February 22, 2006
Philippe Velard
Finmedia Conference, Bucharest

Agenda
1. The relationship between operational risk and insurance
2. Basel II Requirements
3. Main areas of forthcoming challenges for insurance management inside the bank
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How MMC is organised on Basel II and operational risk
Mercer Oliver Wyman
Advisory and consultative services
Marsh/FINPRO
Insurance and other risk transfer transactional services

Expertise in strategy, actuarial and risk consulting to the financial services industry

Pioneered integrated risk management frameworks based on systematic risk quantification
MMC Center of Excellence for Operational Risk
Marsh Risk Consulting
Specialized support in related areas such as STARS, business continuity planning and crisis consulting

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
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The Capital Impact of Insurance
There is significant potential to transfer operational risk through both traditional insurance and alternative risk-financing structures
Operational Risk Distribution
Expected loss
Maximum probable loss
Catastrophic loss
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Earnings
Captive
Retention
Economic Capital
Single Line
Multi Line
Comprehensive
Cover
Alternative Risk Financing
Insurance and Alternative Cover
5

The relationship between operational risk and insurance

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
Technology
Interruptions
Processing
Errors
Fines &
Penalties
Other
Insurance
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How good is the insurance coverage ?
Still numerous uncovered severity operational risks
Investment
Bank
Markets
Commercial
Bank
Retail
Bank
Payments &
Services
Asset
Management
Agency
Services
Retail
Brokerage
Holding
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1
Internal
Fraud
2
External
Fraud
3
Human
Resources
4
Clients &
Markets
Risk
5
Property
6
Systems
Disruption
7
Process
Risk
Crime E&O
Prop. B.I.
7

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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
COMPULSORY
APPROPRIATE VALUATION
OF THE INSURANCE
SHOULD REFLECT :
* 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
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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
Supervisory reviews
Standard
Approaches validation
A.M.A.
validation
2006 2007 2008
U
E
N
C
F
R
E
Q
Y
S
E
V
E
R
I
T
Y
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Internal loss data base
Insurance deductibles and captives business plans
Scenarios, risk maps, external data
Extension of insurance coverage 2006/2007
Capital allocation model
Insurance and capital markets transfers
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The general conditions of the insurance policy
Example of a three year process
Specific operational risks transfered to capital markets
Amended cancellation clauses
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• 24 month coverage
• Cancellation period 12 m.
• simplified policy wording
(compliant with the Basel II risk taxonomy)
2006 2007 2008
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The coverage extension
Example of a three year process
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• Exclusions
• Coverages articulation
(Crime / E&O, etc…)
• Investment banking
2006
• Unauthorised operations
• Cost of correction
• Credit fraud
• Confidentiality
• etc….
• Full comprehensive op. risk coverage
• Large payment systems coverage
2007 2008
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The necessary interaction between risk management and insurance decision
Example of a three year process
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• 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
2006 2007
Fully integrated insurance decision process (associating
Risk Division, Compliance,
Internal Audit, ALM…)
2008
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Other challenges for insurance managers
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Claims management process
Risk & insurance information
Systems harmonisation
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
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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

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
80%
70%
60%
50%
40%
30%
20%
10%
0%
73%
Management framework
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“Some well developed projects, and identified areas for potential improvement”
65%
Loss-data collection
Status of operational risk initiatives
48%
Qualitative assessments
28%
Modeling
Source : MOW - 1Q2004
8%
KRIs
10%
Reporting
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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%
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KRIs Insurance Loss data collection
Credit linked risk
Source : MOW - 1Q2004
Model
23