{"id":1862,"date":"2022-06-01T13:11:39","date_gmt":"2022-06-01T18:11:39","guid":{"rendered":"https:\/\/www.bbrown.com\/?post_type=insight&#038;p=1862"},"modified":"2022-06-01T14:44:34","modified_gmt":"2022-06-01T19:44:34","slug":"beyond-expected-value-considering-volatility","status":"publish","type":"insight","link":"https:\/\/www.bbrown.com\/us\/insight\/beyond-expected-value-considering-volatility\/","title":{"rendered":"Beyond Expected Value | Considering Volatility"},"content":{"rendered":"<div class=\"wpb-content-wrapper\"><p>[vc_row row_style=&#8221;page-hero&#8221; full_width=&#8221;stretch_row_content&#8221;][vc_column]\n\t<div class=\"hero hero--wrap    \">\n\n\t\t<div class=\"hero--background-image hero--background-image-blur\">\n\t\t\t<div class=\"hero--overlay\"><\/div>\n\t\t\t\t\t\t\t<div class=\"hero-background\" style=\"background: url(https:\/\/www.bbrown.com\/wp-content\/uploads\/2022\/06\/WP-AlternativeFinancing1_WebsiteGraphic-2.jpg) center center no-repeat; background-size: cover;\"><\/div>\n\t\t\t\t\t<\/div>\n\n\t\t<div class=\"hero--container\">\n\t\t\t<div class=\"container\">\n\t\t\t\t<div class=\"hero--inner width-100\">\n\n\t\t\t\t\t\n  <div class='content-heading  100%  '>\n    <p class='text-white subheading'>White Paper<\/p>\n    <h1 class='text-white    '>\n      Beyond Expected Value | Considering Volatility\n    <\/h1>\n\t\n  <\/div>\t\t\t\t\t\n\t\t\t\t\t\n\t\t\t\t\t\t\t\t\t<\/div>\n\t\t\t<\/div>\n\t\t<\/div>\n\n\t<\/div>\n\n\t\n[\/vc_column][\/vc_row][vc_row][vc_column width=&#8221;2\/3&#8243;]\n  <div class='content-heading  100% content-heading--ruled '>\n    \n    <h1 class='text-brand-dark-blue    h2'>\n      Beyond Expected Value | Considering Volatility\n    <\/h1>\n\t\n  <\/div>[vc_column_text]<strong>This is the first of three white papers offered by the Brown &amp; Brown Alternative Risk team on the fundamental tools companies use to estimate and review their corporate risk profiles.<\/strong><\/p>\n<ul>\n<li><strong>White Paper 1: Beyond Expected Value \u2013 Considering Volatility<\/strong><\/li>\n<li><strong>White Paper 2: Loss Dependence \u2013 A Portfolio Level View of Retained Exposure<\/strong><\/li>\n<li><strong>White Paper 3: Corporate Risk Appetite and Program Structuring<\/strong><\/li>\n<\/ul>\n<h3>Market Pricing<\/h3>\n<p>As the insurance market strives for capital efficiency, many risk managers are looking into innovative structures for financing risk. Prior to assessing the organizational value that can be added by any new program structure, Brown &amp; Brown recommends a brief review of volatility in the context of uncertain loss outcomes to refresh one\u2019s familiarity with the quantitative tools used to evaluate the relative merits of competing risk financing strategies.<\/p>\n<p>A few simplifying assumptions made as we review volatility are as follows:<\/p>\n<ol>\n<li>Risk managers will look to finance losses in the most capital efficient manner available.<\/li>\n<li>Insurance purchasers, for the purposes of this review, consider risk on a line by line basis without regard for risk interconnectivity.<\/li>\n<li>A credible stochastic model has been estimated for each source of risk, and actual losses will be known and paid at the end of the year.<\/li>\n<li>Risk transfer counterparties hold capital to support each assumed risk at the 90% confidence level, and they back surplus with cash.<\/li>\n<\/ol>\n<p>We understand that the assumptions are somewhat academic, but they are necessary for us to illustrate these ideas both simply and succinctly.<\/p>\n<p>Volatility is defined as a quantitative measure of the potential for losses to differ from their expected value for a specific underwriting year, based on all information known about the corporation\u2019s exposure to loss at the outset of that year.<\/p>\n<p>A simplified risk transfer market pricing mechanism can be described by the following equation:<br \/>\n<strong><span style=\"color: #73a641;\">Market premium<\/span> = E(loss + LAE) + Administrative charge + Capital charge*<\/strong><br \/>\n*computed using a market derived carrier WACC value and a risk-specific marginal economic capital requirement estimate.