Five things your board wishes you’d told them about operational risk insurance

Angelos Deftereos of XL Catlin outlines the advantages of operational risk insurance – for the risk manager and their board of directors.

Financial institutions may receive little sympathy these days, but they’re going through a tough time. Regulatory supervision is becoming increasingly active and capital requirements are on an upward trajectory. 

Regulators require not only high levels of capital but also that boards demonstrate a thorough understanding of their operational risks and control framework. But help is at hand.  Operational risks insurance is being employed to help address both requirements. Here are five things that boards might not know, but would undoubtedly want to:

1.     Immediate value from the point of purchase

Usually, an insurance policy proves its worth at the point of a claim. Without a claim, it’s tempting to think of where else the premium could have been employed. But operational risk policies are different.  They provide substantial quantifiable financial benefits from the moment they are purchased:

• They generate an annual benefit as approved operational risk regulatory capital;
• They function as an asset, offsetting reserves posted for anticipated losses.

With an operational risks policy, your identified risks are covered and you have a quantifiable value whether you need to claim or not.

2.    Insurance is a cost-effective source of capital

Think of insurance not as traditional risk transfer mechanism, but as a part of the capital base. It represents an addition to available capital without penalising loyal shareholders by diluting their stakes. Additionally, like debt financing, the tax efficiency of servicing costs makes insurance an efficient form of capital.

3.    Used tactically, insurance can improve returns

Beyond the corporate level, insurance can be used to improve returns from individual business units including specific businesses, geographies, even products. An operational risk insurance policy can be used to reduce the drag on earnings caused by the allocation of operational risk economic capital to these entities. So a board can ensure that an operational risk insurance policy is used to reduce uncertainty, boost the returns of a well-performing business or get a potentially profitable new venture “over the line”.

4.    Insurance can be used to address major risks on an individual basis

Boards as well as regulators are haunted by the prospect of large unexpected losses punching a hole in a firm’s capital foundation. Insurers have stepped up and can offer hundreds of millions of capacity, per risk, with the ability to cover several risks at this level. In addition, modern insurance contracts have evolved over the years, greatly improving confidence in the speed and certainty of claims performance. Policies can be crafted to cover potentially any major operational risk loss scenario or risk event type.

5.    Operational Risk insurance is straightforward

Operational risk insurance offers a new way of using insurance, and as with anything new, it can take time to understand the full potential. The good news is, the new generation of operational risk policies are designed to be easy to understand, evaluate and apply. The contracts use the client’s own risk definitions and taxonomies to describe the covered risks. This factor simplifies the incorporation of insurance into internal reporting and control assessments as well as making it easier to comply with the board’s Pillar II obligations for the effective oversight of operational risk assessment and control.

Does your board know about the benefits of operational risk insurance?  With risk management and regulation both hot topics for financial institutions, if they aren’t already looking into it, they’ll probably want it on their agenda.

Angelos Deftereos is senior underwriter - operational risks, international financial lines at XL Catlin.

Angelos Deftereos - XL Catlin