ADDRESS

BY THE PRESIDENT

PROFESSOR PETER GERALD MOORE, Ph.D.. D.Sc., F.I.A.

[Delivered 26 November 1984]

THE NECESSITY FOR CHANGE

INTRODUCTION

A HUNDRED years ago last Saturday, on 24 November 1884. Dr Thomas Sprague. my sometime predecessor in this office, delivered an Address. He opened by announcing that, after prolonged and painful negotiations, a Royal Charter had been granted to the Institute placing it, in his words “. . . as a pro- fessional body publicly recognized as representing, and entitled to speak in the name of, actuaries in the United Kingdom”. It was impossible, he wisely added, to predict exactly what new duties would devolve upon the profession as a consequence of this change.

Sprague was President for four years, and he delivered what was then termed an ‘opening’ Address at the start of each session. Your inward sighs of relief that we have a different system today are shared by the current Presi- dent. Reading the four Addresses as a whole nevertheless provides an educa- tion in itself, since Sprague brilliantly reviews contemporary 1880 attitudes to all aspects of actuarial work. For my own address tonight, I pick as my text an extract from the last of his four Addresses:

I do not wish to undervalue the teachings of theory, but only to warn you against too exclusive a reliance upon them. I consider theory is a most useful assistant, but not a guide to which we should trust ourselves blindfold. We must. on the contrary, always be on the watch to see whither it is leading us; and we should refuse to follow it when it is leading us to conclusions that do not commend themselves to our educated common sense. If our companies are to be successful, the theoretical advice of the pure actuary must always be carefully scrutinized by the man of business from a practical point of view before it is acted upon. It should therefore be the aim of every actuary to combine these different qualities in himself; in other words, he should aim at being both a skilled actuary and an experienced man of business.

Tonight, however, my journey with you starts further back—in the second quarter of the nineteenth century—since it was in this period that the founda- tions which shaped our twentieth century destinies were laid. The period was one of great intellectual fervour, with a challenge to the previously un- disputed ascendancy of the Royal Society that led directly to the foundation of the British Association. The ancient universities were awakened from their eighteenth century slumbers. New institutions of higher learning were founded such as University College London, of whom cockneys at the time

1

2 Presidential Address

said: “Each dustman shall speak, both in Latin and Greek, Tinkers beat Bishops in knowledge.” Redressing the balance, King’s College London and Durham University, with their strong faculties of theology were also founded at about the same time. The Reform Act of 1832 had opened up the franchise, whilst a whole raft of societies—Zoological, Botanical, Chemical and Statisti- cal among them—were founded between 1826 and 1841. Our own Institute came into being in 1848 (at a time when Europe was in ferment and the Chartists were talking of revolution) whilst the Great Exhibition of 1851 closes the period, with the era symbolically passing at the death of the Duke of Wellington in 1852.

This combination of intellectual fervour, combined with a strong urge to apply new discoveries to everyday wants, led Britain to a pre-eminent role in the world through its manufacturing and trading activities. The agrarian society of the eighteenth century gave way to an advanced industrial society, in which the greater part of employment was to be found in manufacturing and related industries. The numerous sources of cheap raw materials avail- able from the Empire, allied to the skills of British engineers and others, pro- vided a constant flow of goods for sale into virtually captive markets. Wealth was brought to Britain and, less rapidly, increasing prosperity flowed to our trading partners overseas. The remainder of the nineteenth century was un- doubtedly the apogee of the Empire. but the seeds of economic decline, slow at first but gathering pace later. had been sown with the falling of the com- parative rate of industrial innovation. The manufacturing sector, which had risen so fast in employment terms at the expense of agriculture in the nineteenth century, started to shrink by the early twentieth century, with a growing service sector competing for labour.

EMPLOYMENT AND PRODUCTIVITY

The material well being of the nineteenth century population improved at a rapid rate. In the sixty years from 1851 to 1911 real income per head in Britain rose by about 80%) whilst it rose by a further 100% in the next half century to 1961. Total employment in Britain increased by some 150% over the century, the increased use of machinery coinciding with both greater employment and greater income per head.

Service employment, the predominant area of new employment in the twentieth century, includes more than banking and insurance; it incorporates industries as diverse as education, health, hotels, travel, tourism, shops, and publishing. There are also service occupation activities, for example, catering, clerical work, security, cleaning, all of which are service employment wherever they are performed. Cross-referencing occupation to area of employment shows how, over the past decade, there has been both a swing between employment sectors, and also (not surprisingly) a shift amongst occupations within employment sectors. Much of this swing has occurred

The Necessity for Change 3

because of the growing propensity for people to purchase foreign manufac- tured goods, a trend that has been growing for a century to the point where Britain is no longer primarily a manufacturing nation. Today we import more manufactured goods than we export, and have moved away from labour in- tensive towards knowledge intensive activities. Since the early 1970s the gross profits of the service sector as a whole have exceeded those of the manufactur- ing sector. Our wealth now comes more from doing things than from making things.

