Society of Actuaries (SOA) PA Practice Exam

What is the purpose of a cutoff value in predictive modeling?

1. To categorize predicted probabilities into positive or negative outcomes

2. To determine the overall accuracy of the model

3. To establish the maximum error margin for predictions

4. To quantify the variance explained by predictions

The correct answer is: To categorize predicted probabilities into positive or negative outcomes

The purpose of a cutoff value in predictive modeling is primarily to categorize predicted probabilities into positive or negative outcomes. In models that output probabilities, such as logistic regression, a cutoff value is set to decide the classification of observations based on their predicted probabilities. For instance, if the cutoff is set at 0.5, any predicted probability above 0.5 would be classified as a positive outcome, while those below would be classified as a negative outcome. This threshold allows practitioners to make actionable decisions based on the likelihood of events occurring, such as identifying potential customers who are likely to respond to a campaign or determining which patients may require further intervention. Contextually, determining overall accuracy is related but distinct from the specific role that a cutoff value plays; accuracy depends on how well the model’s predictions align with actual outcomes. Likewise, establishing a maximum error margin pertains to the precision of the model's predictions but does not directly involve setting a cutoff for classification purposes. Finally, quantifying the variance explained is connected to the assessment of model performance, yet it does not focus on the process of converting probabilities into categorical outcomes as the cutoff value does.