get ready for have we seen the golden contingencies age of ......30, small capitalization stocks and...

Get ready for Contingencies

by Dana H. Murphy

I n June, when champagne corks pop in celebration of the centennial of

the actuarial profession, there will be something else to celebrate: the launch of the profession’s sparkling four-color magazine. Conrlngencies. The inception of a first-class publication like Contingencfes marks a coming of age for the profession.

a

Published by the American cademy of Actuaries, the magazine 11 provide the profession with

much-needed visibility. The mailing list for Contfngencfes comprises approximately 12.000 practicing actuaries, most of whom are SOA members. In addition, the publication will be sent to the CEOs and CFOs of the Fortune 1000 corporations. as well as chief underwriters, risk managers, regulators, and influential members of Congress. Although published by the Academy, the magazine will cover all aspects of the actuarial profession, including research and other activities of the Society of Actuaries.

Contingencies will be published bimonthly, with the first issue scheduled for mailing in May 1989. Most issues will contain three feature articles showcasing the diversity of actuarial science and demonstrating the applicability of that science to complex social issues. Whenever possible. the topics will reflect the most pressing concerns of the day as evidenced by media coverage and

ublic debate. Also, each issue will

e ve a more technical “workshop” title highlighting a new area of actu-

arial research. Like most professional journal articles, “workshop” papers will be peer-reviewed.

Continued on page 4 column I

Have we seen the golden age of convertibles?

by W. Theodore Kuck

M ost investors give convertible securities less prominence than

stocks and bonds in their investment portfolios. The attention span given to learning the intricacies and finer points of this hybrid security is quite narrow. In fact, most of us may not even know that a “golden age” existed or whether it has peaked. It’s far beyond our immediate concerns. Besides, why should anyone care?

Every serious investor should care. A closer look at this security class reveals some interesting, relevant and timely information. Convertibles have, in fact, experienced somewhat of a golden age that can safely be measured over 13 years. Lipper Analyt- ical Services, Inc.. which monitors the performance of mutual funds by asset class, has revealed that for the 13 years ending December 31. 1987. convertible mutual funds, on average, outperformed the Standard and Poor’s 500 Stock Index 16.2% to 15.5%. respectively, on an annualized compounded basis. Further study reveals even more spectacular returns

for the nine years ending 1983. For this period. annualized compound returns of convertible mutual funds were 19.9% to the S&P 500’s 15.8%. Not only did convertible portfolios experience such attractive returns, but our own evidence of managed convertible portfolios indicates that the standard deviation of convertible returns versus stock returns shows risk levels of convertibles averaging only 70% of the S&P 500 stocks. Traditional beta calculations as a measure of portfolio risk also confirm this. These points lead to the conclusion that convertibles have provided superior returns with less risk.

These attractive total return figures started a stampede of money into convertible mutual funds. Although institutional-size capital. including insurance companies and pension funds, has been slow to move and reluctant to address the perceived complexities and rewards of this asset class, individuals were quickly attracted to the opportunity to realize these kinds of total returns. The impact of mutual fund assets

Conttnued on page .? column 2

In ttiiS issue: Have we seenthe golden age of convertibles?

W. Theodore Kuck 1 Get ready for Cobntfngencfes

Dana H. Murphy 1

Varying the ROE target by profit center depending on risk

Joseph H-. Tan . 5 The Cqnsumer Price Index: Coverage. limitations. and accuracy

Janet:Norwood 9’

Behind the scenes: The Social Security COLA for 1988

Brtice D. Schobel 10

Factuades Deborah Poppel 11

Editorial: Report from Holland Irwin T:Vanderhoof 12

Convertible securities Art Berry 12

Letters to Editor 13

Numberless nevertheless Barnet N. Berin 14

Actucrossword. Actucrostic - 15,16

2 The Actuary-- January 1989

The Newsletter of the Society of Actuaries

VOLUME 23, NO. 1 JANUARY 1989

Associate Editor responsible for this issue twin T. Vanderhoof

• '!

/ ~ l IF . Editor

Linda B. Emory, F.S.A.

Associate Editors Barnet N. Berin. ES.A.

M. David R. Brown, ES.A. Daniel E Case, ES.A.

Richard K. Kischuk, ES.A. Irwin T. Vanderhoof, ES,A.

Competition Editor Charh:s G. GroescheU, F.S.A.

Features Editor Deborah Adler Poppel, F.S.A.

Assistant Editors Gary E. Dahlman, F.S.A.

Stephen H. Frankel, ES.A. Charles Habeck, ES.A.

Curtis E. Huntington, ES.A. David S. Lee. ES.A.

Society Staff Contacts (312) 706-3500

Diana Montgomery Staff Editor

Lmda M. Delgadillo Director of Communications

Correspondence should be addressed The Actuary

P.O. Box 105006 Atlanta, GA 30348-5006

Copyright@ 1989, Society of Actuaries

The Actuary is published monthly (except July and August) by the SOCIETY OF ACTUARIES, 475 North Martingale Road, Suite 800, Schaumburg, IL 60173-2226. lan M. RoUand, President; Anthony T. Spano, Secretary; Michael J, Cowell, Treasurer; David A. Jeggle, Director of Publications. Non-member subscriptions: students. $5.50; others, $6.50. Send subscriptions to: Society of Actuaries, P.O. Box 95668, Chicago, IL 60694,

The Society is not responsible for statements made or opinions expressed herein. All contributions are subject to editing. Submissions must be signed.

Golden age cont'd under management was dramatic. (See Chart 1).

The golden age for convertibles was at hand, at least for convertible issuers. Seeing the window of opportunity for raising capital, corporations

i s sued a p p r o x i m a t e l y $13.2 b i l l ion o f n e w c o n v e r t i b l e o f f e r ings in t h e th ree year p e r i o d e n d i n g 1984 b u t m o r e tha / d o u b l e d tha t a m o u n t to $28.1 b i l l ion in t h e t h r e e - y e a r p e r i o d e n d i n g 1987.

Continued o n page 5 column ]

CHART 1

Asset Growth of Lipper Convertible Mutual Funds

q~

~ S

[tTT(

2 0 0 0

[O:

595 452

N N 1 2 / 3 1 / 8 4 6 / 3 0 1 8 5

1071

1 2 / 3 1 / 8 5

3046

® / . . . . .

N

i / / / / / ® 6,/30186

5202

1 ~ 3 1 / ~ 6 / 3 ~ 8 7 1 ~ 3 1 / 8 7 6 / 3 ~ 8 8

CHART 2

240%

T. Rowe Price New Horizons Fund Price/Earnings Multiple Relative to the S&P 500 P/E

220%

200~.

1807.

160~

140%

1207.

100~

807. lus

• , , i , , , I ' ' ' l ' ' ' l ' ' ' l ' ' ' l ' ' ' l ' ' ' I ' ' ' l ' ' ' l ' ' ' 1 ' ' '1 ' ' ' f ' ' ' l ' ' ' t ' ' ' 1 ' ' ' 1 ' ' ' I ' ' ' l ' ' ' T ' ' ' 1 ' ' ' [ ' 6~, ' M eo vo vt 72 ~ V4 ~ -re . n vo -to oo ot 6 z 63 04 05 oa o'r

P / C ' S b o s e d o n a v g , q t r l y p r i c e s o n d f o r w a r d 4 q f r e p s

K n m

Golden age cont’d However, somewhat to the

a tsmay of convertible mutual fund vestors. as well as many institu-

tional investors, was the less than stellar total return performance during the last few years. Clearly, deterioration occurred in the relative performance of convertibles to the S&P 500. A casual observer would respond that the reason for performance disappoint- ment is obvious - too many new players, too many new issues and too

CHART 3

The Actuary-January 1989

little analysis. Stating it differently, were not investors throwing more and more money at new issues with aban- don, leading to disaster?

