Modelling the mitigation impact of insurance in Operational Risk management

AbstractThe paper is going to quantify the mitigation of the insurance as a risk mitigant in operational risk management for the commercial bank. Due to the uncertainties associated with the insurance policy, such as counterparty default, payment uncertainty and the liquidity risk (i.e., delayed payment), the recovery amounts are subjected to be kind of uncertainty. Thus, the efficiency of insurance as a risk mitigant may be discounted. We aim at going one step further to consider counterparty default, payment uncertainty and liquidity risk. While the counterparty default model focuses on calibration of the default time, the payment uncertainty is set as a non-increasing function depending on loss severity. The key conclusions are that counterparty default does not have significant impact on the capital calibration but still paramount in risk management, and insurance as a risk mitigant indeed improve the operational risk profile of bank and lower the capital requirement to some extent