<\/p>\n<p>In the following example, we will look at two sources of risk for Company A. Both risks have an expected annual loss pick of $1,000,000. Risk X is less volatile than Risk Y.<\/p>\n<p>Volatility aversion dictates that the market premium for Risk Y be larger than for Risk X. In practice, market participants charge for volatility; this is the case whether the participant is a (re)insurance company underwriter or an institutional investor providing P&amp;C risk capital through an alternative financing mechanism. Merely knowing the expected value of loss associated with a risk is not sufficient to assess its value in the risk transfer market.[\/vc_column_text]\t<div class='wpb_content_element text-left btn-container'>\n\t\t\t\t\t<a class='btn btn-brand-green  '\n\t\t\t\thref='https:\/\/www.bbrown.com\/wp-content\/uploads\/2022\/06\/White-Paper-\u2013-Alternative-Financing-1-of-3-\u2013-Brown-Brown.pdf' target='_blank' data-toggle=''>\n\t\t\t\t<span class=\"btn-text-color--default\">Continue Reading<\/span>\n\t\t\t<\/a>\n\t\t\t<\/div>\n[\/vc_column][vc_column width=&#8221;1\/3&#8243;][vc_single_image image=&#8221;1871&#8243; alignment=&#8221;center&#8221; style=&#8221;vc_box_circle_2&#8243;][vc_column_text]<\/p>\n<h6 style=\"text-align: center;\">Jason Flaxbeard<\/h6>\n<p style=\"text-align: center;\">Alternative Risk Leader<\/p>\n<p>[\/vc_column_text][vc_separator border_width=&#8221;2&#8243; el_width=&#8221;60&#8243;][vc_single_image image=&#8221;1872&#8243; alignment=&#8221;center&#8221; style=&#8221;vc_box_circle_2&#8243;][vc_column_text]<\/p>\n<h6 style=\"text-align: center;\">Andrew Golub<\/h6>\n<p style=\"text-align: center;\">Chief Innovation and Analytics Officer<\/p>\n<p>[\/vc_column_text][vc_separator border_width=&#8221;2&#8243; el_width=&#8221;60&#8243;][vc_single_image image=&#8221;1873&#8243; alignment=&#8221;center&#8221; style=&#8221;vc_box_circle_2&#8243;][vc_column_text]<\/p>\n<h6 style=\"text-align: center;\">Scott Hornyak<\/h6>\n<p style=\"text-align: center;\">Chief Actuary<\/p>\n<p>[\/vc_column_text][vc_separator border_width=&#8221;2&#8243; el_width=&#8221;60&#8243;]\t<div class='wpb_content_element text-center btn-container'>\n\t\t\t\t\t<a class='btn btn-brand-dark-blue  '\n\t\t\t\thref='\/us\/contact\/contact-general\/' target='' data-toggle=''>\n\t\t\t\t<span class=\"btn-text-color--default\">Connect Now<\/span>\n\t\t\t<\/a>\n\t\t\t<\/div>\n[\/vc_column][\/vc_row]<\/p>\n<\/div>","protected":false},"excerpt":{"rendered":"<p>[vc_row row_style=&#8221;page-hero&#8221; full_width=&#8221;stretch_row_content&#8221;][vc_column][\/vc_column][\/vc_row][vc_row][vc_column width=&#8221;2\/3&#8243;][vc_column_text]This is the first of three white papers offered by the Brown &amp; Brown Alternative Risk team on the fundamental tools companies use to estimate and review [&hellip;]<\/p>\n","protected":false},"author":66,"featured_media":1866,"template":"","meta":{"_acf_changed":false,"inline_featured_image":false,"footnotes":""},"insight_category":[34],"class_list":["post-1862","insight","type-insight","status-publish","has-post-thumbnail","hentry","insight_category-property-casualty"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO Premium plugin v27.0 (Yoast SEO v27.0) - https:\/\/yoast.com\/product\/yoast-seo-premium-wordpress\/ -->\n<title>Beyond Expected Value | Considering Volatility - Brown &amp; Brown<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/www.bbrown.com\/us\/insight\/beyond-expected-value-considering-volatility\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Beyond Expected Value | Considering Volatility\" \/>\n<meta property=\"og:description\" content=\"[vc_row row_style=&#8221;page-hero&#8221; full_width=&#8221;stretch_row_content&#8221;][vc_column][\/vc_column][\/vc_row][vc_row][vc_column width=&#8221;2\/3&#8243;][vc_column_text]This is the first of three white papers offered by the Brown &amp; Brown Alternative Risk team on the fundamental tools companies use to estimate and review [&hellip;]\" \/>\n<meta property=\"og:url\" content=\"https:\/\/www.bbrown.com\/us\/insight\/beyond-expected-value-considering-volatility\/\" \/>\n<meta property=\"og:site_name\" content=\"Brown &amp; 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