Certainly this was part of the problem, but more fundamental changes were occurring in the period after 1983. They gave rise to a favorable reevaluation on convertible securities and resulted in a very positive market outlook for convertible assets by year-end 1987 and for the foreseeable future. The discussion of

CHART 4

Lipper Average Convertible Fund Versus S&P 500 Index

Cumulative Total Return-1975-1988 In&. ,mu7&m,m

-Lipper Average Convertible Funrl

---.--s&P 500

------Shearson Lehman Cov’tEorp. Bond lnllcr

3

those fundamentals will require a little more knowledge of the convertible issuer universe.

In the years since 1983, the issuance of convertibles has been concentrated among larger issues and larger issuers. However, even at the end of 1987. the useable (for investment purposes: i.e.. liquidity and marketability) universe of convertible issues was definitely skewed to smaller company issuers. We estimate that 72% of all convertibles now outstanding were issued by companies whose market capitalizations are smaller than 80% of the S&P 500 companies by market capitalization, In short, convertible securities is a small capitalization universe. Addres- sing the relative performance of convertibles requires first addressing the relative performance of their underlying stocks. (See Chart 2.)

Chart 2 shows the relative price/ earnings multiple of the T Rowe Price New Horizons Fund versus the S&P 500. This fund is often recognized as a good proxy for small capitalization stocks in total. Notice the long periods during which small capitalization stocks’ price/earnings multiples were rising relative to the broader larger capitalization universe of the S&P 500, and vice versa. With the exception of the 1981-1982 period of extremely high interest rates. the period from 1976 to 1983 was a strong period of outperformance for small capitahza- tion stocks. Notice that over the period represented on this chart, relative P/R’s peaked at approximately a 200% level and troughed at 100%. From 1983 (a peak year) to 1987. steady deterioration occurred in this ratio with it reaching a trough again in 1987. The conclusion is perhaps obvious: 1975 to 1983 was also a golden age for small capitalization stocks: since 1983. the luster has faded. In fact, in such small capitahza- tion industries as technology. the pain for investors has been sharp and long. Another view of this is shown in Chart 3.

The Value Line Composite Stock Index is a broad-based smaller capitalt- ration universe than its larger-cap counterpart, the Dow Jones Industrial Index. Notice on this relative performance chart that the pattern for smaller stocks, described in Chart 4. is also seen here with the relative outperformance of The Value Line Index from 1975 to the 1983 peak and then

Conthued on page 4 column 1

4 The Actuary-January 1989

Golden age con t ‘d troughing again in late 1987. This pattern of performance for small capitalization stocks also held for convertibles. Furthermore, during the first half of 1988 small-cap stocks and convertibles had strong rebounds. Through June 30. 1988, the convertible mutual fund average performance was 13.0% versus 10.5% for the Dow Jones Industrials and 12.6% for the S&P 500. The Value Line Composite Stock Index was up 19.1%.

No trends like the one that began in late 1987. of course, continue in a straight line forever, and since June 30, small capitalization stocks and convertibles have moderated their relative outperformance. However, it is our belief that the longer-term patterns of superior relative performance for convertibles and small-cap stocks were put in place over several years and that the golden age is only in its early stages. W. Theodore Kuck, not a member of the Society, is Managing Director, Equitable Management Association.

Contingencies cont’d

While written for actuaries, the content of Contingencies will be selected and edited so it also is accessible to the wider audience on the mailing list. In particular, the editors will aim to place each topic within the broadest possible context. so that those not yet initiated into the delightful world of actuarial logic can see how the kind of analysis that actuaries perform every day can be used to make high-level decisions in both government and society at large.

Each issue of Contingencies will also contain departments that wffl appeal to both actuarial specialists and generalists, plus a roundup of the latest legislative and regulatory news. Regularly featured interviews with state insurance commissioners will supplement the nationally focused material, along with interviews profiling actuaries in unusual lines of work. This sort of interview can suggest new employment possibilities to actuaries and underscore the profession’s diversity to the nonactuarial audience. Finally just for fun, puzzles will stimulate the reader’s gray matter to its peak efficiency.

Continued on page 4 cblumn 2

Contingencies cont’d The editorial content will be

enhanced by the eye-catching design selected for Contingencies, which wffl stand out among the competing publications displayed on a busy executive’s coffee table.

The magazine also will fill a crucial need for another group: advertisers. For advertisers, Contingen- cfes will reach an affluent and influential audience.

The in-house editors of Contingencies work closely with the magazine’s Editorial Advisory Board to reach important decisions that will shape the eventual look and content of the magazine. Right now, most design elements for the finished publication have been determined; an advertising sales representative has been selected; and the titles for the first year’s feature and “workshop” articles have been selected. Here are a few details about the progress we’ve made to date. Designing Contingencies We have engaged a magazine designer, Bono Mitchell, to work with us in making decisions about the many elements that determine the look and feel of a publication. We have selected a “nameplate,” the logo that appears on the cover of a magazine.

Because Contingencies is a hybrid publication - between a journal and magazine - the cover design demon- strates characteristics of both kinds of periodicals. The cover design has some of the formality of a journal, but other elements - such as the inclusion of “sell lines” (brief phases indicating article content) - are more typical of a magazine.

Inside, the format is appealing and accessible, but dignified. The publication has its own singular iden- tity, but avoids the extremes of idiosyncrasy. The departments have several format features that allow the reader to open the magazine to any point and know what kind of material he or she is reading. Further, each department has its own identifying design element (a small silhouetted picture, known in publishing as a “bug”). The design of feature material will vary from article to article and issue to issue, depending on content. Drawings or photographs will be used as Illustrations. Other elements. such as typography, will remain constant among articles to unify the total publication and to clearly separate articles and advertisements.

In hope of attracting and holding the widest possible audience and to keep the design simple and elegant, ,f? tables and charts wffl be kept to a reasonable minimum. With the notable exception of the “workshop” pieces, references will not be included at the ends of articles. When tables and charts are necessary to particular articles, our designers will put their heads together to develop an attractive way to present them. Determining editorial content Although we hope Contingencies will have considerable leeway to respond to important new issues as they reach the public eye (and. in some instance, to anticipate and promote public awareness of an issue), we have prepared a roster of feature articles and “workshop” pieces that will appear in the first year of Contingen- cfes. Here is a sampling of tentative titles for articles: l Features

AIDS Victims: A Class of Hninsurables?

Something to Celebrate - 100 Years in the Actuarial Profession

Three Years Down the Road, Tort Reform Hasn’t Really n Changed Things

The Real Effects of FASB’s Accounting Rules

New Accounting Standards for Retiree Health Care Costs - Imminent Hazard for Corporate Balance Sheets

How Good Are the Life Insurance Rating Agencies7

Preserving the Solvency of HMOs Dividend Illustrations -What Do

They Really Mean? . ‘Workshop” articles

What Is the Appropriate Level of Assets in a Pension Plan?

Claims-Made Reserving for Medical Professional Liability

Explicit Methods for Handling Inflation Of course, we hope that actuaries

in a variety of areas will submit manuscripts or story ideas to Contingencies; diversity in style and substance is one of our aims. Advertising Early in the planning stages for Contingencies, we assessed the ,r-Y

magazine’s potential advertising revenues. Publications costs are high for a four-color magazine, and we

Continued on page 5 column 1


Contingencies confd wanted to make sure that Contfngen-

a!i ies would not disproportionately rain funds from other deserving

Academy projects and programs. This is an especially important considera- tion for a nonprofit organization like the Academy.

