Unlike market risk, operational risks are largely linked to the internal processes and policies of an insurance company. On occasions, losses arising from the organization’s operational risks may exceed those stemming from credit losses. 

Operational risk management for insurance ensures there is a proper risk management approach to counter the risks inherent to the insurance business. 

Insurance companies must develop an operational risk management framework that enables them to identify, assess, monitor, and control/mitigate operational risks. 

In particular, the insurance company’s operational risk management policies should cover: 

• An operational risk framework 
• Role of the leadership in overseeing the operational risk framework
• Responsibilities in implementing the framework 
• Control review 
• Monitoring and reporting of operational risk loss data 

Here, the first step is to qualify risks in financial services and insurance. 

Read more: Key regulatory obligations in insurance for 2023. 

The sources of risk in the insurance industry

Operational risk in the insurance industry depends on multiple factors such as the nature and complexity of a particular business. From external to internal risk factors, the organization’s risk culture, the global, economic, and financial uncertainty, all factors add up to the complex nature and sources of risks for the insurance companies. 

They are required to identify existing sources of operational risk as well as potential sources of risk that may arise from the introduction of new products, systems, and activities. Identifying sources of risk implies:

1. Internal errors and abuse of power including unauthorized actions by employees, and  misuse of authority. 
2. External violations comprise unlawful conduct by non-employees of the insurance company, loopholes in the security system, gaps in the employment system, job security, and discrimination at work.
3. Challenges in:

• Managing effective customer relationships, 
• Inadequate product marketing, and business procedures, 
• Improper product standardization, 
• Information protection, 
• Trade secrets, 
• Operating procedures
• Business processes, 
• Regulatory changes
• Damage to the property of the insurance company as a result of natural disasters and other events, and 
• Disruptions in the organization of the insurance company and errors in the operation of the systems set up.

    4. Implementation of inadequate business processes and decisions such as ineffective monitoring and reporting, poorly managed documentation, management of claims and obligations towards customers, relationships with other business partners, and relationships with suppliers.

As the risk sources in insurance are constantly evolving, a well-versed and thorough risk management framework in the insurance industry is the need of the hour for the further development of appropriate guidelines for the management of exposures related to operational risks.

Read more: The role of compliance officer and chief risk officer in the insurance industry. 

Top 10 operational risk management strategies for insurance companies 

There are multiple risk management programs that can be incorporated based on the situation. A few most common and effective insurance risk management strategies are:  

Establish operational  management (ORM)  as a comprehensive function

Establishing ORM as a core function and fostering an understanding of program responsibilities across the organization is key to effective ORM implementation.

Leverage technology for transformation 

Technology can increase the value of ORM to the business, C-suite, and organization. One of the key functions within a program for operational risk is collecting and summarizing operational risk data. Analyzing the vast pool of data is a crucial resource for insurance companies to bank upon and derive a data-driven strategy for operational risk management. 

Focus ORM entirely on risk management

ORM functions add business value when they forgo proving non-compliance and focus on the associated risk factors to help companies reduce material risks and immediate risks. 

Position ORM as an integral partner

The effectiveness of an ORM team depends upto a large extent on its ability to collaborate with other functions within the organization. It must stem from the leadership to take ORM seriously across departments and have a collaborative risk management culture so the ORM team can get all the information and support they need to mitigate the risk factors. 

Fostering risk management culture

Operational risk governance sets the tone at the top needed to embed a strong risk management culture throughout the organization. It should also encourage compliance with the risk tolerance set by the board or other administrative, management, or supervisory body.

The management body should play a key role in establishing a strong operational risk management practice for the insurance company in the following ways:

• Embedding a strong operational risk management culture throughout the organization.
• An operational risk management framework needs to be established, approved, and regularly reviewed.
• Monitoring and approving capital allocated to operational risk versus the insurer’s risk profile.
• Executive oversight to ensure effective implementation and communication across the organization.
• Approving and reviewing risk tolerance. 
• Management of the organization must determine which risks it will mitigate, transfer, or accept in accordance with the organization’s overall risk appetite and tolerance.

Implement risk tolerances for operational risk

Defining operational risk tolerances is an important step in building a robust operational risk management framework. Risk tolerances are used to monitor and control operational risk by setting thresholds and limits that alert governance structures to exposure levels above which management actions must be triggered.

Defining clear roles and responsibilities for operational risk management capabilities

As part of an effective operational risk management framework, roles and responsibilities need to be appropriately defined, following the concept of the three lines of defense.

• All people in the organization have the primary responsibility of managing operational risk and implementing the control framework as an integral part of their day-to-day work.
• Oversight functions should have dedicated resources responsible for defining and maintaining the operational risk methodology and framework. Management must ensure that there is an adequate pool of qualified resources and trainees.
• Internal audit provides an objective and independent assessment of the operational risk framework, including the risk management activities performed in both the first and second lines of defense and validation through independent testing.

Integration of robust risk identification and assessment processes

The goal of the risk identification and assessment process is to articulate operational risks using probability and impact techniques in order to mitigate risks. The scope of the identification and assessment process should be forward-looking and cover the entire business process including outsourcing arrangements. 

A risk profile is defined as an assessment of a company’s risk appetite and the threats that a company faces given a company’s risk appetite. Significant changes in the business environment should trigger a reassessment of risk, providing a more dynamic view.

Data analysis

Data collection and analysis are key elements in the assessment and management of various risks. A qualitative or quantitative risk analysis can help to identify potential risks. Conducting a thorough, data-driven risk analysis will help insurance companies isolate and prioritize risks and strategize to address, monitor, and re-evaluate them.

Risk-reward analysis

Execution of a risk-reward analysis is a risk strategy that helps organizations and project teams identify the pros and cons of an initiative before investing resources, time, or money. It’s not only about the risks and benefits of investing funds to seize opportunities, but also about providing insights into the costs of missed opportunities.

The role of VComply in operational risk management for insurance companies 

Getting a full-scale, comprehensive risk management process up and ready can be a daunting task. Risks emanating from multiple areas are extremely difficult for an organization to assess, monitor, and manage all by itself or on spreadsheets. 

VComply risk compliance and management platform helps insurance companies streamline operational risk management. 

With 360-degree risk visibility, measurable outcomes, and meticulous risk assessment, you can standardize and streamline your risk management method with VComply’s pre-configured risk rating guidance. With a centralized risk register, you can get a complete view of all the risk factors and remove ambiguity from the risk assessment process. In addition, you can drive effective collaboration and increase operational risk efficiency through a centralized risk management workspace. 

Conclusion 

Operational risk management is increasingly becoming the norm for the insurance industry. Due to constantly changing regulatory developments, organizations are required to set up an appropriate risk management system. With uncertainty and ambiguity rising, insurance companies have already started ORM implementation based on internal strategic considerations to improve the quality of the process, effective risk management, and contingency planning. In the near future, the strategies will be put to test and their effectiveness will be measured stringently. 

See why VComply stands out as a G2 high performer in Compliance and Risk Management. Request your demo to see how it can drive your compliance initiatives.