Chapter 22 presented a case study in creating value from uncertainty, and chapter 25 presented the use of efficient frontier analysis in SRM. Assume you are the project lead for the analysis team that uses Efficient Frontier Analysis to evaluate risks of

ITS 835 Chapter 25

Uses of Efficient Frontier Analysis in Strategic Risk Management

Enterprise Risk Management

Dr. Les Stovall

Introduction

• Strategic risk management framework • Modern portfolio theory • Practical application of risk measurement for insurance • Sample case study • Intended uses

Strategic Risk Management Framework

• Enables organization to discover risks • Across organizational boundaries

• Continuous cycle • Considers interactions of multiple risks • Combines risk appetite and risk tolerance • Defines exploitable risks

Strategic Risk Management

Modern Portfolio Theory

• Mathematical model – from 1950s • Risk is standard deviation

• When portfolio is weighted combination of assets

• Rp – return of portfolio • Ri – return of asset i • Wi – weighting of asset i

Practical Application of Risk Measurement for Insurance

• Purpose is to optimize insurance placements • And risk limits

• Tail value at risk of loss – TVaRL • Expected value of loss, given that an event has occurred

Sample Case Study

• Three basic risks • Earthquake exposure to buildings

• Workers’ compensation insurance

• General liability insurance

Portfolio Options

Earthquake Options

Workers’ Compensation Options

General Liability Options

Combined Portfolio Options

Intended Uses

• Help large organizations • Risk management

• Portfolio management

• Insurance and non-insurance risks • Best fit

• Established ERM