Actuarial Notes

A New Approach for Managing Operational Risk: Addressing the Issues Underlying the 2008 Global Financial Crisis

By Towers Perrin and OpRisk Advisory · Society of Actuaries · 2010

Study guide: Exam CFE-101

A research report sponsored by the Joint Risk Management Section of the Society of Actuaries, the Canadian Institute of Actuaries and the Casualty Actuarial Society, prepared by Towers Perrin and OpRisk Advisory. Originally published in December 2009 and revised in July 2010, it asks whether there is a better approach to managing operational risk than the traditional audit-based one, and outlines a top-down Modern ORM approach and why the methods commonly used today may not adequately meet the challenge.

On the syllabus

  • Exam CFE-101 — A New Approach for Managing Operational Risk, SOA, Jul 2010 (section 8); outcome 3.2f; Ch. 8 (the syllabus cites it as "A New Approach for Managing Operational Risk, SOA, Jul 2010 (section 8)"); outcomes 2.2h, 3.2f.

1 Executive Summary

2 Introduction

  • 2.1 Project Background and Scope
  • 2.2 Project Team

3 What is Risk?

  • 3.1 Origin and Use
  • 3.2 Traditional and Modern Interpretations
  • 3.3 A Practical Definition of Risk

4 Key Risk Concepts

  • 4.1 Likelihood vs. Frequency
  • 4.2 Expected Loss and Unexpected Loss
  • 4.3 Risk Measurement and Assessment
  • 4.4 Risk Assessment/Measurement Under Traditional ORM
  • 4.5 The Educational Challenge

5 What is Operational Risk?

  • 5.1 The Nature and Magnitude of Operational Risk
  • 5.2 Wrong Turn: From Operational Risk to Operations Risk

6 Risk Architecture and Taxonomy

  • 6.1 The Traditional Risk Universe
  • 6.2 The Modern Risk Universe
  • 6.3 Modern Operational Risk Taxonomy
  • 6.4 Criminal Risk and Principal-Agent Risk

7 The ORM Business Problem

  • 7.1 Roles and Responsibilities
  • 7.2 Modern ORM in Practice
  • 7.3 The Modern ORM Infrastructure
  • 7.4 Traditional ORM in Practice

8 Measuring/Assessing Operational Risk

  • 8.1 Goals of Measuring/Assessing Operational Risk
  • 8.2 The Actuarial Approach
  • 8.3 Data Requirements
  • 8.4 Frequency and Severity Distributions
  • 8.5 How to Model Frequency
  • 8.6 How to Model Severity
  • 8.7 Combining Internal and External Loss Data
  • 8.8 Risk Assessment, Scenario Analysis and Stress Testing
  • 8.9 Calculating Value at Risk
  • 8.10 Modeling the Operational Risk Component of Other Risks

9 The Business Case for Modern ORM

  • 9.1 The Current State of ORM
  • 9.2 Key Differences between Traditional and Modern ORM
  • 9.3 The ORM Evolutionary Path
  • 9.4 The ORM Roadmap
  • 9.5 The Economics of Modern ORM

10 Conclusions and Recommendations

11 References

12 Appendix A — Principal-Agent Risk and the 2008 Global Financial Crisis

  • The Sub-Prime Credit Crisis
  • AIG and Credit Default Swaps
  • Summary and Conclusions

13 Appendix B — Modeling ORM: Key Concepts

14 Appendix C — Glossary of Operational Risk Terminology

Sources