Mariano Selvaggi

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    Internal Modelling of Operational

    e ra an s n erna ona pera ona sConference, 12-14 May 2010

    www.abioric.com

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    Agenda

    Operational risk under Solvency II

    Challen es of internal modellin

    How ORIC fits in

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    Solvency II: principle-based regulatory themes

    PILLAR 1

    uantitative

    PILLAR 2

    Su ervisor activities and

    PILLAR 3

    Re ortin

    requirements

    internal risk governance and disclosure

    Risk-based capitalre uirements

    Identification of risks notca tured under Pillar 1

    Improve private and publicrisk disclosure

    MCR

    Supervisory review

    Market-consistent valuation

    : s an ar approacversus internal modelling

    s ou cover rsidentification, measurement,management, reporting andmonitoring

    ore ransparency rmsrisk profile & managementpractices)

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    20102010 20112011 20122012

    Level 2Level 2implementingimplementing

    measuresmeasures

    Level 2Level 2implementingimplementing

    measuresmeasures

    2009 June 10

    ECs draft proposals for level 2

    October - November

    Adoption of L2 by EC

    H2 2011

    Final discussions inCouncil and Parliament

    QuantitativeQuantitativeImpact StudyImpact Study

    (QIS) 5(QIS) 5

    QuantitativeQuantitativeImpact StudyImpact Study

    (QIS) 5(QIS) 5

    Feb - Mar

    Draft QIS 5

    Early May

    Deadline for

    comments

    July - October

    QIS 5Q1 2011

    QIS results

    UKs IMAPUKs IMAPprocessprocess

    UKs IMAPUKs IMAPprocessprocess

    Apri l - October

    Entry into FSAs pre-application process

    A ri l 2010 H2 2011

    H2 2011 - H2 2012

    Application review

    IM application process runs

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    Operational risk in Solvency II

    Operational risk included in the SCR (arts 101, 103)

    Definition: inadequate or failed internal processes, orfrom personnel and systems, or from external events

    .

    Includes legal but excludes strategic and reputational.

    Outsourcing viewed as a potentially major source ofopera ona azar s ar .

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    Standard Formula approach

    9 Key features of the SII Level 1 text

    SCR for operational risk depends on volume,

    Technical rovisions

    Earned premiums

    Expenses related to unit-linked business

    Also, Capital charge capped at a % of Basic SCR

    100% correlation with other risks (no divers. benefits)

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    Standard SCR

    Life Ca ed Ex enses

    PROVISIONS

    Other

    Non-lifeHealth

    at X% ofBSCR unit-linkedbusiness

    PREMIUMS

    MAX of loadingfactors++

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    Standard SCR: technical provisions

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    Standard SCR: premiums

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    Standard SCR: other factors

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    Internal modelling approach

    9 FSAs Internal Model Approval Process (IMAP)

    or - erm ac ons

    Firms who aim at IM encouraged to do QIS5

    -

    Optional process; note not pre-approval process

    If IM is rejected, firm reverts to standard SCR

    IM is tool to better understand firms risk profile criteria:

    ,

    Timeline, methodology, tests, statistical quality, documentation

    Model governance, change policy (for full and partial models)

    Group issues (for complex groups)

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    Pre-application timeline

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    Internal model SCR

    Use test

    Statistical

    quality

    P&L

    attribution

    Tests and

    standards

    for IMA CalibrationValidation

    DocumentationModel

    overnance

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    Challenges of oprisk modelling

    Internal loss data collection understand key drivers,

    Risk categorisation event classification boundary

    Data consistency and quality (e.g., measurement)

    Scaling of external losses / benchmarking

    Root-cause analysis (key learning tool)

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    OpRisk M&M

    Internal

    loss data

    ExternalReporting,

    ORM

    s, e c.

    Scenarios

    Self-

    assessments

    Root cause

    analysis

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    Scenarios forward-looking element

    Identifies and characterises33 to - riorit scenarios foroprisk in insurance

    Provides industry guidelinesor requency an severtyassessments

    sound scenarios programme

    Anal ses behavioural biasesin SA workshops

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    Loss data and scenario assessment

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    Robust internal modelling

    Less reliablemodelling

    Less reliablemodelling

    Publicly available (and some proprietary)losses

    -More reliable

    modellingMore reliable

    modelling

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    Evidence on the need for scaling

    Analyses robust techniques for

    scaling the size and number of

    Illustrates sound approaches

    the ORIC database

    Size of the insurer is correlatedwith the severity and number ofoperational losses

    in observed variability remainsunexplained by models roomfor im rovement

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    Key exposures for benchmarking/scaling

    Written Premiums

    Non-financial Assets

    Number of FTEs

    Operating Expenses

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    Illustrative ORIC benchmark report (WIP)

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    Quarterly benchmark report for oprisk losses

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    Example of scaling

    Internal losses only Internal and scaled external losses

    0.5

    0.6

    0.5

    0.6

    0.3

    0.4

    Probability

    0.3

    0.4

    Probability

    0

    0.1

    .

    0.0

    0.1

    0.2

    1 1 1 1 1 1 1 1 1

    Loss amount (in natural logarithm)

    Input BetaGeneral

    6 810

    12

    14

    16

    18

    Loss amount (in natural logarithm)

    Input Lognorm

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    Thank you!

    For more information

    Mariano Selvaggi, Head of ORIC

    +44 (0)20 7216 7387

    Mariano.Se vaggi@a i.org.u

    www.a or c.com