Overshadowing the major change in the employment profile has been a massive rise in unemployment. The bare facts for the U.K.—which are closely mirrored in Western Europe as a whole—are clear:

(i) In 1963, 24·6m were in employment; in 1973, 25·1m and by 1983, 23·9m: a loss of 700,000 jobs over 20 years.

(ii) 2·5m jobs were squeezed out of the industrial and manufacturing sectors in the twenty years from 1963 to 1983, although output in- creased: many jobs transferred to the services sector, with the percentage of employed in manufacturing falling from 51% to 35% over the 20 years.

(iii) In 1983 the available labour force was 1·8m greater than in 1963: statistically much of the rise has been due to the increased number of working wives (up 2·5m over the last 20 years).

Running parallel with the employment problem has been a general lack- lustre performance of the U.K. economy, demonstrated by the low return on capital in virtually all sectors of the economy. This has been principally due to excessive real wage costs and under-investment, especially after the oil price jumps in 1973 and 1979.

The U.K. has had. as I have already indicated, a poor record of innova- tion in its widest sense. not just over the past quarter-century, but from way back into the last century. We seem to have the ideas, but also a congenital reluctance to push the consequences right through the system to the point of successful exploitation. This is disturbing since industries historically tend to shift to other countries as they become more mature. Thus, at the same time as the textile, steel, shipbuilding, heavy engineering and automobile in- dustries matured, the knowledge of how to create and run them became transferable to other parts of the world. In due course, former customers no longer needed to import these products, and later became themselves inter- national export competitors. Today, whilst the European steel industry is currently undergoing drastic cut-backs, the same industry is growing in parts of the third world such as Latin America and Asia. Additionally, jobs are lost from a geographical area simply because a particular industry ceases to be required.

The growth of high technology does not in itself imply an overall automatic loss of jobs, but immobility of labour, union practices and lack of finance can

4 Presidential Address

all hinder the development of alternatives within both existing and new organizations. The contrast here with other countries is disturbing.

It is frequently argued that top priority should be given to reversing the downward trend in manufacturing employment, and a great deal of effort from all political parties has been directed to that end in terms of the spending of public money. It is not immediately obvious that this is a desirable stance; switching workers from service industries back to manufacturing could simply worsen the efficiency of both sectors. This is akin to the story of the Scotsman leaving Edinburgh to seek work in London because he thought it would raise the average intellectual standards of both cities! There is little evidence that manufacturing industry is seriously short of highly trained labour. Any evi- dence of labour shortages centres almost exclusively around the need for a few thousand more electronics engineers and computer scientists. That indus- try is not held back by cash resources is demonstrated by the cash mountain of some £1·5 bn held by GEC. The firm cannot find things to make that fit its areas of expertise and are competitive in world terms—a thought provoking situation with the world electronics industry flooding the U.K. with imports. On the other hand, there is strong evidence of unsatisfied consumer demands for many services for which consumers are willing to pay—paradoxically often those that are basically provided by Government through direct taxation. Examples are the consequential developments when direct-grant schools were abolished, or pay-beds in NHS hospitals eliminated, whilst the insistence that motorways must be toll-free has led to enormous delays in completing roads such as the M20.

At the same time as British Government industrial policy has been directed towards preserving manufacturing industry generally, primary attention in countries such as Japan has been channelled more towards encouraging the development of carefully selected growth areas in manufacturing. As a con- sequence, whilst manufacturing employment has been falling sharply in Japan, output has been rising even more sharply. The wealth thus generated has been increasingly spent on services, most of which are highly labour inten- sive, employing more people (within Japan) than those displaced by the manufacturing reductions.

Just as manufacturing has displaced agriculture as an employer, and services have been displacing manufacturing, so will conventional services be displaced because they also will become capable of capital/labour substitu- tion. At the same time a new area of employment is growing, namely the in- formation and technology sector symbolized by the micro-chip; any British economic revival must surely be based on high added-value, high mark-up products or services in which existing knowledge is allied to new ideas.

Communities create wealth by the exploitation of knowledge and must con- tinually extend their knowledge base if they wish to maintain-or raise-their position in the league table. Oil, for example, has existed under the North Sea and in Kuwait for countless centuries, but it was valueless until the appropriate

The Necessity for Change 5

expertise from geologists, engineers, marine specialists, shippers, managers and financiers was available to capture and exploit it. Research is important, but without developing the commercial activities that flow from the research, it remains an item of curiosity value only. As basic manufacturing industries move abroad where the immediate returns are greater, there is little alterna- tive but to substitute high technology, high added value new products and ser- vices if economic momentum is to be maintained.