For this reason, we signed Judy Solomon Associates of Bethesda. Maryland, as the ad rep for Contingen- cies. In her work for other association publications, Ms. Solomon has posted dramatic increases in ad income. Several other ad reps we interviewed wanted quite hefty “media development” fees, so Ms. Solomon’s willing- ness to take on our project on a straight commission basis is a boon for our budget.

In September of last year, pre- liminary contacts with potential advertisers revealed a keen interest in advertising in Contingencies. Prospects include insurance companies. reinsur- ante companies, actuarial consulting firms, and purveyors of computer soft- ware: several companies have signed on to appear in the inaugural issue.

Now, the full-scale campaign to

a licit advertising for Conffngencfes is

nder way. The principal tool for attracting advertisers to a magazine. the media kit, has been designed and printed. To help advertisers target their ads to specific markets. we developed an “ad calendar,” which provides advertisers with a general idea of the content of each issue, selected readership demographics, and a rate card that details the cost of various sizes of ads and printing specifications of the magazine.

During the next several months, Ms. Solomon will contact each of the 350 firms identified as potential Contingencies advertisers. Developing guidelines One of the less visible, but vital. aspects of starting any new publication is fashioning the “rules of the road” that govern such procedures as the selection and editing of manuscripts To ensure consistency among the articles in each issue (and from one issue to another). as well as to maximize continuity in a world where

igh job turnover is a reasonable

e pectation. we have developed three

asic documents: l A style manual that specifies. for

example, what terms are capitalized; l An editorial policy manual that

provides guidelines for procedures

such as how manuscripts are selected and edited, and how copyrights are transferred from authors to the publisher;

l A set of specifications for each department itemizing elements such as anticipated length, audience, and appropriate tone.

Where you fit in There are limits to what an editor, even when working with an inspired Editorial Advisory Board like the one guiding Contfngencfes, can accomplish. A professional magazine, in a word, can be only as good as the input from the profession. Working in Washington, DC.. we see a gamut of professional magazines. Some could compete handily against anything for sale on a newsstand for elegance of design and quality of content: others are meager pamphlets, carrying the same tired articles every month.

We would therefore like to extend both an invitation and exhorta- tion to SOA members to participate in the publishing of Contfngencfes. If you are interested in writing for the magazine, send us samples of your writing. If you have a finished manu- script sitting in a file somewhere. send that to us. Or if you are one of the apparently vast number of people who do not care much for writing, please contact this office anyway with an idea for a story If it has merit, we will work with you to produce an article.

If you hear of a company or vendor that might find Contfngencfes a useful vehicle for advertisements. please give us a call about that. and we will pass the word along to our ad rep.

We hope Contfngencfes will engage and excite you and that the finished product will make you proud of your profession. Dana H. Murphy is Editor, Confingencies. She is not a member of the Society.

Study manuals for SOA exams Study manuals for Courses 110. 120. 130. 135. 140, 150. 151. 160. 162. 165, EA-1. and EA-2 are available from Actuarial Study Materials. For a complete list of manuals, write to A.S.M., PO. Box 522. Merrick. NY 11566.

Varying the ROE target by profit center depending on risk

by joseph H. Tan

A recent SOA regional meeting featured discussion on an age-old

actuarial debate: Within the same company, should the return on equity (ROE) target vary by profit center (PC) depending upon the risk of the PC? For example, should company management (represented by the Corporate area) demand a different ROE from the Group Health line versus the Ordinary Life line?

In actuarial literature and discussions, several arguments for not varying the ROE target for various profit centers have been presented. The main argument is:

If the allocated required surplus (RS) of the PC already reflects its associated risk, and such RS is a part of the basis for the PC’s net investment income alloca- tion and is included in the denominator of the ROE formula, the PC’s ROE calculation already implicitly reflects the risk of the PC. In this case, there is no need to require higher ROE from the riskier PC, because requiring higher ROE from the riskier PC would result in double counting. A uniform ROE target should therefore be used for all PCs if RS is included in the ROE formula.

Most actuaries would agree that return should be commensurate with risk and higher return should be expected from riskier PC. Here’s where the confusion arises: If RS already reflects risk and is incorporated in the ROE formula, should the ROE target still vary by PC? Arguments against uniform ROE despite the existence of RS This section presents arguments to show that ROE target should still vary by PC, even if the PC’s RS reflects risk and is included in the PC’s ROE calculation. To simplify our discussion, we assume that each profit center sells only one product, and we will use the terms - profit center and product - interchangeably.

Contlnued on page 6 column I

6

Vaxying ROE confd Also, the following acronyms wffl

be used: a) TI stands for Total Investment.

This is the company’s total investment in a PC, i.e.. including the RS needed to support the PC.

b) IERS stands for Investment Excluding Required Surplus. This is equal to TI minus RS.

The basic argument for uniform ROE across all PCs is that RS already covers the PC’s risk and, thereby, results in the same risk on the total investment (TI) for each PC. That is, the larger RS of the riskier PC reduces its risk, thereby making the risk of TI the same for all products.

The author disagrees with the above argument and will argue that it is unlikely that the risks of the resulting TIs of the various PCs are the same. 1. Situation without required surplus To aid in the explanation, let us consider a simple example involving the corporate area wanting to sell two one-year products. In real life, situations are more complicated, but the arguments are essentially the same. Product B is considered riskier (i.e.. more potential for income fluctuation and losses) than Product A. Without any RS provision, Corporate determines that it IS reasonable to expect an average 15% return on IERS from Product B. versus 10% from Product A. For instance, a $100 IERS on both Products A and B should pay back, on the average, $115 for Product B and $110 for Product A, at the end of the year. The term payback will be used to refer to the total amount received at the end of the ,year. i.e., the original principal plus the return on the principal. The $5 average additional payback for Product B is deemed by Corporate to be an appropriate reward for Product B’s riskier nature.

Graph I depicts the above situation. Because Product B is riskier and has more uncertain results: l The spread of its probability distri-

bution of R (the payback from IERS at the end of the year) is wider, and

l The probability of obtaining a loss and the magnitude of such a loss is greater

as-compared to Product A. However, since Product B returns higher on the average. Corporate views the returns of the two products as equivalent. That is, the additional $5 is deemed


Probability of R.

GRAPH I Probability of PaYback aI the End of the Year

on IERS CR)

Product A

Probability of Intolerable Valuer

a $110 R = S Amount of Payback al the End of the Year on IERS

Probability of R

(f-7

Produc1 n

b $115 R = S Amount cd Payback at the End 01 the Year on IERS

*Note: We are not requiring that R be Normally distributed.

an appropriate reward for the extra risk of Product B.

Also shown in Graph I are points a and b, the minimum payback amounts that management ,will toler- ate. The values of a and b can be equal or different and can be negative, zero, or some positive numbers less than $110 or $115. Reasons for not tolerating values below a and b may include: l Statutory insolvency, l Apparent company’s insolvency or

weakness in public eyes, l The manager of the Corporate area

will lose his/her job. Whatever the reason, the

manager of the Corporate area (or top management) determines that values below points a and b are intolerable and requires that before the products are sold, additional assets need to be set aside to guard against such intoler-

able situations. We will term such additional assets as required surplus (RS), even though RS is often used to refer to assets set up for insolvency concern only.

