Measuring risk
Understanding exactly what risk means
The problem
Our client wanted to set up a reserve to cover the risk of losses from the failure of their IT systems. They wanted the reserve to be sufficient to cover a "one in ten year event".
Solution
The starting point was to calculate the "Value at Risk" or "VaR". This is a way of measuring risk that is widely used in the banking and insurance sectors. It told us the maximum loss that was expected 9 times out of 10; however it gave no information about how big losses could be on the 10th occasion.
LCP used a more robust method called "Tail Value at Risk" or "TVaR". This method estimated the average size of losses that would happen in the worst year in 10.
Benefit to client:
By going beyond the traditional way of measuring risk, we were able to inform our client fully about the risks they were facing. Our client was able to set up a reserve that accurately reflected the amount of risk it was willing to take.