THE MICRO-CHIP AND ORGANIZATIONAL STRUCTURES

The micro-chip revolution is having a dramatic effect on organizational struc- tures. The traditional structure had three employment layers—a large basic group of unskilled and semi-skilled, a substantial middle layer of supervisory and lower level management, and then a relatively small top layer of the senior manager cadre who are strategic rather than tactical managers. Already the micro-chip has had a startling effect on both the speed and poten- tial quality of decision making, and this can in turn affect the manner in which decisions are made.

There are implications for employees at all levels of an organization. The need for clerks may be reduced, with a relatively few re-structured ‘managerial’ decision making points substituted. Manufacturing industries may require fewer, but more highly skilled, personnel with a greater intensity of sophisti- cated equipment per employee than hitherto. The current informal informa- tion networks, with their slightly ‘hit or miss’ air, overloads in one direction being compensated for by underloads elsewhere, will disappear. The monitor- ing and filtering role of middle managers is likewise diminished, since much of this can now be achieved more quickly and simply by programmed informa- tion handling systems allied to appropriate hardware.

The enhanced ability to coordinate, gather and process information poses a threat to some managers. They see it encroaching on their judgement, their free- dom, or what is sometimes termed the ‘artistry’ of their professionalism. Instead of feeling that increased information augments their effectiveness, managers may well resist new enhanced information systems since, as well as limiting their freedom, it increases the measurability and assessment of their work. At present, most professionals and managers function in fairly ambiguous environ- ments. Information is imperfectly exchanged and a considerable time-lag usually occurs before the quality of a decision can be assessed. A continual flow of more complete information reduces that level of ambiguity. For example, a bank manager could be given a regular and comprehensive up-to-date picture of all the lending decisions he has made over a considerable period of time, with appropriate current assessments of the degree of ‘success’ of each decision. Whilst this change should enable managers to adjust future decision criteria positively in the light of the extra information made available to them, it in- creases their personal assessability on a regular and immediate basis.

6 Presidential Address

One of the less attractive features of the industrial revolution has been the de-humanizing of work-the requirement for many individuals to work on a repetitive and extremely narrow basis. Micro-technologies are changing matters so that plants or offices need, in terms of output, fewer workers to operate them. At the same time the gang principle is being re-born with small groups of workers being given responsibility for a total operation, rather than breaking down every operation into very small pieces, each being solely and permanently handled by one particular individual. The next evolutionary step is that the gang may not necessarily be directly employed by the firm con- cerned; the firm finding it more economic to sub-contract and effectively pay fees rather than wages. Fees imply independence which is perhaps why it has long been more respectable socially in Britain to be a ‘professional’ rather than an employee.

The fee can be paid to a group rather than to an individual-a form of sub- contracting. Writ large, this kind of sub-contracting shows up in Marks and Spencer’s policy of contracting out all its production, as opposed to Rank Xerox’s individual networking. A construction site is perhaps the most visible example of the contractual organization at work with its myriad of contribut- ing firms, partnerships and individuals all listed on the site hoarding. Fees for individuals are, however, still a novelty in most industrial or commercial or- ganizations, except when it is a long-established tradition of the trade, for example with publishing.

There are signs that this attitude is changing as more organizations put fringe activities out to contract. Sub-contracting will grow because it is cheaper to use spasmodic and specialist talent in this way, though it is in- convenient when in-house experts are not around all the time. When people were cheap, convenience won over economics. Now that people are expen- sive, convenience has to go. In manufacturing systems it is the highest common factor, namely machinery, which prevails, and so large is cheap. The opposite applies in service systems where small is generally equated with efficiency. With the swing away from manufacturing and towards services, small specialist firms will become more prominent in the economy. Over recent years the top 250 companies, in employment terms primarily manufacturing in nature, have employed between them a diminishing per- centage of the total employed labour force—a trend that continues.

SOME ACTUARIAL CHALLENGES

Let me pause at this point and focus on some challenges that arise for actuaries from the employment analysis I have just developed. The first and dominant area of challenge that must be uppermost in most people’s minds today lies in the area of pensions, since a pension, together with the home, are the two primary components of wealth which most individuals accumulate during their working life. Undoubtedly, there is currently both

The Necessity for Change 7

hope and anxiety about legislative changes in the pensions field that are in the pipeline.

The final salary pension scheme—of which the actuarial profession is con- sidered the progenitor—is in principle an excellent approach to the provision of worthwhile pensions. It grew out of the switch from an agrarian to an industrial society with its larger employment units and has fulfilled its original objectives well. All systems must. however, be reviewed from time to time in the light of contemporary developments and, in doing so, two areas of criticism commonly arise.

The first relates to the rigidity for the individual in terms of benefits he or she will receive. The member may well feel, without questioning the total value of his or her benefits receivable from the scheme, that some different combination of benefits better suits his particular circumstances. An interest- ing paper by Livesey and Roberts at the recent Sydney Congress, suggested that flexibility in benefit terms was a much appreciated aspect by the members of many United States schemes. Decisions on this are primarily internal matters, but scheme members themselves may well press for greater flexibility more vigorously than hitherto, although Inland Revenue rules could be an unnecessary and undesirable inhibiting factor.

