Adding up the skills: enormous opportunity awaits firms that master the ability to combine quantitative and managerial skills. (Property/Casualty: Loss/Risk Management Insight).

It's been said that there are two types of people: those who can count and those who can't. At the risk of caricature, we will call them quants and managers. Managers and quants see the world differently. For managers, the world is malleable and can be changed by taking appropriate actions. For quants, however, the world is not something to be manipulated, but to be observed, understood and measured. What's missing, but is sorely needed in our industry, is a third type of personality that combines the strengths of the other two.

For managers, risk is, well, manageable. In particular, managers see a crucial difference between gambling, where risks are determined by unchangeable external forces, and risk-taking, where uncertainty can be limited by the appropriate use of skill or information. Managers see their jobs and careers as necessarily involving a tension between taking risks and limiting risks by actions that shift the odds in their favor. They believe that their essential skill is their ability to distinguish intuitively between "good" risks--ones that turn out favorably--and "bad" risks, which turn out badly. Managers who take on bad risks are typically fired or demoted; those who take on good risks are retained and promoted. Senior managers have a consistent track record for taking on good risks, and they are confident in their ability to avoid bad risks.

For quants, an insurance firm is best viewed as a huge portfolio of underwriting and investment risks, and the essence of management is choosing which risks to accept at what price. Particular risks can be accepted or rejected, but not influenced in any fundamental way, and the successful insurer is able to measure these risks and price them appropriately. Model-building, the quant's essential method for accomplishing this, is vastly superior to human intuition and deserves far more credibility from managers than it receives. Successful quants are those whose models are admired by their peers, a fact that reinforces their confidence in focusing on what can be measured and modeled.

Given these different ways of perceiving the world, managers and quants are often critical of one another. According to quants, managers often confuse luck with skill and rely on intuition rather than rigorous methods for making decisions. The result--quants say--is overconfidence, a tendency to dismiss conclusions arrived at by quantitative methods, and a reluctance to recognize constraints on what is possible. Quants at one major firm vividly recall a meeting at which the chief executive officer said he needed a substantial increase in investment and underwriting income during the coming year but firmly opposed taking any extra risk to do so.

To managers, quants value cleverness more than realism and practicality, are unwilling or unable to clearly explain the reasoning underlying their elaborate models and cannot appreciate the many immeasurable factors relevant to most decisions. Managers also suspect that the results produced by quant models may be highly sensitive to slight changes in assumptions or data. Their suspicions are reinforced when they hear quants defy intuition by asserting that, for example, a one-day; 20% drop in the stock market is improbable--despite the fact that such an event has occurred in recent memory.

The friction between quantitative and managerial personalities is reinforced by the fact that in most companies they are assigned to separate departments, training programs and career paths. Notably lacking are institutional roles that bring together their complementary talents and proclivities--roles in which managerial intuition is routinely confirmed or challenged by rigorous analysis of data, or in which realistic, robust, and dearly explained models are focused on analyzing the costs and benefits of alternative corporate strategies.

Roles and individuals that combine the strengths of quants and managers will be in high demand in the world that is emerging. As always, insurers will need to convince reinsurers, regulators and rating agencies of their ability to rigorously manage their risk exposures. Quantitative techniques will play an increasingly critical role in this task, as has occurred in banking.

Far more important, however, is the enormous opportunity that awaits firms that master the ability to combine quantitative and managerial skills, In the next decades, the greatest rewards will go to firms that most effectively use their capital. Doing so requires a corporate-level synthesis of the quantitative techniques to measure risk and allocate capital and the managerial skills to effectively incorporate that information in business decisions.

William H Panning, a Best's Review columnist, is senior vice president of Willis Re Inc. He can be reached at [e-mail].