As seen in Graph I, the probability (i.e., the area under the probability curve) of having intolerable values (i.e.. values less than a and b. respectively) is greater for Product B than Product A. This is due to the riskier nature of Product B. II. Situation with required surplus Assume Corporate determines that RS of $10 is needed for Product B. and $5 for Product A. Also assume Corporate decides to invest RS in risk-free inves!- ment earning a 5% after-tax yield. Graph II depicts the paybacks resulting from TI of $110 in Product B and $105 in Product A.


Varying RQE cont’d Since RS is invested in risk-free

investment, the shape of the probability curve of R* (

P ayback from TI) is

the same as that o R (the payback from IERS). The curves merely shift to the right by:

$5 (1 + 5%) = $ 5.25 for Product A and $10 (1 + 5%) = $10.50 for Product B

This is because a product’s claim and persistency experience, actual expenses, and the investment experience of the product’s IERS are not affected by the setting aside of assets equal to RS. For instance, it is just as likely for 200 policyholders to die with or without RS. That is. the occurrence of a product’s Cl, C2, and C3 risks is not affected by its RS. (In reality, if RS is not invested in risk-free investment, the shape of the probability curve of TI payback will change somewhat. And the Cl and C3 risks of TI will be somewhat different from those of

The Actuary--January 1989

IERS. However, those differences are quite immaterial unless RS is extremely large as compared to IERS.)

Looking at Graph II. we see that the probabilities of having intolerable values (i.e.. values less than a and b respectively) have been substantially reduced. And Corporate is now comfortable with the magnitudes of such probabilities.

Table I summarizes the average rates of return of the two products.

Table I Product A Product B

IERS $100 $100 Average return

on IERS 10% 15% Risk Index

of IERS* RS ifi $:o Composite Yield

of TI 9.8% 14.1% *This represents a relative measure of risk for the product. We assign a risk index of 1 for RS.

GRAPH II ProbabililY of Payback at Ibe End of the Year

on TI (R-j

Probabilily 01 R

Product A

a Sl15.25 R’ = S Amount of PaYbach

al the End of the Year on TI

7

Without RS. Corporate views the average differential of 5% as appropriate. Based on our example. 4.3% (i.e.. 14.1%-9.80/o) should be the ap

P ro-

priate average return differential or TI. However. it can be argued that an appropriate average return differential for TI should be somewhat less than 4.3%. The reason for this relates to the point we raised earlier - in reality. RS is often not invested in risk-free assets, thereby making the Cl and C3 risks of TI somewhat different from those of IERS. This will have a greater effect on Product B than A due to the larger RS of Product B. But. as argued earlier, the magnitude of such effect should not be material unless RS is extremely large compared to IERS. Hence, the appropriate average return differential for TI should be around 4% to 4.2%. but not 0%.

Based on our analysis, under what circumstances is it appropriate for Corporate to demand a uniform rate of return on TI for Products A and B? These circumstances, with corresponding counterarguments. are shown below: 1. Corporate views it appropriate to

demand the same return on IERS from both products.

This can be discarded because we started with the premise that various products have different risks requiring varying return on IERS. 2. The magnitude of RS is extremely

large as compared to IERS. And such magnitude is large enough to “mold’ (reshape) the probability curve so that the resulting probability curves of TIs are the same for the various products.

As argued earlier, the possibility of having RS of such huge magnitude is unlikely Also. even if unusual “mold- ing” of the probability curve took place, it will be only by coincidence that the resulting probability curves of the two TIs would be viewed as identical by Corporate. Hence, Corpo- rate should generally demand ROE on TI to differ by product. 3. RS works in such a way that the

left tail of the probability curve is shortened. Examples of the resulting probability curve for Product B are shown in Graphs III and IV. (The resulting curves for Product A are not shown since they are similar to Graphs III and IV.)

In Graph 111. the left tail of the probability curve is somehow “molded” so


8

Varyfng ROE cont’d that the probability of intolerable values occurring is small enough and is deemed acceptable by Corporate. However, such a situation is not likely to occur by merely setting up RS. Instead. it could occur if:

The product is redesigned to reduce risk. The guarantees offered by the product are reduced. Investment strategy is changed to reduce risk, Risk is reduced by management actions based on strategic or financial planning.

In Graph IV, the probability of having intolerable values is eliminated (or minimized). However, Graph IV will not result by merely setting up RS. since the latter will only shift the probability curve to the right (as we had seen earlier). Graph IV could occur if the government (or some indepen-


dent third party) agrees to pay for ail the additional losses below point b and hence assures Corporate that intolerable values would not occur. Under such an arrangement, it is conceivable that Corporate will not demand an additional return from the riskier product since the risks of the two products have effectively been reduced (and maybe made equal) by the government guarantee. This is quite different from the case of merely setting up RS by corporate. In the latter case, Corporate would still be paying for losses below point b.

In summary, we have argued that if Corporate believes that it is appropriate to demand a higher return on IERS from a riskier PC, then demanding uniform ROE on TI is generally inappropriate. The latter is appropriate only if, by coincidence, the composite ROES (which is a weighted return of IRS and RS) of both PCs are equal.

GRAPH Ill

Probability of R

I

Pmd”Cl tl

b R

Probability 01

I

GRAPH IV

R

Product B

b

Summary In this paper, arguments for varying the return on equity target by profit f”t.

center depending on risk are presented. It is concluded that even with the presence of required surplus (which reflects risk) in the ROE formula. ROE target should still almost vary by profit center. A direct extension of our conclusion is that pricing internal rate of return target should vary by product depending on the product’s riskiness.

It is hoped that this paper will encourage further discussion and research in the area of appropriate ROE expectations for the various product lines. The determination of appropriate ROE targets is an important requirement for effectively managing an insurance company Joseph H. Tan is Senior Consultant, Coopers & Lybrand.

First Intensive Seminar scheduled The SOA will offer the first Intensive Seminar in Applied Statistical Methods at the University of

./-Y

Wisconsin - Madison in August 1989. Only students who pass the Course 120 examination in November 1988 or May 1989 are eligible to attend the seminar. Students successfully completing the seminar will receive 10 elective credits toward the ASA designation.

An insert mailed with this issue of The Actuary asks for an expression of interest in serving as business faculty for the seminar and briefly describes the seminar in general terms. More detail will be provided in the March issue of The Actuary Detailed information and registration materials will be mailed directly to potential eligible attendees by early February Anyone who thinks he or she is an eligible attendee and has not received a brochure by March 1 should contact Pat Holmberg at the SOA office (312-706-3527).

Problem workshop EA-1 in April /? An intensive three-day problem workshop for EA-1 exam will be given by Actuarial Study Materials in April 1989 in New York City. For details. write to A.S.M., PO. Box 522, Merrick. NY 11566.

The Consumer Price Index:


@Coverage, limitations, and accuracy

by Janet Norwood

T he Consumer Price Index (CPU affects almost all Americans in

some way As the most widely used measure of inflation for the U.S. economy, the CPI is a key indicator of the effectiveness of government economic policy. The President, Congress, Federal Reserve Board, and many financial and economic consultants use the CPI to formulate and evaluate fiscal and monetary policy. Business executives, labor leaders, and other private citizens also use the index as a guide in economic decision making. The CPI and its components are used as deflators for other economic series to adjust for price changes and transform the series into inflation-free dollars. Examples

a elude retail sales figures, compo-

ents of gross national product, and financial reporting under Financial Accounting Standards Board FAS 33.