The second, and more vocal, criticism relates to the level of benefits received on leaving an organization before retirement age. The amounts re- ceived, either as a transfer value or a frozen pension, have in the past commonly been derisory when the pension is payable, principally due to infla- tion, and there have been increasingly raucous comments in the press and elsewhere on this issue. The argument that the pension industry was built up primarily to provide an employee reward system for life-long service no longer cuts much ice in an era where redundancies, bankruptcies, take-overs etc. have become, unfortunately, a way of life. On the positive side, the vola- tile and ebullient economy we currently seek must, by its very nature, imply a great deal of movement of individuals; firms will grow or diminish, new firms will need to be established, some firms will amalgamate, or even go out of business. Life-long service for everybody with one firm is not only impracticable but also, with its overtones of immobility, a far from desirable universal ideal.

One school of thought, expressed by some actuaries, is that employees on changing jobs should recoup their poor preserved benefits by seeking higher com- pensation in their new firm to balance the effective loss of pension rights. This is a highly dangerous argument and one that is contrary to a public policy which wel- comes the setting up of new industries and new firms, as well as the expansion of the more successful amongst existing firms. To load such firms with extra com- pensatory employee costs would make them less competitive, and hence inhibit these desirable developments. The difficulties that have arisen must be overcome by other mechanisms. Whilst transfer clubs are one approach, they are unlikely to be practicable over industry as a whole, and hence one is impelled to review again attitudes towards frozen benefits and transfer values.

8 Presidential Address

Contrary to what pension consultants and others commonly say, pension provision is clearly seen today by many employees and trade unions as a form of deferred pay, and therefore something in which they have a stake in bar- gaining and negotiating terms. There is, however, widespread misunderstand- ing by members of final salary pension schemes regarding its financing. The primary source of confusion stems from the belief of many employees (and trade unions) that, when the scheme contribution is A% of salary for the employee and B% of the payroll from the employer, then the contribution attributable to an employee in a given year is (A+B)% of his or her salary. In truth, a very widely varying percentage of salary costs is required, to provide the defined benefits to different employees in a final salary scheme. David Wilkie, in correspondence with me, has given some illustrations where A+B = 15. He shows that, with an annual salary rise 2% below the assumed salary scale, each year, the true actuarial cost of the benefits is 10% of annual salary. Alternatively, if the annual salary rise is 5% above the assumed scale each year, the true cost is 34% of annual salary. These kinds of difference in treatment relative to salary between individuals in the same scheme aggra- vates the problem of determining a ‘fair’ transfer value or deferred pension value in any particular situation.

Naturally, any financial improvements in current practice regarding frozen benefits or transfer values for those who leave a scheme before retirement age must involve a cost. If total scheme costs are to remain fixed, such changes must be detrimental to those who are still active members at retirement age, or to the company itself. But pension schemes receive substantial tax privileges and it is therefore only right and proper that public policy, which seeks to encourage job mobility, should play a role in determining the appropriate balance in treatment between the two classes of pensioner, the one who leaves a firm before retirement age and the other whose departure coincides with retirement age.

Inflation leads to higher investment returns as measured by monetary pro- ceeds, and it is only reasonable that some adjustments should be made to frozen benefits in such circumstances. Following the Occupational Pensions Board’s voluntary proposals on the revaluation of frozen benefits some years ago, the Government is now intending to legislate. However, it is proposing a very minimal set of bases: prices—not earnings—are to be used (at a time when Government expects GNP per capita in real terms to rise by some 25% in the next decade); the revaluation only applies to actual service after 1 January 1985; whilst there is an overall limit of the lesser of 5% compound per annum revaluation or the rise in prices, in each case over the period from the granting of the frozen benefit until pension age. The practical effects will hardly be spectacular, and will not become noticeable in the retirement benefits actually received by pensioners until well into the next century. Current unrest is therefore unlikely to be stilled. Indeed the mere act of legislation could make these figures not a minima, but the norm, and thus make the situation worse

The Necessity for Change 9

rather than better in some instances. Transfer values currently depend primarily upon the basic frozen benefits, and no change in this approach is proposed. With the added dimension of uncertainty in the interest rate used to capitalize these benefits, unease with transfer values is equally likely to remain.

