Latest Developments in Managing Operational Risk - Center for ...
Latest Developments in Managing Operational Risk - Center for ...
Latest Developments in Managing Operational Risk - Center for ...
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<strong>Latest</strong> <strong>Developments</strong> <strong>in</strong> Manag<strong>in</strong>g<br />
<strong>Operational</strong> <strong>Risk</strong>:<br />
The Insurance Perspective<br />
19 March 2004
2<br />
Background<br />
“Most f<strong>in</strong>ancial <strong>in</strong>stitutions will neither need nor be<br />
expected to achieve the complex risk-management<br />
practices required by the new Basel Accord <strong>for</strong> large,<br />
complex bank<strong>in</strong>g organizations, but their operations will<br />
not be unaffected. Success, <strong>in</strong>deed survival requires<br />
that we all adapt.”<br />
-Alan Greenspan, Federal Reserve Chairman<br />
October 7, 2002
3<br />
Introduction<br />
Unlock<strong>in</strong>g the value of <strong>in</strong>surance<br />
− Case study<br />
Keys to optimis<strong>in</strong>g <strong>in</strong>surance<br />
− Steps to success<br />
The way <strong>for</strong>ward<br />
− Creat<strong>in</strong>g the hedge<br />
Emerg<strong>in</strong>g best practice<br />
− New vs. old methods of purchas<strong>in</strong>g <strong>in</strong>surance<br />
Aon’s role
4<br />
Unlock<strong>in</strong>g the Value of Insurance<br />
Natural hedge <strong>for</strong> operational risk<br />
− Most major operational risks are <strong>in</strong>surable:<br />
− Unauthorised trad<strong>in</strong>g<br />
− Product mis-sell<strong>in</strong>g<br />
Potential to use risk transfer as a capital mitigant <strong>for</strong> up<br />
to 20% of the operational risk charge<br />
Integral element of the capital spectrum
5<br />
Unlock<strong>in</strong>g the Value of Insurance<br />
Case Study<br />
Profile of sample <strong>in</strong>stitution:<br />
Headcount 43,202<br />
Total Assets 353,193<br />
<strong>Risk</strong> Weighted Assets 228,808<br />
Tier 1&2 Capital 24,468<br />
Gross Income 16,071<br />
* All figures <strong>in</strong> Euro millions except headcount<br />
* Source Adjusted Annual Report
6<br />
Unlock<strong>in</strong>g the Value of Insurance<br />
Case Study<br />
Basic Approach:<br />
M<strong>in</strong>. Regulatory Capital 18,305<br />
12% of MRC 2,197<br />
Capital charge @15% of Gross Income 2,411<br />
* All figures <strong>in</strong> € millions<br />
* Source Adjusted Annual Report
7<br />
Unlock<strong>in</strong>g the Value of Insurance<br />
Case Study<br />
Standardised Approach:<br />
Bus<strong>in</strong>ess L<strong>in</strong>es Weight<strong>in</strong>g Revenue Capital Charge<br />
Corporate f<strong>in</strong>ance 18% 1,906 343<br />
Trad<strong>in</strong>g and sales 18%<br />
Retail bank<strong>in</strong>g 12% 6,837 820<br />
Commercial bank<strong>in</strong>g 15% 2,930 440<br />
Payment and settlement 18%<br />
Agency services 15%<br />
Asset management 12% 4,398 528<br />
Retail brokerage 12%<br />
Capital charge<br />
* All figures <strong>in</strong> € millions<br />
2,131
8<br />
Unlock<strong>in</strong>g the Value of Insurance<br />
Case Study<br />
Advanced Approach<br />
Basic Approach charge 2,411<br />
less possible reductions :<br />
Institut<strong>in</strong>g an AMA approach 362<br />
Maximum allowable <strong>for</strong> <strong>in</strong>surance 482<br />
AMA Capital charge 1,567<br />
Total Capital Sav<strong>in</strong>g 844<br />
Annual Net Profit Increase 1 68<br />
* All figures <strong>in</strong> € millions<br />
1 Assum<strong>in</strong>g 8% return on free bank<strong>in</strong>g capital
9<br />
Keys to Optimis<strong>in</strong>g Insurance<br />
Identification & <strong>Risk</strong> Mapp<strong>in</strong>g<br />
Ga<strong>in</strong><strong>in</strong>g <strong>in</strong>sight <strong>in</strong>to the sources of operational risk<br />
– Extract exist<strong>in</strong>g loss experience<br />