The CPI is also used to escalate income payments. As a result of statutory action, the index affects the income of more than 60 million persons: 38 million Social Security beneficiaries: over 3 mihion military and federal Civil Service retirees and survivors: and about 19 million food stamp recipients. Changes in the CPI also affect the cost of school lunches for 24 million children. In addition, over 3 million workers are covered by collective bargaining agreements that tie wages to the CPI. Some private firms and individuals use the index to keep rents, royalties, alimony, and child support payments in line with changing prices. And

i finally, since 1985, the CPI has been used to adjust the federal income tax structure to prevent inflation-induced increases in tax rates. Each 1% annual change in the CPI results in an ’ crease of $2.8 billion in federal

(16 titlement programs. In a period of

/o annual inflation, the change could amount to 8% of the projected federal deficit. The effect of CPI changes in the private sector is not known but may be even greater.

Coverage The CPI. which measures the average change in prices over time for a fixed market basket of goods and services, is available from the Bureau of Labor Statistics (BLS) on a monthly basis for two population groups. The first, and broadest, measure covers alI urban families (CPI-U) while the other covers only wage earners and clerical workers (CPI-W). The CPI-W is a continuation of the historical index introduced well over a half-century ago for use in wage negotiations. As new uses were developed for the CPI in recent years, the need for a broader and more representative index became apparent. The CPI-U. introduced in 1978, is re resen- tative of the buying habits of a Fl out 80% of the noninstitutional population, compared to 32% represented by the older index. The methodology for producing both indexes is the same: only the population coverage differs.

The CPI is based on a sample of prices for goods and services people buy for day-to-day living, i.e.. food. clothing, shelter and fuels, transporta- tion, medical care, entertainment, etc. Change is measured by pricing essentially the same market basket of goods and services at regular intervals and comparing aggregate costs with the costs of the same market basket in a selected base period. Prices are collected in 85 urban areas across the country from about 19.000 retail estab- lishments and 57.000 housing units. Indexes are published for about 425 items or groupings of items at the national level for the CPI-U. Indexes also are

tI ubhshed for 27 individual

metropo tan areas as well as aggrega- tions of the 85 areas by region and population-size class. limitations While the CPI reflects price change for all urban consumers, it may not be representative of the experience of demographic subgroups such as the elderly or the poor. Measurement of price change for such subgroups would require specifically designed surveys to determine the precise market baskets of items, retail outlets.

and pricing structure applicable for the group when computing their price index. Second, area indexes cannot be used to determine relative living costs. Individual geographic area indexes measure only how much prices have changed in the respective areas over the specific time period. They do not indicate whether prices or living costs are higher or lower in one area relative to another. Finally, because the index IS estimated from a sample of consumer purchases, the results may deviate slightly from those that would be obtained if all consumer transac- tions were covered. These estimating or sampling errors are statistical limitations of the index.

A different kind of error in the CPI can occur when a respondent provides BLS field representatives with inaccurate or incomplete information. BLS attempts to minimize these errors by obtaining prices by personal observation wherever possible and by correcting errors immediately upon discovery. The field representatives, technicians. and commodity specialists who collect, process, and analyze the data are trained to watch for devia- tions in reported prices that might be due to errors. Also. an independent audit staff conducts a systematic evaluation of all CPI collection and processing activities. Accuracy The Market Basket: The American economy is quite dynamic and continually changing. Consumer spending patterns. therefore, change over time. New products such as personal computers, VCRs. compact disc players, etc., emerge. Consumer tastes and preferences change as shown in the decline in purchases of food for home consumption. Consumers also substitute commodities and services, one for the other, in response to change in relative market prices as demonstrated by the shift in demand to lighter, more fuel- efficient automobiles following the energy crisis of the mid-1970s. This. of course, implies that the consumers’


10 The Actuary- January 1989

CPI cont’d market basket changes. The CPI. however, is based on price movement for a fixed market basket and does not reflect shifts over time in the quantities of goods

alf urchased. These

shifts occur gradu y and there is no clear evidence to indicate the frequency with which the market basket should be updated. Historically, the CPI market basket has been held fixed for a period of 10 years or so. The past three market basket revisions took place in 1964. 1978. and 1987, reflecting consumer spending patterns during 1960-61. 1972-73, and 1982-84, respectively Beginning in 1980. annual consumer expenditure surveys have been conducted so that changes in consumers spending can be monitored and the need for more frequent revisions to the market basket can be evaluated. Sample Design: The two most recent CPI revisions were also accompanied by markedly improved sample designs that increased the CPI’s efficiency and quality The 1978 revision introduced full multi-stage statistical probability

sampling into the CPI. greatly impro- ving its reliability. The 1987 revision introduced an optimum design using a cost constrained minimum variance model and further improved the statistical reliability. Because of budget reductions in 1988. the sample of cities was reduced from 91 to 85. Even with these cuts, the new design still produces estimates of price change that have less variation than those based on the sample of cities prior to the 1987 revision. BLS is in the process of compiling measures of sampling variance and should have them available for release in the fall of 1989. Future enhancements The worldwide explosion in new technology presents new challenges and opportunities for the future of the CPI and BLS. Barring further budget cuts, a number of projects underway should yield future improvements. Current research exploring new index methodologies could allow for more frequent and less costly updating of the CPI market basket. New survey technologies that use computer-

assisted telephone-interviewing techniques are also being evaluated to determine whether they wffl speed q the introduction of new products into the CPI framework. Similar technologies should aid in the collection of more consistent. higher quality information in respondent dependent interviews by controlling the flow and editing data during the interview. In addition, plans are being developed to use knowledge-gathering expert systems to aid commodity specialists in ensuring consistent decisions when determining and measura 1

roduct comparability le quality differences.

The BLS continues to strive for improvements in quality, timeliness. and accuracy of all economic information it produces despite the tight budgetary climate. Similar efforts are being made in the other programs on prices, unemployment. employment, wages, productivity, and occu- pational injury statistics for which BLS has responsibility. Janet Notwood is Commissioner of Bureau of labor Statistics, U.S. Department of Labor. She is not a member of the Society.

Behind the scenes: The Social Security COLA for 1988

by Bruce D. Schobel

0 n October 21. the Bureau of Labor Statistics (BLS) released

the Consumer Price Index KPI) for September. With that figure, the Social Security Administration calculated the Social Security cost-of-living adjust- ment (COLA) for December 1988. which was 4.0%. This COLA was announced in the Federal Register October 31. and nearly 39 million beneficiaries received that increase with their December checks. payable on January 3. 1989. Although the COLA announcement was quite routine, much was going on behind the scenes.

Automatic cost-of-living adjustments have been part of the Social Security Act since 1972. The first automatic COLA was effective for June 1975. The only major change in the procedure came when the Social

Security Amendments of 1983 shifted the COLA effective date from June to December. Since 1984, the COLA has been equal to the percentage increase in the average CPI for the third calendar quarter of the corresponding average or the third Y

ear over the

quarter of the previous year, rounded to the nearest 0.1%. (The 3% “trigger,” which never took effect, was repealed in 1986.)

The law does not say which CPI to use for the COLA because when automatic adjustments were enacted. only one existed. That CPI. now called the CPI for Urban Wage Earners and Clerical Workers (CPI-W). is specified in Social Security regulations as the one to use. The use of this index to adjust Social Security benefits has been criticized, especially by former Senator John Melcher. past Chairman of the Senate Special Committee on Aging, because it excludes the vast

majority of beneficiaries, who are not currently wage earners or clerical workers. (Senator Melcher lost his bid for reelection in 1988 and is not a member of the 1Olst Congress.)

In 1987, Congress directed BLS to study the concept of a special CPI based on a market basket of goods and services purchased by the elderly (although not all beneficiaries are elderly). The BLS report, issued in June 1988. emphasized the limitations of such a special index. When BLS Commissioner Janet Norwood testified before the Senate Committee on Aging in October, she repeated the conclusions of the June report but was willing to conduct a more thorough, - three-year study of the matter.