In an ideal world the concept of a portable pension, in the sense that the pension is equalized for the same salary progression however many employers the employee has, can be seen to have great attractions. However, the consul- tative document recently issued by the Government outlines a complicated approach that is unlikely to produce this ideal. If there are alternatives for the individual to choose from, the young man joining XYZ company will prob- ably select the route which leaves him with the most immediate cash in his pocket. The low take-up of self-employed pension rights suggests that the pre- miums paid would be well below the maximum allowed. Any portable pension, moreover, is heavily dependent, not just on the career pattern of contributions, but also on the choice of investment vehicle and the precise timing of retirement in relation to investment conditions. Should our young hero opt for a portable pension and then stay with his firm throughout his career he will be disappointed if, as is likely, he receives a lower pension than the man who has had the same career but remained in the firm’s final salary scheme. Equally if he does have a successful multi-firm career, it again seems unlikely he will be able to match the final salary scheme equivalent man. Additionally the string of complications in the consultative document arising from the desired marriage with the second tier state scheme will prove an administrative albatross causing undue difficulties both for firms and for indi- viduals making their choices.

We have seemingly created for ourselves a vicious circle. Portable pensions are proposed because of poor frozen benefits and transfer values in terms of inflation. Portability is, however, likely to be complicated and an administrative nightmare, with pressure from unions for uniform salary allowances for individuals outside the firm’s scheme comparable with those costs inside. For an individual it will produce uncertain end results, so that disappointments will still occur. Total provision made for pensions will undoubtedly fall (and possible taxation changes that are currently mooted could aggrevate that fall further). It would surely be more desirable, even at this late stage, to re-examine the bases of final salary schemes, to see whether a format cannot be found to give more equitable treatment for those who have equivalent service in an organization, not tying benefits so firmly to service that ends with retirement. If this involves some modest element of re-distribution, I believe society as a whole would accept that as a worthwhile price for greater equity.

The second challenge relates to investment. Actuaries, by the nature of their work, have a direct concern with investment where the scene has changed dramatically in recent decades. When I qualified as a Fellow (which wasn’t so very long ago) private individuals owned 67% of equities and

10 Presidential Address

financial institutions 17%. Today the figures are 25% and 60% so that actuaries now play a decisive role in determining the scope and nature of the economy.

Maximizing the long-term expected return remains the aim, but the invest- ment manager today requires some constructive vision as to how the economy ought to develop, not just over the next two or three years, but in the next two or three decades. The task has come somewhat incidentally to actuaries, but I believe they can shoulder this responsibility, always provided they operate in an imaginative way which demonstrates an understanding of the immense technological changes taking place, changes that should provide us with the underpinning for a strong economy in the twenty-first century. For this pur- pose adequate primary investment is essential and, whilst an active secondary market undoubtedly helps to encourage primary investment, those generating substantial new cash flows must take an active part in the primary market.

Much institutional investment is secondary. Even new issues such as British Telecom, Enterprise Oil, or Jaguar are basically secondary investment since no new net primary investment directly arises from the sales. Institutions are perceived, wrongly in many instances, as undertaking little for primary in- vestment (or investors); an image that needs correction now they are recog- nized as the dominant force in the market. Suggestions from some quarters that investment in Old Master paintings may be more appropriate than direct investment in manufacturing doesn’t help to achieve the desired image!

A number of criticisms are made of the institutional investment process. The first relates to the emphasis perceived to be commonly placed on the short-term performance of funds with their frequent review procedures, allied to the relatively high turnover of holdings by institutions, a point commented upon by the Wilson Committee in its report.

Secondly, critics detect an uncanny similarity of investment views and note the continuing squeeze on the number of separate investors. If there were only one financial institution and its investment manager was say, anti- alcohol, the brewers would have a hard time raising funds! That position may seem absurd but, in 1978, some 23 insurance companies controlled 70% of the insurance funds under investment, whilst some 58 pension schemes controlled 70% of the pension funds. Insurance companies themselves have a substantial overlap of directors which reinforces this unease. The concentration effect, moreover, is growing rather than diminishing. This opens investment not only to the potential charge of unwarranted sector selectivity, but also the possi- bility of its becoming anti-small business since the larger the fund, the larger are the minimum parcels of investment with which it prefers to deal. If the responsible investment executives are alike in background, education and experience there is some danger that they can unconsciously block particular lines of development.

Thirdly, there is some perceived hesitation to invest in new small knowl- edge based industries, for example the development of software companies.

The Necessity for Change 11

Part of the problem relates to the reluctance of many entrepreneurs to acquire management expertise either themselves or through other staff, or to share the fruits of success with such staff. A good idea with poor management ex- pertise will fail, whilst a modest idea with good management expertise may well succeed. The difficulties are being overcome, painfully slowly, by the venture capital arms of some institutions. Nevertheless, problems still arise for many smaller, high-technology companies seeking to raise funds for launching or expanding their business where the investment is commonly in people, rather than in land, buildings or equipment. To augment what institu- tions can do, it seems desirable for Government to give extra investment in- centives to individuals. One such mechanism is the Loi Monory in France, where a tax credit of 20% can be claimed for investment up to £1,000 per annum, provided the investment is held for four years. Another mechanism is to allow the formation of companies along the lines of the Small Business Investment Companies which have operated successfully since 1958 in the United States of America.

