Is Insurance a Substitute for Capital under the Revised Basel Accord?

This chapter discusses several aspects of the Basel II framework relating to operational risk and the use of insurance products or risk transfer mechanisms in the context of capital that must be allocated to operational risks. Those capital charges for operational risk are anything but trivial. A few major institutions have already estimated that operating risk capital allocations may well equal or exceed their capital allocations against market risk. To the extent those capital charges may be reduced by qualifying insurance products, interest in such products or structures is likely to be high. The chapter summarizes the operational risk aspects of the Basel II capital framework. Basel II allows for three different risk measurement techniques in the world of operational risk…the basic indicator approach, (BIA); the standardized approach (SA); and the advanced measurement approach (AMA). But Basel II does not provide for any regulatory capital relief through use of insurance products when either the “basic indicator approach” or “the standardized approach” is used for operational risk.