In the meantime, the Senate adopted a compromise position - that the CPI for All Urban Consumers (CPI- U) be substituted for the narrower


The Actuary--January 1989 11

COLA cont'd

cPI-W. While the CPI-U is not based

O exclusively on the purchases of the elderly, at least it includes most of them in its coverage. The Senate position was included in its version of the tax technical-corrections bill. (Actually, the provision required all federal agencies to use the CPI-U; the IRS already uses it for indexing tax brackets and the personal exemption.) The Admin- istration testified against the switch, saying that it would make no difference, and the provision was dropped in conference.

Another tssue considered simul- taneously involved changes to the CPI-W itself. In January 1988, BLS changed the base period for the index from 1967 to 1982-84. The CPI for the base period is set equal to 100.0. Accordingly, the "official" CPI value for January dropped from about 340 to about 115. One might not consider this too important, but Social Security regulations require the average CPI to be rounded to the nearest one-tenth of a point, before the percentage increase is calculated. Such rounding has a greater effect on a smaller figure,

This wa:~ not just an academic :onsideration. To obtain the actual 40% COLA, the 1967-basis CPI-W needed to reach 352.5 in September, a 6.3% annual rate of change over August. On the 1982-84 basis, the CPI-W needed to reach 118.4, a 7.4% annual rate of change. In other words, if the CPI rose at an annual rate between 6.3!% and 7.4%, the new basis would produce a COLA of 3.9%, but the old basis would produce 4.0%. For a program paying benefits of $230 billion in 1989, the difference is not small, and it would continue into future years.

The Social Security Administra- tion chose to use the 1982-84 basis, as did every other federal agency that uses the CPI. Fortunately, the actual CPI-W values for September were 353.0 on the old basis and 118.5 on the new one. The COLA would have been 4.0% either way! Bruce D. Schobel is Senior Consultant, Social Security Division, Mercer-Meidinger- Hansen Inc.

memoriam Morgan H. Alvord FSA 1942

Joseph A. Christman FSA 1929 George W.K. Grange ASA 1936 Joseph T. McNeely ASA 1929 Donald C.H. Potter ASA 1932

FACTUARIES by Deborah Poppel

This is the second in a series o[ pro[iles o[ members o[ the Society's Board of Governors.

Name: C. S. (Kit) Moore

Birthday: September 17, 1940, 12:15 a.m.

Birthplace: Toronto, Ontario, Canada

Current hometown: Toronto

Employer: William M. Mercer Limited

Children: Graeme, 22; David, 20; Jennifer, 17

My first job was: as a summer student for Manufacturer's Life Insurance Company, converting insurance policy dividends from pounds, shillings, and pence into dollars and cents - by handT

The number of exams I flunked: 3 or 4, which includes my only pass course at university - religious knowledge!

The book I recommend most often: The Wanderer by Alain-Fournier

The last movie I saw: Planes, Trains, and Automobiles (also one of the funniest I've seen!)

Nobody would believe it if they saw me: home for dinner before 6 p.m.

The TV show I stay home to watch: is yet to be created.

If I could change one thing about myself: I'd start with my socks.

When I'm feeling sorry for myself: I shop.

My fantasy is: to spend an evening with Xaviera Hollander (The Happy Hooker).

The silliest thing I've ever done is: to spend an evening with Xaviera Hollander.

If I could do it over I'd have: overdone it again.

My proudest actuarial moment was: becoming one.

The best time of my l i fe was: the last 10 years or so!

12

Editorial

Report from Holland

by Irwin T. Vanderhoof

I recently was privileged to represent the Society of Actuaries in Holland

at the 100th anniversary celebration of the Dutch Actuarial Society. I’m not going to do a travelogue telling you how friendly the people are. Rather, I want to bring two important matters to your attention. First. the whole world is involved in the business we think of as particularly ours. Second, the problems we face are again problems of the profession around the world.

When we hear about the inter- nationalization of the financial markets, we think of the British and the Japanese. During my visit, I learned that the investment of

The Actuary- January 1989

Holland in the United States is exceeded only by the investment of the Arabian oil countries. Nationale- Nederlanden. Aegon, and AMEV, the three largest Dutch companies, have substantial interest in the life industry in the United States. Many SOA members are employed by the North American subsidiaries of these companies. Linda Emory, a former SOA Vice President and now Actuary Editor, is on assignment at The Hague working on the international opera- tions of Nationale. In another 10 years everyone will realize that the U.S. insurance industry is not autonomous but a part of the internationally inte- grated financial markets. We had better try to keep up with this trend, It’s more fun, too.

Internationally, we share concern about the future of the actuary. After listening to discussions of this ques- tion within the Society, I was surprised that the principal business meeting of the Dutch anniversary

celebration would feature a panel discussion on that subject. The points r of view and problems were similar to those discussed here. The academics believed there should be more support for academic institutions in the development of the profession. The consultants talked about the future of consulting. The managers talked about the importance of broader training for the future actuary. Even as our business is becoming internationalized, our problems already are.

Finally I should mention some little known actuarial history. A Dutch mathematician and politician named Johan de Witt wrote the first descrip- tion of the correct way to value a single premium annuity He seemed to have all the qualities we would now desire in an actuary: mathematician, politician, manager. He published his paper in 1671. He was lynched by a mob in 1672. We should try not to draw any conclusions from those facts.

Convertible securities

by Art Berry

T his article will cover the back- ground, objectives, investment

strategy, fee structure, and results to date of an investment management account dedicated to convertible securities for a major insurance company’s general account. This account was established in March 1986 and funded in 10 equal monthly installments throughout the remainder of the year. This method of funding is especially helpful to the investment manager in creating the portfolio, as opposed to a substantial lump sum payment. which can create at least some pressure to commit funds very rapidly

As mentioned, this account is invested almost solely in domestic convertible securities, both publicly issued and privately placed. This includes both convertible debentures and convertible preferred stocks. although some 90% of the securities in the account are currently bonds. In my judgment, were the need to exist, such an account could be managed with all the securities being debentures. On occasion, the account has held modest amounts of common

stock derived from successful conversion of convertible securities called for redemption, at significantly higher price levels than the conversion value of the security originally held. These very small stock holdings are eliminated gradually, usually within several months following conversion.

The account has remained fully Invested since inception, and it would be our intention to continue to refrain from market timing in the future. The amount of cash (short-term securities) awaiting permanent reinvestment rarely exceeds 3% to 4% of the total account value. The account is widely diversified by company and by industry group with specific weight- ings broadly in line with the industry sector emphasis of the equity portfolio group of the parent investment management firm. Emphasis is on small- to medium-market capitalization companies exhibiting above- average and consistent growth. Some larger restructuring candidates are also included in the portfolio.

Considerable attention is given to maintaining an overall portfolio premium level in the mid-20% range. As a result, the average convertible holding is a so-called hybrid, that is, selling at 20% to 45% above its value as a straight fixed-income security. At this level, the security contains about equally weighted elements of

both a fixed-income security and an equity Ideally, it would provide over ,n a three- to four-year period a total rate of return composed of roughly one- half income (bond interest or preferred stock dividends) and one- half appreciation.

The account today contains some 30% in private financing securities. which give the added dimensions of 1) increased portfolio diversification, 2) enhanced current yield and potential total return, 3) reduced volatility, and 4) an ability to tailor a portfolio to the needs of the client.

