Strategic uses of value at risk: Long-term capital management for property/casualty insurers

In contrast to alternative measures of risk, value at risk (VaR) has important virtues intelligibility, comparability, and practicality that make it a potentially valuable tool for strategic decision making and capital management in a wide variety of industries. However, capital-management decisions in most industries including financial services, such as property/casualty insurance have time horizons far longer than the one-day horizon that prevails in commercial and investment banking, where the use of VaR is now concentrated. For VaR to be usefully applied to longhorizon decisions, it must address three fundamental problems unique to that context: estimation risk, adaptive risk modification, and franchise risk. This paper describes each of these problems, shows how they can be solved, and provides examples applicable to property/casualty insurance.