A further area of investment conflict is the increased emphasis being placed by customers and potential customers upon the social goals of invest- ment. In this we seem to be following in the wake of the U.S.A. The pressure usually takes the negative form of not wishing to see investments made in companies which are in specified lines of business, for example tobacco, alcohol, or arms manufacture; or in countries whose social or polit- ical practices are considered to be unacceptable, like South Africa; or in directly competitive companies. An example of the latter was demonstrated in a recent court case by Mr Scargill’s plea against the National Coal Board’s Pension Fund investing in alternative forms of energy. In some instances, this line of reasoning has been taken even further with queries as to whether overseas investment is desirable at all at a time when it is com- monly believed that Britain is short of entrepreneurial capital. At present the benefits of members are commonly not directly affected by investment decisions, since it is usually the employer who bears the residual costs of most final salary schemes, so that any underperformance in the investment of funds falls on his shoulders.

Under present trustee law in relation to pension funds, recently re- interpreted by the Vice-Chancellor Sir Robert Megarry in the Scargill/NUM case already mentioned, pension funds should be administered solely for the benefit of the pensioner, and any wider interests should not be of prime con- cern to the trustees. Even gazumping, it was suggested, should be practised if it would be of benefit to the generality of members. Yet the worker’s interest can never be absent because there is a thread of continuity: today’s workers may take 30 or 40 years to become pensioners, but to deny them the financial resources to develop their skills and abilities needed to create the wealth that would generate the income to provide their pensions, could produce a self- defeating system.

12 Presidential Address

The simplistic answer of ignoring such areas of potential conflict and asking the investment manager to concentrate on the simple (but not straightfor- ward) objective of maximizing the expected long-term returns wherever they can be found could well become more contentious. First, Sir Robert Megarry acknowledged that, if the beneficiaries had a uniform view of what were de- sirable or undesirable investments, the trustees would have to take that view into account. It would, nevertheless, be incumbent on the trustees to demon- strate what they believe is likely to be lost in the return on investment if such constraints were imposed. A frequent concern in this context relates to the attitude towards overseas investments where many of the risks are extremely difficult to estimate, and certain dimensions of risk may be overlooked. Invest- ment fund managers may well find it impracticable to determine the public interest themselves and to act upon it, but political pressure may ultimately be brought to bear to define the public interest for investment purposes.

Secondly, investment managers commonly stress in public that investment is primarily an art and not a science, and that judgement is a prime require- ment in deciding upon the allocation of funds. Yet this approach is a two- edged weapon, since it leaves open the line of argument that actuaries cannot claim any monopoly of judgemental skill on these issues, and we would un- doubtedly be wise to avoid claiming any such omniscience. Nevertheless, the more we can put investment on to a scientific basis, albeit a complex one, the more we are likely to be listened to on these matters. It therefore surprises me to note the antipathy of many actuaries to developments which aim to intro- duce greater rationality into investment decisions, when the whole history of the actuarial profession has been based on making more scientific the handling of areas that had previously appeared to be of a random nature. The motto on our Institute coat of arms suggests that we should constantly be searching for the scientific model that is most appropriate to each area of un- certainty which concerns us.

My third challenge relates to the consequences of the greater availability of information, and the ability to process it, on actuarial work. There are some obvious effects. Insurance companies will inevitably be expected to give greater details of their investment performance to assist policyholders in making decisions as to the relative merits of policies available in the market. Bonus projection methods commonly used in the past for marketing purposes have been thoroughly discredited; indeed it seems surprising that the format used by so many companies still continues, commonly on the specious argument that if others do it, so must we. Surely it would at the very least, be more plausible to express past performance figures in real, and not in inflation led, terms, and to express future figures similarly. With pension schemes, members may start to take a greater interest in the in- teraction between potential benefits (with possible improvements) and investment performance.

The Necessity for Change 13

Increasing availability of information leads to the possibility of greater flexibility in the range of products offered and, particularly within the general insurance field, a greater awareness of the somewhat loose concept of fairness in the rating of risks. Nowadays there is a demand for greater flexibility in product rating—why should all those who live in district X be charged a higher home insurance premium than those in district Y, or why should all under 25-year-olds be charged higher motor premiums? This is a direct challenge to the actuarial principle of the simple ‘collective’, but how far the collective used should be multi-dimensional and able to subsume a variety of factors within the one overall rating is more contentious. Our text-books stress the need to form homogeneous risk classes, but current premium struc- tures don’t always seem to reflect the principle!