The fee structure for the account consists of a modest base fee with a substantial incentive component. The latter component is an annual performance bonus equal to 20% of the excess realized return over an average of long-term government bond yields. Realized return is defined as interest income adjusted for: accrued interest on purchase and sale, accrual of discount and amortization of premium. realized capital gains and losses on sale. and losses that the insurance company would have to recognize if bonds cease to be amortizable for their statement.

This resulted in a total fee to the manager of .6l basis points in 1986 and .56 basis points in 1987. Art Berry, not a member of the Society, is Vice President of Alliance Capital.

The Actuary-January 1989 13

Dear Editor: aN ot a ‘blacksmith

(Ed. note: The following letter is in response to Assocfate Editor M. David R. Brown’s editorial in the November Actuary.) How dare you call me a blacksmith because I oppose an action by the Board!

The arguments raised in the letter to the Board do not depend for their validity on the attitudes of the signers. When asked about some issue by its government, the electorate can expect that the government will act in accordance with the electorate’s answer. It is entirely improper for the government to say, ‘*Well, they don’t like the idea, but, poor dears, they really are just a bunch of blacksmiths who cannot see the future. Let’s conduct an experiment (doing what they do not want us to do) and show them the excellent results to convince them of the error of their clumsy and backward-looking thinking.”

Of course, it is necessary and

6

roper for the Board to carry out the ociety’s business without checking

m with the membership...that’s what we put you there for. But you may not seek the opinion of the membership and then act in opposition to it because you are disappointed with the electorate’s expressed opinion.

And don’t call me any more names.

I. Ross Hanson

Don’t follow FASB road Dale Gerboth’s article on “Standard Setting” in the October Actuary struck a very sympathetic note in my heart. I have in the past been rather close to the Financial Accounting Standards Board, and I would not like to see the actuarial profession follow the same road.

The problem is very difficult. On one hand, I agree heartily that profes- sions like ours should have high standards. should have techniques to make them known to practitioners and should police them. But in the

recess we should not degenerate into

ai profession of exegetists. and I have problem defining just what are

“basic principles.” Let me begin with the latter

element. Actuarial work is not like the physical sciences in which basic princi. ples can be intuitively arrived at or

deduced from observation and then tested by unbiased experiment. What may be misdefined as basic principles may in fact be merely conventions or judgments by highly respected persons. A classic example in the accounting field is the venerable APB 11. As I understand the present situation with regard to the recognition of taxes, the minority opinion in APB 11 has now become the bible. “Basic principles” have turned out to be only the majority opinion of a number of years ago. In the meanwhile, practitioners have had to shut off their fundamental thought processes and devote their intellectual activity to the rationaliza- tion of what was in that bible.

It is also, in my opinion, psycho- logically impossible for the promul-

%e ators of such “principles” to resist coming so fanatic about their

pronouncements as to want to set up rules for the excommunication of heretics.

The fact that FASB has on occasion received a very favorable rating from its public does not “prove” that is doing a good job. In my own case, I have contributed a favorable rating because the alternative of accounting rules being set by a government bureaucracy was too dreadful to contemplate! (There were apparently a substantial number of voters in the recent federal elections who similarly voted for the least undesirable candidates.)

I do not have a solution to the problem. But my silence with respect to presenting such a solution does not mean that I am satisfied with the solutions presented by others.

Robert C. Espie

learn from FASB’s mistakes The article by Dale Gerboth on the Financial Accounting Standards Board does an excellent job of describing what I believe is the good and the bad about the Financial Accounting Stan- dards Board. I have been involved with the FASB for many years, both as a supporter and a critic. I am currently serving on the Financial Accounting Standards Advisory Coun- cil, which is a source of information on the FASB about how its activities are perceived by those concerned about their work.

Perhaps the most serious criti-

cism of the FASB is its inclination to supplement its accounting policy decisions with extensive detailed instruc- tions as to how those policies are to be applied. By specifying exhaustive detail relating to application to accounting standards, the clear implication is that applications not proscribed by these rules are permit- ted. There is little room for application of professional judgment.

Such a level of directive detail is favored by many accountants because it simplifies their relationships with those clients who seek maximum flex- tbility in accounting policy But. they are abdicating their responsibility as professionals. It is only a modest exaggeration to say that it is reducing the role of the practicing accountant to that of a bookkeeper. And, the quality of corporate financial reporting suffers greatly as a result.

There is a lesson to be learned by the actuarial profession. Thus far, the Actuarial Standards Board has issued or proposed standards that address basic concepts or approaches. The application of these standards to such specific situations has been left to the professionalism of the actuary. Let us keep it always so.

Dick Robertson

Using SSNs to select random sample Bruce Schobel’s article about Social Security Numbers (SSNs), in the IO/88 issue. reminded me of some investiga- tions I undertook several years ago.

In particular, I looked into use of the last four digits as a way to select a random sample of any desired size from a given population. Presumably there isn’t any bias in the assignment of those digits, since they were (still are?) issued in sequence within large blocks of numbers. For example. Schobel notes that the first three digits have some geographical bias. but the “last six digits had no special significance.”

Our checking of the randomness, while minimal, proved to be satisfac- tory For example. in order to get a 25% sample for interview purposes, SSNs divisible by 4 were selected. The number of persons selected was 25.1% of a multi-employer workforce. Furthermore. a review of employer


14 The Actuary-January 1989

Numberless nevertheless by Barnet N. Berin

I n the United States, things were never the same after a universal

credit card, good for everything private and public, was adopted. It was agreed to use the Social Security number. Once put into effect, there were strange developments.

Letters began to arrive without their usual greetings of “Dear - ,‘I but rather. “Dear XXX-XX-XxXx.”

This turned out to be acceptable, and people began to be referred to by their numbers. To those who were not close friends, letters tended to be formal: “Dear XXX-XX-XxXx. please send $5.” But to friends, “Dear XXX, please send $5.” However, the short form was a failure: Social Security assigns numbers by states so thousands had the same first three XXXs. While the $5’s poured in, conversation became confusing because so many persons responded to the same three digits.

Fractions. decimals, irrational numbers, roots, and powers were experimented with but quickly dropped since both private and government computers would reject these.

People wore their numbers on their lapels. It was so efficient that, in time, names were dropped for numbers, leading to complaints and some unhappiness.

Even-numbered persons were preferred and became an elite class. Odd numbers were considered odd. Numbers ending in zero were considered neither odd nor even and ended up in numerical analysis.

Dear editor con t’d and age characteristics of the sample were acceptably close to 25% of the overall workforce distributions.

Since the selection algorithm was arbitrary, some comparable rule (e.g.. SSNs ending in 00 to 24) probably would have produced similarly acceptable results.

More recently, I have used the same technique on a smaller scale: to allocate assignments among students in large class, their Student Numbers (which are derived from their SSNs) are the control.

Howard Young

For some reason, certain combinations of XXX’s became desirable. Others were frowned upon, and these people joined the inferior, odd- numbered class. Of the even numbers. those ending in two were considered superior, and fortunate college candidates whose numbers ended this way were admitted to the better schools even though their College Board scores might not have qualified them. A study of Nobel prize winners. funded by the Commerce Department’s Economic Development Administra- tion ($200.005). suggested certain favorable combinations. The Social Security numbers of famous people were published annually for parents eager to favorably number their children. Einstein’s Social Security number was retired from circulation as too big a burden to carry. (His sweatshirt remains on the wall at the Institute for Advanced Studies.)

For a fee, genealogists would consult with numerologists for ideal number-names for babies and would trace a person’s ancestors, who simply shared the same number, not the same blood.

Numbers were taking over our lives. Worse yet, 000-00-0000 became depressed, refused to eat and had to get special vitamin supplements to survive, while 999-99-9999, full of odd-number disappointments. became obese and was put on a crash diet.