– Map risk <strong>in</strong>to relevant categories
10<br />
Keys to Optimis<strong>in</strong>g Insurance<br />
Quantification<br />
Develop<strong>in</strong>g the operational risk profile<br />
– Determ<strong>in</strong>e:<br />
– Exposures<br />
– Economic capital requirements<br />
– <strong>Risk</strong> dependencies / correlations<br />
– Cross-validate with qualitative assessment
11<br />
Keys to Optimis<strong>in</strong>g Insurance<br />
<strong>Risk</strong> Profil<strong>in</strong>g<br />
Assess<strong>in</strong>g risk appetite<br />
– Determ<strong>in</strong>e level of risk appetite<br />
– Establish risk tolerance thresholds<br />
– Align profile to strategic goals
12<br />
Keys to Optimis<strong>in</strong>g Insurance<br />
Develop the <strong>Risk</strong> F<strong>in</strong>ance Programme<br />
M<strong>in</strong>imis<strong>in</strong>g quantity & cost of capital<br />
– <strong>Risk</strong> f<strong>in</strong>anc<strong>in</strong>g programme:<br />
– Internal risk f<strong>in</strong>ance<br />
– Insurance<br />
– Capital markets
13<br />
Keys to Optimis<strong>in</strong>g Insurance<br />
Match<strong>in</strong>g Capital to Exposure<br />
Exposure (€b)<br />
5.0<br />
4.0<br />
3.0<br />
2.0<br />
1.0<br />
Expected Loss<br />
Reta<strong>in</strong>ed Loss<br />
Cont<strong>in</strong>gent Capital<br />
Insurance<br />
0.0<br />
50% 60% 70% 80%<br />
Cumulative Probability<br />
90% 100%
14<br />
The Way Forward<br />
Creat<strong>in</strong>g the Hedge<br />
Future<br />
Lead<strong>in</strong>g<br />
edge<br />
Typical Advanced<br />
0%<br />
Clients,<br />
Products &<br />
Bus<strong>in</strong>ess<br />
Practices<br />
Fidelity<br />
Fidelity<br />
Relationship<br />
<strong>Risk</strong><br />
ECCP<br />
ECCP<br />
Internal<br />
Fraud<br />
PI<br />
PI<br />
People<br />
<strong>Risk</strong>s<br />
D&O<br />
D&O<br />
External<br />
Fraud<br />
EPL<br />
Executive,<br />
Delivery &<br />
Process<br />
Management<br />
Physical<br />
Assets<br />
All <strong>Risk</strong>s<br />
Unauthorised<br />
Trad<strong>in</strong>g<br />
Organisational<br />
Liability<br />
<strong>Operational</strong> <strong>Risk</strong> Protection<br />
Damage<br />
to Physical<br />
Assets<br />
External<br />
Fraud<br />
Employment<br />
Practices and<br />
Workplace<br />
Safety<br />
Non-F<strong>in</strong>ancial<br />
Property<br />
All <strong>Risk</strong>s<br />
Property<br />
All <strong>Risk</strong>s<br />
Cont<strong>in</strong>gent<br />
Bus<strong>in</strong>ess<br />
Disruption<br />
and System<br />
Failures<br />
Technology<br />
<strong>Risk</strong><br />
General &<br />
Other Liability<br />
General &<br />
Other Liability<br />
Capital<br />
100%<br />
Hedge
15<br />
Emerg<strong>in</strong>g Best Practice<br />
New approaches to <strong>in</strong>surance purchase<br />
Previous<br />
− Budget Based<br />
− Market Availability<br />
− Peer group analysis<br />
New<br />
− Aligned with strategic<br />
goals<br />
− Economic tool<br />
− Incentive based across<br />
bus<strong>in</strong>ess l<strong>in</strong>es
16<br />
Aon’s Role<br />
Invest<strong>in</strong>g <strong>in</strong> the necessary tools of the discipl<strong>in</strong>e:<br />
− OpBase<br />
− ORiLDA<br />
Extensive expertise <strong>in</strong> risk assessment and transfer<br />
Advis<strong>in</strong>g regulators<br />
Work<strong>in</strong>g with practitioners to take <strong>in</strong>surance to the next<br />
level
17<br />
Conclusions<br />
Insurance has a significant role to play <strong>in</strong> operational risk<br />
management<br />
Maximis<strong>in</strong>g the benefits requires a discipl<strong>in</strong>ed, “scientific”<br />
approach<br />
Early adopters are emerg<strong>in</strong>g<br />
Competitive advantage if best practice adopted
18<br />
Questions?<br />
Daniel Butler<br />
Telephone: +44 207 668 90814<br />
email: daniel.butler@aon.co.uk
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