Actuaries must, of course, be careful not to stray into areas outside their spheres of direct competence, or impute to themselves special abilities that cannot be justified. An illustration of this was the case, which again involved the National Coal Board, which went to Appeal on a judgement regarding claims for damages for injury and death. The Appeal was dismissed, with the issue revolving, in part, around the allowance made for inflation over a long period ahead by an actuarial witness and incorporated into his calculations. The judge commented that “as a method of providing a reliable guide to indi- vidual behaviour patterns, or to future economic and political events, the pre- dictions of an actuary could only be a little more likely to be accurate (and would almost certainly be less entertaining) than those of an astrologer.” This was high falutin’ language, but perhaps the danger here lies in our predilec- tion to use point estimates, rather than confidence limits. The rebuke was a reminder that we should be careful how we give advice in areas where judge- ment is involved, and we cannot in the nature of things be precisely right.

THE EDUCATIONAL DILEMMA

The major technological shift in the economy hoped for over the next decade involves a number of concomitant changes. I have already discussed the necessary access to appropriate financial resources and the need for flexible pension arrangements, but changes are also conditional on the availability of appropriately skilled manpower (or womanpower). This has likewise to be linked to changes in general attitudes so that society accepts, and indeed welcomes, enhanced technology as a way in which much of the drudgery of many forms of work can be eliminated, bringing in its train increased overall economic prosperity.

The provision of appropriately skilled manpower is a crucial matter, since growth points in the U.K. economy have often in the past petered out through shortages of skilled labour of one form or another. Britain has been slow to adapt to the increasing need, not just for trained minds, but for minds trained in specific contexts. In the U.S.A. some 42% of a cohort undertakes tertiary

14 Presidential Address

education, in Japan 39%, Germany 19%, but in Britain only 14%. Whilst education is not in itself a sufficient condition for enhanced economic pros- perity, all the available evidence suggests it is a necessary condition. Moreover, we still have some interesting relics from the past. An overseas in- dustrialist recently remarked how surprised he was to find that in Britain a young man aiming to become a manager should consider it appropriate to take a bachelor degree in classics, followed by some experience in the City, rather than to study subjects such as production engineering or economics or accountancy at university level. This is unlike Japan, Germany or the U.S.A. where it would be considered more appropriate to develop minds at the tertiary education stage with intellectually challenging areas of study of direct relevance to subsequent employment areas. This in no way denigrates the cultural areas of study—indeed quite the reverse—since a strong economy provides greater opportunities for people to spend time on pursuits which preserve and transmit our cultural heritage.

To increase the supply of relevant skills two problems have to be overcome. The first relates to the priorities amongst young people in their subject choices. There are signs that attitudes are changing with science, engineering and technology becoming relatively more popular, along with other pro- fessional courses. This will affect those non-vocational areas of higher educa- tion which do not necessarily need to be raised pari passu with increases in the total size of the higher education sector, as has tended to occur in recent decades. Any such shift is considerably hampered by the shape of our sixth form education. The problem dates back to a decision made during World War I, when the shape and content of school examinations at sixth form level was handed over to the then relatively small university sector. The content which emerged, with its emphasis on two or three subjects and decentralized syllabus control has remained virtually unchanged to the present day. If the educational system is to be used to assist in achieving current national goals, some broader form of sixth form education is desirable, together with a greater level of central guidance of the knowledge content at sixth form level.

Central direction of education has always been anathema to the British, who are more likely to continue to tinker with a series of select committees, working parties or committees of enquiry, each scratching at the surface of the problem but never making revolutionary changes. Such is the current problem, however, that greater centralism by itself may not be enough if the ablest of our young people continue to observe that the careers which offer the most prestige, and also commonly the best material rewards, lie outside the major manufacturing and commercial industries on which our economic well being is, and will continue to be, based.

The second problem is demographic. In 1983 the 18-year-old cohort reached its peak for the foreseeable future, reflecting the baby boom of the mid-sixties. Numbers are now dropping and, by the mid-nineties, the 18-year- old cohort will have fallen by one-third. This change has profound national

The Necessity for Change 15

implications. At present, as cohorts rise and fall in numbers, the percentages studying various A level subjects remain relatively constant. The exception is that girls are now more frequently staying on for sixth form study, albeit with a different subject pattern from boys, involving relatively fewer scientific sub- jects. If no action is taken, the overall output of graduates in the various subjects is likely to fall approximately pari passu with the diminution in total numbers.

The shortage of 18-year-olds can, it is frequently suggested, be made up with mature entrants. Whilst this route should be energetically encouraged, I do not believe the likely numbers involved can do more than scratch the sur- face of the problem. Furthermore, mature students tend to opt for the non- vocational and cultural subjects, commonly seeing education at that stage of their lives—not surprisingly—as more of a consumption good, something you have if you can afford it, but not otherwise. The 20–25 age range would seem to offer greater possibilities, provided any full-time periods of study involved are condensed into shorter periods than usual—perhaps by altering the some- what archaic term arrangements—and greater flexibility can be introduced through a system of transferable credits, commonly available in many other countries.