It was proven, numerically, that astrologists had been right all along: the position of the stars (coordinates. i.e.. numeric identification) did determine our fate. The executive branch came out of the closet.

Inevitably, the Social Security Administration had to change its way of issuing numbers. Instead of being assigned by computer, numbers were sold at huge auctions. Especially desirable ones brought as much as $100.000. The auctions raised so much money that Social Security taxes were reduced, the deficit decreased. and the 18th version of Gramm-Rudman phased out.

Eventually, the number of acceptable positions in a name had to be increased, for subsequent births, to accommodate the number of possibilities and avoid duplications. Later, people would go to court to have their numbers shortened. or made more attractive (even-number

ending), and this created problems, nasty ones, for the courts. This almost led to a war of numbers between the three (!) branches of government.

’

Commercial products were alphabetical at first, then alphabetid numeric, and finally numeric. There was much litigation over proper rights to a trade-number.

Gradually people noticed that numbers could be shorthand for commands and then, gradually, for basic conversation: number 7 = How are you? and number 9 = Fine. how are you? This was quite efficient, since you could 719 quickly and sincerely and then go about your business. It was noticed that all bad words had four digits. Four zeros became an unrepeatable oath.

But it got out of control. The whole world was talking in numbers and understanding each other. This was considered undesirable by states- men, lovers of the romance languages, and distinguished linguists unaccus- tomed to such simple communication. Number theory moved from the -, department of mathematics to the department of languages, renamed the department of numbers at most learned institutions.

However, this didn’t last, Some xenophobic countries began to change bases and adopt new number systems, so that the original number system of base ten (ten fingers, ten toes). began to be supplemented by other systems. Unfortunately, the computer’s base of two (zero and one, yes or no) was felt to be inferior to other bases (including base one, “no” only, in a tiny princi- pality noted for its sloth). and each country began to adopt a different base. The French adopted base four. It was said, unkindly, that this was in tribute to Napoleon’s characteristic pose. In time, this multiplicity led to primary, secondary and tertiary number languages so that everyone’s language was once more unique and conversational ability, between countries, decreased numerically.

We were drawn back to the past and became somewhat muddled, with- writing and conversation once again confused between countries. i Barnet N. Berin is Managing Director-Chief Actuary, William M. Mercer-Meidinger- Hansen. He is a Vice President of the Society and an Associate Editor of The Actuary.

0 The Actuary--January 1989 15

u ACTUCROSSWORD Across Down

1. Quadrilaterals and owl make an honest person (6,7) 9. This month, briefly, emmet is right now (7)

10. Island for new development in copper (5) 11. Finger. Do you follow? (5) 12. One of the fair maidens (4) 13. Animal in first again - bring the guns back (4) 15. Actuaries help in providing this (4,3) 17. Veteran albatross marksman (7) 18. Proposed feed for a change (7) 20. Bright prospect - tennis not bad (3.4) 21. Get on with the job; here’s a trifle (4) 22. Animal color to cringe (4) 23. Indian of alphabetical extremes and a bit technical (5) 26. Animal factor in Orient scene of Lorelei’s spells (5) 27. Bestow a claim to the lint tee (7) 28. Kindly freight, a French husband and take the sun (4,9)

1. Non-sedentary societies always operative (8,6) 2. Taking advantage of a bit of calculus in graduation (5) 3. There is a chance they have gold in Part 5 (4,6) 4. How a gin rash is spread (7) 5. Best work it back and keep silent (7) 6. Credit check beat (4) 7. Land of Hope? (9) 8. Rude little French deed but not decimal (6.8)

14. One paid starts and thespian finishes this instrument (10) 16. Plenty sung about loudly here in France (9) 19. What became of shopkeepers who sparred about (7) 20. Re 24 can and must change (7) 24. Stand: this is pay (5) 25. City catering for disaffected union members (4)

December’s Solution 100% SOLVERS - October: D Baillie, F Bernardi & R Wilton, J Braue, G Cherlin, S Colpitts, C Conradi, S Cuba, E & G Fairbanks, N Fischer, C Galloway, P Gollance, J Grantier, R

Hohertz A P Johnson, R & J Koch, D Leapman, M Lykins & C Mutti, B Mowrey, B Packer, J Schwartz, G Shemtt, N Sha- piro, D Weill, and D S Williams.

Send solutions to: Competition Editor, 8620 N. Port Washington Rd (312) Milwaukee, WI 53217

-

16

A. Premature; untjmely. (2 wds)

B. Gruesome; macabre.

C. As far as; to the end. (3 wds)

D. Most numerous nonqxemmental people in DC.

E. Diirence; fluctuation; music arrangement.

F Reason gone to seed.

G. (2 MIS)

H. Head of an Arab tribe or farnib; lady l&T.

I. Music City, USA.

J. Battle in war; surrender in courtship.

K. Desirable: appmpdate.

L. Objector; resistor.

M. Day of rest.

N. FMng rumor; public acclaim. (4 wds)

The Actuary--January 1989

ACTUCROSTIC

I 1 1 1 1 1 ’ I 53 15 69 229131 31 166

I 1 ' ' ' ' ' ' I 62 135 104 86 17 111 146 2xl

11 11 11 11 1 I 81 16 la, 101 65 49 212 143 27

II 1 fl 11 11 'I 3 37 157 216 194 151 109 64 141

I I1 I I I I I I I

11 190 168 213 55 145 32 115 95

I 1 1 ’ fi 1 1 1 I 4 71 191 217 175 25 108 195

I 1 1 1 1 1 I 19 21 168 162 82 119

I I I I I I

196 147 39 181 125

11 11 11 11 1 I 14 173 90 114 148 180 219 70 51

I 1 I 1 1 I I , 52 203130 79 161 97 9

11 11 11 11 1 I 225171158 5 94 20133155200

I I I1 I 56 116 73 38

0. Outlandish; we&y. (3 wds)

P. Emission or propagation of heat and light.

Q. Reason in a hurry.

R. Culture pattern; mores.

S. Gladys had enough prote&n from the sun.

T Undecided; in suspense. (4 wds)

U. Go on a spree; make merry. (4 wds)

V. Caps on thr~away bottles. (2 wds)

w. Clumsy; stupid.

X. a z + b 2 = c >. (2 wds)

Y. Wherever it may be; anyplace. (3 wds)

2. Nllolame of USA top man until the 20th.

II 11 11 11 1 I 1 ml 83 132185150 29 la? 48

I II 11 I 23 98 218 47 182

I II I 14 1 II 11 61 46 126 177 149 118 31 2U3 84 19

I 1 1 1 1 1 1 1 1 45 13677 202 92 172122m

I I I I1 I I I

33 60 110152 22 m 2

II 11 11 11 1 I 7 184 91 211 58 121 44 la3 72

I1 11 11 I 8 197 85 107224 68

II 11 1 fi 11 1 I

66 210137106221128164144 6

II 11 11 11 1 I 193 117 154 59 188 174 75 12 42

LI 111 1’ 1 L’ I 10 112 43 192 63 170 167 156 206 28

I I I , 129 87 227

I 1 1 I 26 228124

LAST MONTH’S SOIllION: Jacob Lamar, Kids Who Sell Crack - ‘They call him Frog. He is a cocky prince of the barrio. His mane of lustrous jeri curls, his freckled nose and innocent brown eyes belie his prodigious street smarts. He rakes in two hundred dollars a week selling crack. He has used his drug money to rent a Nissan on weekends. Frog is thirteen.” TIME, May 9, 1988.

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