The bias of size


The bias of size

Research carried out by GR-NEAM has shown an inverse relationship between financial strength ratings and VaR, but the sheer size of a company also plays its part, says Dr Jim Bachman.

Enterprise value at risk (VaR) remains relevant as a key metric in solvency assessment and insurer capital adequacy measurement by regulators in Solvency II regimes. More broadly, including the US, as companies continue to develop their internal economic capital models, VaR is a reference statistic to adjudicate modelled outcomes. In addition, as a competitive assessment tool, VaR metrics can be insightful for benchmarking performance. In all instances, the need for a singular metric comparable across industry segments and geography will increase, as will the need for transparency and uniform methods of estimation.

Individual companies can impact VaR by managing capital composition and leverage, altering product mix and margins, investment allocations and returns, and by mitigating their volatility through a myriad of strategies, all of which change prospective enterprise total return and risk, but often at a cost and not always with guaranteed success. VaR can be used as a calibration tool by insurers seeking to balance return/risk trade-offs from these strategies. It can also be used for performance benchmarking by insurers, investors and other stakeholders.

The dilemma faced by every insurer is to decide its risk appetite and articulate it. Using VaR, or any other set of metrics regardless of the confidence interval or time frame, leaves fundamental questions to be answered such as: “How much capital is enough?” “What is an adequate margin of solvency?” “What is an appropriate/desirable risk appetite?” Unfortunately, there are no published benchmarks. There are no standards. But there are bases of standards: rating agencies, peer reviews and capital market assessments.

Intelligent Insurer