It is a process through which all the possible future events are analyzed having considered the alternative outcomes. Such scenario analysis is a significant form of projection which does not try to show the exact picture of the future. In that place, it usually presents few alternatives to the future developments. As a consequence, there is a scope that the future outcomes are observable. Along with this, the development paths are also observable. It further puts effort to consider the turning points that might be connected to the past events. The scenarios usually consist of pessimistic, optimistic and more or less probable developments.
The scenario analysis can also be considered as a process which forecasts the expected value of the performance indicator, the occurrence of various situations in a given time period. It can be used for estimating the behavior as a response to one of the unexpected events. It can also be utilized for the exploration of system performance change. It can be in a theoretical scenario and the possible effect of the scenario can be considered for the development of a strategic plan based on the scenario analysis. The primary aim is to analyze all the results of the extreme outcomes for the determination of investment strategy.
The scenario analysis is needed for structuring the thinking about the future and recognizing the potential issues and at the same time increasing the preparedness to manage those issues. The outcomes are required to be visible because there are various scenarios which are envisaged and at the same time those paths lead to the current situation. It is helpful in giving an organization all the scopes and plans accordingly. It further puts effort to consider the turning points that might be connected to the past events. The scenarios usually consist of pessimistic, optimistic and more or less probable developments.
The insurers can easily use the scenarios in order to do the enterprise risk management. It can in turn improve the whole financial performance of the organization. The entire procedure of conducting a scenario analysis can help in the learning of effectiveness of the insurer’s risk management practices along with the environment in which it operates. At the time of the financial crisis, the scenarios can be used with the advanced technologies, the heightened oversight capabilities and the rating firms.
As a criticism of the scenario analysis, the limitations can be explained. It is the subject to the weaknesses in three of the major areas such as the data quality, the scenario quality team and the model quality. The models can easily be structured, Intuitive or implicit. Those which are the mathematical models are straightforward which are clearly specified. The mathematical models and the quality of the model can also be affected through the specifications and the errors of the parameters. The quality of the data also leaves impact on the reliability of the model. When the data is of improper quality, the results will be unreliable or incorrect. Taken for example, the historical data along with all the emerging risks makes it impossible to be used as the quantitative models. . At the time of the financial crisis, the scenarios can be used with the advanced technologies, the heightened oversight capabilities and the rating firms.
The scenario analysis can be referred to as the process of estimating the value of a particular portfolio which is given at a specific period of time. It is also assumed that there are specific changes in the values of the securities of the portfolio. It is the change in the rates of interest which can be taken for example. The scenario analysis is used for the estimation of the changes in the value of the portfolio as a response to the unavoidable event which might be used for examining the worst case scenario. As a technique, it works by involving the computing of different investment rates for the returns which are reinvested in the investment horizon. It is founded on the statistical and the mathematical principles founded on the occurrence of different situations. A special type of scenario analysis is the worst-case scenario named as stress-testing. It is often used as the computer stimulation technique for testing the resilience of the investments and the institution portfolios against the future of the critical situations.