Uses of Efficient Frontier Analysis in Strategic Risk Management

Uses of Efficient Frontier Analysis in Strategic Risk Management: A Technical Examination

WARD CHING

Vice President, Risk Management Operations, Safeway Inc.

LOREN NICKEL, FCAS, CFA, MAAA

Regional Director and Actuary, Aon Global Risk Consulting

Over the past 25 years, the use of advanced quantitative financial and behavioral analysis has received increasing attention in an attempt to better understand and predict the performance impact on hazard risk portfolios. The limitations of single discipline modeling and decision making, which can lead to misreading of financial and performance risks across broad operational categories, were highlighted by the collapse of the financial markets in mid-2007. The need to answer broader risk questions has motivated the risk management industry (i.e., insurance, actuarial, finance, audit, and operations) to recalibrate and redirect core analytical protocols toward a more integrated approach.

The effort to take advantage of complex data techniques was, in part, stimulated by the evolving risk management framework integration into what is now being modestly referred to as enterprise risk management (ERM) or strategic risk management (SRM).

Within the 2013 Risk and Insurance Management Society (RIMS) SRM Implementation Guide, the concept of strategic risk management is defined as a “business discipline that drives the deliberations and actions surrounding business- related uncertainties, while uncovering untapped opportunities reflected in an organization’s strategy and execution.”

What distinguishes this definition from previous descriptions of enterprise wide risk management (ERM) approaches is the effort to sustainably deliver a robust fact-based strategic dialogue across the entire organization. This new strategic dialogue requires an analytical framework that is dynamic and encompasses all areas of an enterprise. In this chapter, we demonstrate how the use of efficient frontier analysis (EFA), and many of its derivative techniques, provides a robust portfolio approach to hazard, operational, market, and reputational risk domains.