Philippe VelardFinmedia Conference, Bucharest

Basel II – Operational RiskHow insurance will play

February 22, 2006

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1. The relationship between operational risk and insurance

2. Basel II Requirements

3. Main areas of forthcoming challenges for insurance management inside the bank

Agenda

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Marsh/FINPROInsurance and other risk transfer

transactional services

Mercer Oliver WymanAdvisory and consultative services

Marsh Risk ConsultingSpecialized support in related areas such as STARS, business continuity

planning and crisis consulting

MMC Center of Excellencefor Operational Risk

Expertise in strategy, actuarial and risk consulting to the financial services industry

Pioneered integrated risk management frameworks based on systematic risk quantification

World leader in insurance services

Full range of services to identify, value and transfer risk

Knowledge of global insurance markets and capital markets risk solutions

How MMC is organised on Basel II and operational risk

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Section 1.

The relationship between operational risk and insurance

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The Capital Impact of Insurance

CaptiveRetention

Single LineMulti Line

ComprehensiveCover

Earnings Economic Capital

Operational Risk Distribution

Alternative Risk Financing

Expected loss

Maximum probable loss Catastrophic loss

Insurance and Alternative Cover

There is significant potential to transfer operational risk through both traditionalinsurance and alternative risk-financing structures

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Traditional insurance does not cover all operational risks in financial institutions, indeed it will cover selected impacts of selected risk scenarios

Basel and Advanced Measurement Approaches has shown that insurance is associated with less than 30% of operational risk capital

The relationship between operational risk and insurance

Fines &Penalties

TechnologyInterruptions

ProcessingErrors

Other

Insurance

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How good is the insurance coverage ?Still numerous uncovered severity operational risks

InvestmentBank

Markets

RetailBank

CommercialBank

Payments &Services

AgencyServices

AssetManagement

RetailBrokerage

1InternalFraud

2External

Fraud

3Human

Resources

4Clients & Markets

Risk

5Property

6Systems

Disruption

7Process

Risk

Holding

Crime E&O Prop. B.I.

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Section 2.

Basel II Requirements

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Basel II requirements : insurance will reduce the regulatory capital allocated to operational risk, under specific circumstances :

Limited to the advanced measurement approach (A.M.A.)

Capped at 20 % of the regulatory capital before insurance

Subject to a list of qualitative requirements

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The qualitative requirements from Basel II

* claims paying ability rating of A* initial term > 1 year* residual term > 90 days* notice of cancellation > 90 days* coverage provided by a third party insurer (no captives)* no exclusion linked to the failure of the insured* disclosure of the insurance program

* Delay and uncertainty of payment

* mismatches in the coverage of risks (likelihood and impact)

* cancellation clauses and residual term of the policy

COMPULSORYAPPROPRIATE VALUATION

OF THE INSURANCE SHOULD REFLECT :

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The Romanian context

Romanian independent banks will look for basic or standard approaches, with a view, for some of them, to apply for A.M.A. in the medium term

standard banks will have to follow the operational risk management best practices guide

Romanian subsidiaries of A.M.A. foreign banks are integrated in the A.M.A. project of their mother company

They have to comply with their own group procedures

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In both cases, Romanian banks should capitalise now on the first available results of the risk identification projects they have launched

2006

Supervisory reviews

Internal loss data base

Insurance deductibles and captives business plans

Scenarios, risk maps, external data

Extension of insurance coverage 2006/2007

Insurance and capital markets transfers

FREQUENCY

SEVERITY

2007 2008

StandardApproaches validation

Capital allocation model

A.M.A.validation

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Section 3.

Insurance management : main challenges on the way for compliance

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The general conditions of the insurance policyExample of a three year process

2006 2007 2008

• 24 month coverage• Cancellation period 12 m.• simplified policy wording (compliant with the Basel II risk taxonomy)

Amended cancellationclauses

Specific operational riskstransfered to capital markets

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The coverage extension Example of a three year process

2006 2007 2008

• Exclusions• Coverages articulation (Crime / E&O, etc…)• Investment banking

• Unauthorised operations• Cost of correction• Credit fraud• Confidentiality• etc….

• Full comprehensive op. risk coverage• Large payment systems coverage

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The necessary interaction between risk management and insurance decisionExample of a three year process

2006 2007 2008

• Use of the loss data base to determine the deductibles• Use of scenarios to choose the limits of guarantee

• Tailored audited risk information provided to insurers• Loss data base linked warranty statement• Insurance modelised and input in the capital model

Fully integrated insurancedecision process (associating

Risk Division, Compliance,Internal Audit, ALM…)

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Other challenges for insurance managers

Risk & insurance informationSystems harmonisation

Claims management process

Articulation risk management / captives

management

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Questions ?

Philippe Velard

European Operational Risk Team

FINPRO Division

philippe.velard@marsh.com

Tel: (33) 1 41 34 50 29

Eduard Simionescu

FINPRO Romania

Tel: (40) 21 232 1874

eduard.simionescu@marsh.com

This document or any portion of the information it contains may not be copied or reproduced in any form without the permission of Marsh Ltd, except that clients of Marsh Ltd need not obtain such permission when using this report for their internal purposes.

Copyright Marsh Ltd 2006 All rights reserved

Registered in England Number: 1507274, Registered Office: 1 Tower Place West Tower Place London EC3R 5BU

Marsh Ltd is authorised and regulated by the Financial Services Authority.

Marsh Ltd conducts its general insurance activities on terms that are set out in the document "Our Business Principles and Practices". This may be viewed on our website http://www.marsh.co.uk/aboutMarsh/principles.html

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Extra slides

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Global Study of Operational Risk Management Practice – Mercer Oliver Wyman

Mercer Oliver Wyman, a leader in financial services strategy and risk management consulting, recently completed a study of operational risk management practices at financial institutions globally.

The goal of the study was to assess current industry practices, understand developments in those practices, and examine firms’ current challenges and surrounding issues such as the position of rating agencies and regulators.

The study included an examination of industry trends in management approaches, resources, the use of qualitative risk assessments and risk measurement techniques, business mapping and capital modelling tools, and the use of insurance in mitigating operational risk.

The results presented are based upon interviews with 43 financial institutions between October 2003 and March 2004. The majority of these firms are large, internationally active banks that are subject to the guidelines for operational risk management found in the New Basel Capital Accord (‘Basel II’) and resulting regulations.

The study included institutions located in the United States, Canada, United Kingdom, Europe, Australia, Japan and South Africa

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Institutional benchmarking: status of operational risk projects

73%

65%

48%

28%

8%10%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Managementframework

Loss-datacollection

Qualitativeassessments

Modeling KRIs Reporting

Source : MOW - 1Q2004

Status of operational risk initiatives

“Some well developed projects, and identified areas for potential improvement”

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Institutional benchmarking: under-developed areas

A confirmation that insurance is considered as under-developed by Operational Risk managers and is becoming one of their priorities.

50% 50%

30%

18% 18%

KRIs Insurance Loss datacollection

Credit linkedrisk

Model

Source : MOW - 1Q2004