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Using First Principles Thinking to Create Business Solutions

November 11, 2020 / by Ben Cohen, FSA, MAAA

The “First Principles” is a four-step approach to breaking down complex problems and generating original solutions. It has been used by some of the best minds of all time, yet no one epitomizes First Principles thinking quite like entrepreneur Elon Musk.

Musk's First Principles focuses on digging deeper and deeper until you're left with only the foundational basics of any given problem. As an actuary, this approach is one of the best ways to learn how to think for yourself and move away from error-prone, time-consuming, and costly offerings. 

In this article, we'll explain why First Principles works and how. As always, the team at Wakely Actuarial is here to lend a hand. Feel free to contact us if you need more apt, helpful, and expert advice.

The Building Blocks of First Principles Thinking

A first principle is a basic, unconditional, and self-evident proposition or assumption that cannot be broken down any further. Some two thousand years ago, Aristotle explained the First Principle as "the first basis from which something is brought into existence."

  • When we solve problems, many times, we replicate what someone else has done. We use an analogy to make deductions and draw our own conclusions. Sometimes, however, solving a problem from the ground up can help us develop quicker, easier, and more concrete solutions.

That's exactly what First Principles is all about: you discard preexisting knowledge and explore a problem independently. You cut through the mud until you reach a "first principle" — an outright truth that doesn't have to be elaborated by another.

Elon Musk & First Principles Thinking

While many great thinkers — such as Feynman, Euclid, inventor Johannes Gutenberg, and military colonel John Boyd — employed First Principles, Elon Musk is arguably its greatest proponent. In fact, his life illustrates this thinking paradigm really well. 

In 2002, Musk began his journey to Mars. His idea was to get the human population off one planet to a second one, and Mars was his target destination.

However, he faced an all-too-common problem. Rockets cost a ridiculous sum of money, upwards of $40 million for single-use rockets that you fire off and become useless thereafter. So he thought: "What really can a rocket be composed of? What are the individual parts?" 

  • He then applied this scientific framework to start from first principles. He broke down the parts of building a rocket. Well, there's titanium. There are also some aerospace-grade aluminum alloys, carbon fiber, and copper. 

Then he went on to establish the cost of these parts on the commodity market, and he found that the material cost of a rocket was only 2% of the standard price. The hike was in the assembly of parts, manufacturing, and R&D. As he disintegrated a rocket, it turned out it wasn't that costly. 

So he thought: "Why not rethink the entire manufacturing process, buy the parts ourselves, engineer it, and build it?" The goal was to cut down costs, and Musk achieved exactly that. After lots of testing and prototyping, they eventually cut the cost down to 10% of the initial price and that’s how SpaceX came to existence.

The good news is you don't have to break down every problem to the atomic level like Elon Musk. The idea here is to think outside the box, and these four steps can help you maximize the benefits of First Principles thinking.

The Four Steps to Applying First Principle Thinking: Identify, Deconstruct, Brainstorm, Innovate

1. Identify — Single Out Problems You Want to Solve

It might be "our package policy is too expensive" or "our CEO and I have different visions for the company."

2. Deconstruct — List all the Reasons You Think You Can't Solve This Problem

Your reasons might include "our individual policies are too expensive" or "the CEO doesn't want to spend more dollars on newer, cutting-edge solutions."

3. Brainstorm — List All the Things You Think Would Solve This Issue But Doesn't Solve It Exhaustively

This is where compromise often comes in.

A possible solution for an overly costly product is to move it abroad — but then, tax remittance and quality control might increase. You and the CEO might agree to cut off one coverage option in the package policy but then optimized policies might reduce the monetary benefit in the short term.

4. Innovate — Create New Solutions

If your main goal is to create an effective policy that is inexpensive, then you'll want to come up with an entirely new policy package. It could be made of inexpensive coverage options or with a unique approach to risk coverage.

The CEO might rethink how your company tackles policy development, perhaps by including all actuaries in every phase and introducing original thinking incentives. You won't run out of quick, sustainable, and cost-effective solutions.

How First Principle Thinking Helps in Making Better Business Decisions

In this digital age, it's nearly impossible for something to be 100% unique. At least some parts of any idea have to be inspired or borrowed from something else — just like Elon Musk had to build his first rocket based on parts from other manufacturers.

The first outcome of what you come up with might not always be original. 

  • However, by applying First Principles, it compels you to look at your product offering through a new lens. 

Even if your products (pensions, policies, etc.) are similar to that of some other company, they'll still work for you because you took the time to think about the audience, context, risks, and other associated factors.

These principles can help you make smart business decisions in the world of insurance and other high-priced actuarial firms. The most common mistake that most of us make is overlooking the basics and offering a policy or pension package that's already in the market. Before we know it, sales have stagnated, and we're faced with a difficult decision on whether or not to write off the package as "bad investment." First Principles thinking acknowledges such gaps and provides an approach to help.

What We've Seen in Our Practice

In our practice, we often suggest that our clients strongly consider starting a project with a First Principles approach. This means that you set up assumptions, models, or product structures that are built from the most granular elements., By doing this, the company is prepared for changes that may be needed in the future. It's not always clear upfront how your actual product experience may develop, and of course the market can change quickly. If your models or product packages are built from the smaller components, then rapid changes to either your analysis or product offerings become much more practical. We often find that poor business decisions can be made because of the practical problems with refiling a product or recreating reporting. Although you might incur higher upfront costs, the benefits of having a First Principles structure will give you the confidence to make the right decisions to manage your business.

Our Final Thoughts

Using this approach, insurance professionals learn first to break down what they know into fundamental truths. Once they understand what is true, they identify gaps, highlight probable solutions, brainstorm to find the best ones, and innovate if possible. You'll learn what you shouldn't be spending time on, and better yet, you'll have a much better sense for where real areas of opportunity lie.

 

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Topics: Insider, Insights

Ben Cohen, FSA, MAAA

Written by Ben Cohen, FSA, MAAA

Ben serves as Wakely Actuarial’s President & Consulting Actuary. He joined Wakely in 2002 and enjoys the variety in the day-to-day of his current role.

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