BCBS - Recognising the risk-mitigating impact of insurance in operational risk modelling
In my work related to Advanced Measurement Approach (AMA) operational risk modeling, the use of insurance is always one of the first questions asked. Today, BCBS released a document for comments titled "Recognising the risk-mitigating impact of insurance in operational risk modelling". This aims to provide clarifications and bring the global practice into alignment. Section 4 cover the important process of supervisors' assessment of coverage and alignment of insurance and banks' operational risk profiles. The paper also calls for independent review specifically of the use of insurance and how it is modelled, in order to qualify for capital reduction. It also consider and reject the concept of 'experience requirement', which basically only allow banks to have in place the insurance for certain period of time before starting to recognize it as mitigation for regulatory capital. I agree with the paper's rationale that experience requirement is not that useful for the type of risks that insurance is meant to cover (low frequency, high impact) as banks will not learn much more about the nature of the insurance within the period. In the end, it comes down to - as it often does - banks being able to demonstrate to, and convince the regulator that the method used are sound, and based on reasonable assumptions and convincing data.On the criteria of recognizing insurance mitigation, the paper clarifies many of the criteria first specified in Basel II Accord, which, while cover many areas, still raises many questions for banks which start to seriously consider incorporating insurance into their AMA models. The most challenging (but reasonable) requirements is still the mapping of insurance cover to the risk profiles.
