When a portfolio is properly diversified, the insurer can expect which outcome?

When a portfolio is properly diversified, the insurer can expect which outcome?

• A. Increases return while increasing risk
• B. Increases risk without changing return
• C. Reduces risk for a given level of return
• D. Eliminates all risk

Answer: (C)

Diversification lowers risk by spreading investments across assets that don’t move in perfect harmony, which reduces the portfolio’s overall volatility while keeping the expected return intact. By combining assets with imperfect correlations, the unsystematic risk of individual investments is offset, so the insurer can achieve the same level of return with less risk. However, diversification cannot eliminate all risk because market-wide factors affect nearly all assets, leaving only systematic risk. That’s why the best outcome is reducing risk for a given level of return.

Diversification lowers risk by spreading investments across assets that don’t move in perfect harmony, which reduces the portfolio’s overall volatility while keeping the expected return intact. By combining assets with imperfect correlations, the unsystematic risk of individual investments is offset, so the insurer can achieve the same level of return with less risk. However, diversification cannot eliminate all risk because market-wide factors affect nearly all assets, leaving only systematic risk. That’s why the best outcome is reducing risk for a given level of return.