The Management of Operational Risk Through Appropriate Insurance Schemes

Claims Banks which have strong internal audit and investigative functions and are able to properly document losses, generally experience little difficulty in getting claims paid in a prompt and satisfactory manner. As a very general measure, insurers typically pay about 75% of the claimed value for about 90% of the items for which legitimate claims are submitted. Therefore, if an insured submitted ten legitimate claims totaling SR 1 million in a year, they could reasonably expect to receive between SR 600,000 and SR 800,000 in compensation less deductibles. It is extremely important that the bank clearly understand what is covered and more importantly what is not covered under the insurance contract. The filing of frivolous claims for which no coverage was contemplated in the policy not only creates extra work for the banks but also serves to antagonize both brokers and underwriters. However, it should be noted that claim payment is almost entirely a function of the quality of claims. Fully documented paid in full by underwriters, while poorly documented claims are, at best settled for a negotiated amount below that claimed or denied completely. In addition the quality of claims documentation and processing by both the bank and its broker directly effects the speed with which claims are settled. If underwriters must repeatedly request additional documentation in order to reach a settlement decision, claims processing becomes a drawn out and cumbersome process. In addition, if a bank has inadequate audit trails and investigative documentation procedures it will be necessary to secure the services of outside accountants, attorneys' or loss surveyors to conduct a proper investigation and generate claim documentation which will be acceptable to the underwriter. This process is both costly and time consuming and materially erodes whatever financial settlement is ultimately reached with the insurer. It should also be noted that nowhere in any BBB/FIB or ECC contract a condition precedent to liability exists which requires a court judgment against a perpetrator to prove a claim. In fact, no condition precedent to liability exists in the insurance contract that incidents of either internal or external fraud be reported to the police. Although this may be a legal/regulatory requirement and is certainly a prudent action on the part of the bank. 3.3. Other Insurance Alternatives In addition to conventional insurance programs, a number of alternative techniques have developed in recent years to facilitate the external financing of operational risk. 3.3.1 Risk Retention Groups. Group Captives,. and Risk Sharing Pools Although they are established as insurance companies, they are more properly viewed as self-insurance mechanisms. Risk retention groups, group captives and risk sharing pools are simply cooperative risk funding vehicles designed to write insurance to cover risks. They maybe formed to reduce insurance costs within a specific group of participants, increase limits of coverage and secure more favourable terms of coverage, or to spread the risk as compared to going without insurance entirely. Pools are developed by group captives and self insureds that wish to transfer some of the risk they have agreed to assume. Pooling arrangements frequently occur when group captives cannot find adequate reinsurance or the cost of such reinsurance is excessively high relative to the risk. Thus, participants in a risk retention group, group captive or pool should understand that they are participating in self-insurance. Viewing the captive or pool in this manner is important for two reasons: Paying for Loss - With the exception of reinsurance for potential catastrophic losses, the group will pay for virtually all of its own losses. Pooling the Risk - Experience indicates that the "average premium" theories that underline traditional insurance industry thinking are valid only if good risks are willing to stay in the pool with the bad risks.