Module: | MODULE B: RISK MANAGEMENT
Q419: Consider the following statements regarding the use of insurance as an operational risk mitigation tool under the Basel framework:
1. Banks are permitted to use insurance to offset their operational risk capital charge, but the maximum mitigation recognized is strictly capped at 20 percent of the total operational risk capital charge.
2. To qualify for this capital mitigation, the insurance policy must be provided by a third-party entity with a minimum claims paying ability rating of 'A' or equivalent.
3. The insurance policy must have an initial term of no less than one year, with a strict 90-day notice period for cancellation or non-renewal.
Which of the statements given above is/are correct?
2. To qualify for this capital mitigation, the insurance policy must be provided by a third-party entity with a minimum claims paying ability rating of 'A' or equivalent.
3. The insurance policy must have an initial term of no less than one year, with a strict 90-day notice period for cancellation or non-renewal.
Which of the statements given above is/are correct?
✅ Correct Answer: D
The correct answer is D. Statement 1 is correct: Under the Basel framework (specifically under the older AMA and recognized within advanced mitigation principles), banks are allowed to recognize the risk mitigating impact of insurance.
However, regulators impose a strict ceiling: the recognition of insurance can offset a maximum of only 20 percent of the total operational risk capital charge calculated.
Statement 2 is correct: To prevent counterparty risk, the regulatory guidelines specify strict eligibility criteria for the insurance provider.
The insurance must be provided by a third-party entity (not an internal captive insurer), and that entity must possess a minimum claims paying ability rating of 'A' (or equivalent) from a recognized external credit assessment institution.
Statement 3 is correct: Operational stability requires predictable coverage.
Therefore, the insurance policy must have an initial term of no less than one year.
Additionally, to prevent sudden shocks from loss of coverage, the policy must include a mandated minimum 90-day notice period for either cancellation or non-renewal.
Therefore:
Option A is incorrect because Statement 3 is also true.
Option B is incorrect because Statement 2 is also true.
Option C is incorrect because Statement 1 is also true.
Option D is the only correct option as all statements are factually accurate.
However, regulators impose a strict ceiling: the recognition of insurance can offset a maximum of only 20 percent of the total operational risk capital charge calculated.
Statement 2 is correct: To prevent counterparty risk, the regulatory guidelines specify strict eligibility criteria for the insurance provider.
The insurance must be provided by a third-party entity (not an internal captive insurer), and that entity must possess a minimum claims paying ability rating of 'A' (or equivalent) from a recognized external credit assessment institution.
Statement 3 is correct: Operational stability requires predictable coverage.
Therefore, the insurance policy must have an initial term of no less than one year.
Additionally, to prevent sudden shocks from loss of coverage, the policy must include a mandated minimum 90-day notice period for either cancellation or non-renewal.
Therefore:
Option A is incorrect because Statement 3 is also true.
Option B is incorrect because Statement 2 is also true.
Option C is incorrect because Statement 1 is also true.
Option D is the only correct option as all statements are factually accurate.