically it introduces probability theory, which underpins actuarial science, into the analysis of sport. To take a simple example, take a batsman who is a compulsive hooker of short pitched balls. To counter him, they compile statistics which show, for example, that nine times out of fifteen he will hit it for four or six, twice he will miss it altogether, once top-edge it for six and thrice he will give catches in the deep. Three times out of four those catches will be caught. For the bowling side there is a risk and reward analysis: 40 in 60 chance of being hit for a four or a six, nine in 60 of getting him out. Whether it is worthwhile to bowl short-pitched deliveries to him depends upon who the batsman and the bowler are and the state of the game. In the old days seasoned pros did this sort of analysis instinctively. Today we have detailed analysis to corroborate or correct our instincts; the latter more often than you may think.
Over the last decade or two, similar probabilistic approach has been used by actuaries to assist the boards of life insurance companies and trustees of pension schemes. It enables them to consider various alternative strategies, specifically but not exclusively investment strategies. Indeed the regulators in assessing the capital adequacy of a company have a rule that the probability of ruin must be less than 0.5 per cent.
At this point in time with unwinding of annuities in the pipeline, you are giving advice in a fluid environmentProbability of ruin is a deliberately frightening expression. What it means is that the chance of the company running out of capital must be less than one in 200. The actuary builds financial models looking at various scenarios.
He no longer says that assets are X and liabilities Y. The assets are still X as for publication purposes market values are used but a range of values is given for Y under various scenarios.
The board can look at the impact for example of investing in equities rather than gilts to see if the extra rewards come at an acceptable degree of risk.
I think the time has come to apply this technique when giving advice to individuals. Life is too complex and the outcome too uncertain to give a simplistic advice. Secondly, it helps to make the customer aware of how uncertain the future is and get his involvement in plotting his future. Consider what variables you have to consider when advising a man of 45:
1. Spending versus savings issues
2. Profile of financial commitments and its evolution over future years
3. Profile of current and future income and their evolution over time
4. Current portfolio
5. Likely future investment scenarios
6. Attitude to risk and likely change over time
Likely future investment scenarios include the following:
7. The effect of the coming of quantitative easing
8. Possible break up of the euro
9. Deflation
10. Growth of major third world countries
11. Britain becoming more right wing
12. Britain becoming more left wing
Each of these have a wide range of possible outcomes.
Much of these analyses (7-12) will be pre-prepared - the client specific ones would be numbers 1-4,6. But it is important to engage the client in the analysis of the issues involved in them and the assumptions made in 5 so that he understands the issues and has bought into the decision taken.
One example will suffice to show how uncertain the outcome is. That is the question of QE. This the way the country, through the Bank of England, pumps in billions of pounds into the economy to stop it from going into recession. This is not printing money, because the Bank of England has told us it is not. But it looks like it is and if it is, the effect would be to increase inflation. At present we are defying gravity and heading towards deflation. Which will prevail? They require completely different strategies. You cannot take an average of the two as that is the worst of both worlds; you are always wrong. Far better to do some analysis and choose to run with one or the other. You then watch carefully as events unfold.
It is only after such in-depth analysis has been carried out that you look at the type of product to recommend and only after that a specific provider is selected. In the past the financial adviser might have done some of this analysis intuitively (or not at all). When he comes to review the outcome a few years later the uncertainty of which outcome will prevail has been replaced by the certainty of the one that actually happened. The six balls have been selected and the winning lottery number is a matter of record not speculation. It is then very difficult to remember the circumstances surrounding the original decision.
That is why it is very important that all decisions are properly documented.
I am not suggesting that the change to such an approach would be easy. It took directors and trustees quite a while to get the hang of it.
So far we have talked about a man of 45 who is still investing. How about someone 20 years older who is thinking of disinvesting? There are a different set of issues:
13. What is the appropriate time to disinvest?
14. Do you do it in one go or phase it?
15. Which assets do you disinvest from?
16. How much do you disinvest and how much do you keep for long-term care or bequests, for example?
Just at this point in time with unwinding of annuities in the pipeline and cashing of annuities nearly available but not all the details finalised, nor all the providers ready, you are giving advice in a fluid environment. You can be sure that there is a fleet of people waiting by the sidelines to pounce two years from now, when all the rules are known and their impact fully understood, to shout, ‘mis-selling, mis-selling.’ They are professional vultures who charge for their services on a time-cost basis with no control on how much time they can spend on it.
My advice to anyone who gives advice in this area is to document everything, make the client fully understand all the issues and get him to sign that he is doing it of his own free will.
Icki Iqbal is a former director of Deloitte