Risk Appraisal - Case Study: Measuring Risk
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.
