Risk Appetite in Theory and Practice: an Application to Property-Liability Insurance Companies

This paper sheds light on the concept of risk appetite by exploring its meaning from both a theoretical and practical perspective. An organisation’s enterprise-wide appetite for risk should reflect the holistic relationship between the desired level of performance and the overall level of residual business risks incurred to generate that performance. This holistic approach requires that the organisation’s performance should reflect the internal costs and revenues generated in the process of creating value, including those involved in the control of risk. Similarly, risk should be conceptualised and measured more broadly than the traditional focus on convariance with the market return. The paper develops accounting-based metrics for risk appetite and illustrates these using data from the U.K. property-liability insurance industry. The metrics can then be used to generate risk-adjusted hurdle rates for investment appraisal decisions, and can utilised to guide risk choices.