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IAI Actuarial Core Principles · Business Management · Decision-making process, attitude to risk and competition

An actuary advising a Kolkata insurer notes that the board's chosen option has the highest expected monetary value but a small chance of ruinous loss. Which is the most appropriate professional comment on using EMV alone?

EMV ignores the spread of outcomes and the decision maker's attitude to risk. For a one-off decision with a small chance of ruinous loss, the actuary should highlight variability and the board's risk appetite alongside the expected value.

  1. AEMV is sufficient because it accounts for every attitude to risk
  2. BEMV ignores the spread of outcomes and the board's risk appetite, so variability should also be consideredCorrect
  3. CEMV should be replaced by maximax because it is always more prudent
  4. DEMV is invalid whenever probabilities are subjective
  5. EMV only works for decisions with exactly two outcomes

Explanation

EMV is a long-run average and says nothing about dispersion or the possibility of an unaffordable loss. A one-off decision with a severe downside needs risk appetite considered. Maximax is optimistic, not prudent.

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