Future modelling considerations for operational risk
As part of the ORIC International 2020 Capital Benchmarking Survey, firms were asked to consider the influence of regulation and political decision making on their operational risk models, as well as the areas most reliant on expert judgement. The high level results of these are as follows:
Board Ownership & Training
Best practice within the insurance and investment management industries is that the board have ownership of the capital framework. The board will then delegate its operation and oversight to the sub-committees in line with the three lines of defence model that they have adopted.
In 2016, the Solvency II directive was launched in the European Union in order to ensure insurance companies held sufficient capital to reduce the risk of insolvency. A subsequent effect of the new directive was that firms embedded ORSA processes within the board agenda and timetable. Given this, and following the implementation of the Senior Managers and Certification Regime (SMCR) regulation, our survey finds that only 29% of firms have undertaken specific board training relating to operational risk capital over the last 12 months and only 52% of firms have allocated operational risk scenarios to executive owners, which appears quite low.
A key principle of this new regulation is ensuring that the board and executive team clearly understand and can demonstrate where responsibilities lie for key risks. Training the board to understand the capital framework and allocation of risk scenarios to executive owners would be good evidence to demonstrate compliance with SMCR and this is an area that firms may wish to review. This point is even more important given the current regulatory review of operational resilience across the UK financial services industry. When boards are considering resilience scenarios, impact tolerances and contingency plans, key elements will be linked to their capital frameworks
Brexit
Following the June 2016 referendum in the United Kingdom, in which the UK electorate voted to formally withdraw from the European Union, firms have been preparing for the consequences of Brexit. Brexit has appeared countless times within firms’ emerging risk registers and board agendas over the past three years and clearly a lot of the thinking and preparation is now complete for firms, with 69% of firms stating that Brexit is likely to have minimal or limited impact on their operational risk capital models. The remaining 31% of firms are either factoring the effects of Brexit into their scenario analysis and/or ORSA/ ICAAP processes or increasing capital for certain legal entities within their group that are likely to be affected.
Use of expert judgement
As expected, the survey confirms that for the majority of the insurance and investment management firms, expert judgement continues to be used extensively throughout the capital modelling process as a result of a lack of internal historical data (including quality). The three areas of the operational risk framework that rely the most on expert judgement are scenario assessments (81% of participants, which include frequency and severity assessment), correlations between operational risks and other risks (50%) and the determination of specific parameters within the model (25%). In addition to this, firms also cited scenario identification and selection (19%), capital appropriateness (including reasonability of the model outputs, 19%), model selection and calibration (19%) and allocation methodologies as key areas of expert judgement.
Want to find out more?
Discover more key takeaways from ORIC International's 2020 Capital Benchmarking Survey in our summary report HERE.
If you'd like more information on how you can take part in next year's survey, which is open to both member and non-member participants from the insurance and investment management industries, please contact enquiries@oricinternational.com