Operational Risk Modeling for Insurance

What Is Operational Risk?

Operational risk covers losses from failed internal processes, people, systems, or external events. For insurers, this includes data breaches, processing errors, fraud, and regulatory penalties. The Basel framework categorizes operational risk into seven event types, and MAS-II expects you to understand how each applies to insurance operations.

Modeling Approaches

The Loss Distribution Approach (LDA) is the most common quantitative method. You model frequency and severity separately, then aggregate using convolution or simulation. Frequency is often Poisson or negative binomial, while severity uses lognormal, Pareto, or generalized Pareto distributions. Scenario analysis and expert judgment supplement data-driven methods when historical loss data is sparse. For exam purposes, focus on computing aggregate loss distributions, understanding capital allocation under different confidence levels, and recognizing the limitations of purely statistical approaches to operational risk.