ORIC was launched partly as a response to new regulations. The UK Financial Services Authority (FSA) and Solvency II, the EU Directive, both consider operational risk when defining solvency requirements for insurers.Since the end of July 2011, ORIC have been pushing ahead with assorted modelling projects in order to enhance our services  - adding more  Solvency II value for both existing and new Members.The FSA is supportive of this industry-led initiative on operational risk and is showing a keen interest in the future development and expansion of the consortium.

Value to Operational Risk Managers;

Importance of external loss data

Quantifying appropriate capital requirements for operational risk remains a challenge for many insurers. This is because internal data on operational losses is often limited and biased. An external source of loss information not only provides evidence for the robust assessment of capital requirements for operational risk, but provides insight to loss scenarios and risk management issues experienced by peers.Consortium data thus offers a benchmark against which a company’s individual loss experience and risk-management approach can be compared.At the EU level, the Committee of European Insurance and Occupational Pensions Supervisors (now EIOPA) set up an Internal Models Group to take forward the work on internal models within Solvency II. EIOPA is also developing detailed advice on implementation measures around Operational Risk.

Modelling tools

1              Scaling

ORIC is working with the Members to design and deliver scaling tools early in 2012. This will allow the scaling of operations by business class, size, loss events and other parameters across a variety of sectors, ensuring the loss data is as valuable as possible. One of the major benefits of scaling is that ORIC loss data can be made relevant for Insurers of all sizes, class of business and location.

2              Scenario Benchmarking

In parallel with the scaling project, Members are commencing phase 2, which will deliver scenario benchmarking tools for all. The objective here is to utilise the current range of 33 scenarios (developed by ORIC) permitting Members to assess processes, procedures and impacts, as well as to facilitate capital modelling. New scenarios can be developed and added to the database as required. This will reduce the frequency of events and their impacts, minimising balance sheet exposures whilst actively demonstrating good risk management practice.  

 3              Capital modelling

The final piece (upon delivery of 1 & 2 above) of tool development will be in respect of capital modelling. The amount of capital required by insurers to fund operational risk liabilities can more accurately be quantified by reference to an industry wide external database. Whilst Operational Risk may only constitute circa 10% of Solvency II driven capital requirements, this will amount to £millions.  The annual ORIC Membership fee is a tiny outlay by comparison to the savings that can be achieved by reducing your Operational Risk capital needs. The projects ORIC are about to embark on will culminate in the provision of Operational Risk capital modelling tools, allowing Members to calculate their capital requirements in a manner designed to satisfy the demands of regulators and the Solvency II directive.

Alternatives

Some insurers are developing their own internal models, or buying expensive software and support from the rapidly increasing array of suppliers, all jostling for space in the market. Whilst this may be the preferred option for managing internal loss data, both these solutions incur considerable capital outlay with annual licence fees and service costs, but leave the user still needing access to external loss data in order to validate that model.The ORIC solution provides the best cost access to reduced Operational Risk capital requirements, as well as access to in excess of 3,500 (and rising) events for benchmarking and modelling purposes. The new tools we are installing will assist Members in producing more accurate and pertinent reports for significant compliance and balance sheet benefits.

Value to CFO’s, CRO’s and main Board;

The ORIC solution (with the added benefits of modelling) delivers the most economic possible method to achieve Solvency II Op Risk capital savings.For example, a company with a Solvency II capital requirement of £500m would have (circa) £50m of this allocated to Operational Risk, and if use of ORIC brings about a 20% reduction to this figure, then savings of £10m are achieved. The capital position of each company will vary, but most companies have 8-12% of total capital under ICAS (IRM survey) tied to operational risk. With the cost of capital at typically 8-10%, these savings generate  £1m/p.a. by the release of capital tied up in non-value adding activities.With ORIC Membership fee at  £17.5k p.a. from April 2012, plus estimates of circa £20k for the additional modelling tools, then even with an allowance for internal costs of (say) £75k, the cost benefits alone are substantial, as demonstrated below.Using a rounded ORIC cost of (say) £100k annually in order to deliver benefits of £1m gives a conservative payback  period of only 6 weeks.There are other notable risk management benefits, but we recognise that it is the financial argument which accesses the budget necessary to make ORIC a ‘must have’ Op Risk tool