Question 430
A finance director presents annualized loss expectancy as exactly $80,000, but its incident-frequency estimate comes from only two historical events and a wide expert range. What should the risk analyst do before relying on the figure?
Explanation
Correct Answer
Sparse loss-frequency data supports a range of plausible ALE outcomes rather than treating one model estimate as precise fact. Risk work separates frequency and loss estimates, risk tolerance, authorized treatment and documented residual exposure. The case turns on its incident-frequency estimate comes from only two historical events and a wide expert range; “Document model uncertainty and perform sensitivity analysis on the annual frequency assumption” addresses that precise condition. “Assume the largest historical loss happens every week without evidence” is not equivalent because an unsupported extreme frequency distorts expected loss rather than improving confidence in the model.
Incorrect Answers
An unsupported extreme frequency distorts expected loss rather than improving confidence in the model. Risk work separates frequency and loss estimates, risk tolerance, authorized treatment and documented residual exposure. In the reported situation, its incident-frequency estimate comes from only two historical events and a wide expert range. The effective mechanism is “Document model uncertainty and perform sensitivity analysis on the annual frequency assumption”: sparse loss-frequency data supports a range of plausible ALE outcomes rather than treating one model estimate as precise fact.
Extra digits cannot create statistical certainty when the underlying frequency estimate is weak. The evidence is its incident-frequency estimate comes from only two historical events and a wide expert range. Risk work separates frequency and loss estimates, risk tolerance, authorized treatment and documented residual exposure. By contrast, “Document model uncertainty and perform sensitivity analysis on the annual frequency assumption” operates on the specific concern: sparse loss-frequency data supports a range of plausible ALE outcomes rather than treating one model estimate as precise fact.
Arbitrarily suppressing modeled event frequency hides rather than resolves epistemic uncertainty. Risk work separates frequency and loss estimates, risk tolerance, authorized treatment and documented residual exposure. Here the decisive fact is its incident-frequency estimate comes from only two historical events and a wide expert range. “Document model uncertainty and perform sensitivity analysis on the annual frequency assumption” matches that requirement because sparse loss-frequency data supports a range of plausible ALE outcomes rather than treating one model estimate as precise fact.






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