Riskiness Leverage Models [Discussion]

Rodney Kreps has written a paper that is a major contribution to the CAS literature on the central topics of risk load and capital allocation for profitability measurement, which is a core component of an enterprise risk management system. He has given us a rich class of mathematical models that satisfy two very desirable properties for a risk-load or surplus-allocation method: They can allocate risk down to any desired level of definition and they satisfy the additivity property. Tail Value at Risk and Excess Tail Value at Risk reasonably satisfy the properties that management would likely want of such a model, while still satisfying the properties of a riskiness leverage model and the properties of coherent measures of risk. Donald Mango’s ground-breaking work in developing the concepts of insurance capital as a shared asset and Economic Value Added are discussed. A Risk Return on Capital model is suggested as an integration of the approaches presented by Kreps and Mango. This method measures returns on capital after reflecting the mean rental cost of rating agency capital. Reinsurance alternatives are compared using both the Return on Risk Adjusted Capital approach presented by Kreps and this integrated approach.