Such moves are unlikely to solve the problem completely, and the only realistic alternative is to return to a shift in the balance of 18-year-old tertiary en- trants as between subjects. This could be done, but at a cost that is both financial and attitudinal. It requires the feedstock to be changed at school level; the uni- versities to accept a broader based subject entry system; a squeeze made on the places offered in the non-vocational areas to increase those in vocational areas; and employers generally to demonstrate their wish to recruit graduates from the nationally desired areas. All four changes are required.

The Institute of Actuaries has become primarily, but not exclusively, a graduate profession, predominantly attracting those with university mathematics degrees. Recruitment for the Institute could be affected over the next decade by three primary factors. First is the diminution in the cohort size, and its likely effect on sixth form and university numbers in mathe- matics; second is the increasing competition for mathematics graduates in computing, statistics, operational research, etc. as well as in teaching; third is the low input proportion of women. The proportion of women amongst total graduate output has been slowly, but steadily, rising although the Institute proportion is way below the national proportion amongst mathematics graduates. Many professions seem able to make better use of the increasing numbers of women graduates than we do. It must surely be desirable for actuarial employers to give urgent consideration as to the way that women graduates can combine an actuarial career with marriage and child-bearing.

Since demand for actuarial recruits is unlikely to be primarily linked to the size of the 18-year-old cohort, it is inevitable that competition for good quality

16 Presidential Address

recruits will become fiercer. We all hope that the efforts of our recent very thorough in-house review of the actuarial education process will enable dedi- cated students to qualify more quickly, with those unlikely to make the grade being deflected to other pastures at an early stage. This combined pair of moves should enormously enhance the profession’s image and its ability to recruit adequate numbers of able young people. These changes will not, how- ever, be achieved without very full co-operation from employers and, in particular, their willingness to see that for students their training is a priority, rather than an ancillary, activity.

Many Fellows of the Institute reach managerial positions, some very senior positions indeed. This is both praiseworthy and desirable, since their training gives them valuable skills in general financial management. The reputation of the profession is thus not just in the hands of its members as technical actuaries; it rests equally upon the leadership given to many companies by actuaries occupying a managerial position. The widespread—and expand- ing—responsibilities thus encountered demand a breed of actuary who is broad of vision, deep in analytical skills, effective in communication both written and oral, and rich in human skills. Many of the serious problems we experience with actuarial students in the ‘B’ level examinations may also stem from the excessive concentration that appears to be made on mathematical skills in the primary selection of actuarial students. This suggests that the selection procedure should desirably be widened to include a wider range of skills and attributes than hitherto.

Using such an enhanced specification when seeking potential students, the existing pool of recruits could narrow even further than presently anticipated. I am sure, however, that in the long run such a move would not only enhance the image of the profession, but would make it easier to recruit the desired kind of people. They will in turn be better able to reach out on the one hand to the ultimate consumers. namely society generally, and on the other hand to Government, commerce and industry.

SOME CONCLUDING THOUGHTS

Nobody can specify a simple blueprint for immediate and sustained economic success in the U.K., since we are involved in reversing the trend of a century and need to embrace enthusiastically the new industrial revolution based on the computer, the silicon chip and automation. We, in this hall tonight, repre- sent a numerically small profession whose manpower (and womanpower) is hardly a blip on the computer print-out of the economy’s available personnel resources. Yet we have an influence on national and indeed, international, affairs that is way above our proportionate numerical strength.

The general public perceives actuaries as part of the financial establish- ment, not as personal advisers to them in the way that a solicitor or accoun- tant may be. As a consequence, actuaries are held more directly accountable

The Necessity for Change 17

on a macro-basis for the overall consequences of their collective advice than might be the case with many other professions. At present this accountability lies in a number of directions some of which I have touched upon this evening: investment with the very considerable combined power of the insurance com- panies and pension funds as investors; the structuring of pension schemes and the effect on the mobility and rewards of skilled people in a desired virile and innovative economy. Above all, though, the image of the profession depends upon the qualities and actions of its members individually and collectively. It must therefore be a prime endeavour for us to ensure that those recruited to the profession match our highest expectations.

If Thomas Sprague were here tonight he would be surprised, but not dis- mayed, by the growth in the responsibilities of the actuary in the light of the immense economic and the structural changes envisaged for the next decade or so. He did not see the profession as an island with its role confined to tech- nical advice of a strictly constrained nature. Rather he saw the Institute play- ing a pro-active role in which it used its professional competences to provide leadership to the general body politic. We are at a fork in the road; we can choose to put our primary emphasis on technical professional matters, with little heed for the context in which our advice is given, or we can aim for a higher profile in the shaping of the future economic development of the country. I personally believe, like Sprague, that we should follow the latter road whilst maintaining our professional integrity. We must be absolutely sure that, at the turn of the century, we cannot be accused of having hindered the enhancement of economic performance, in both absolute and internation- ally comparative terms. You, who collectively comprise the Institute, should be seen to have risen to the challenge that the new technological revolution poses, and be able to point with pride in the year 2000 to the contribution that your profession has made to the enhanced well-being of the nation.