Insurance (prudential standard) determination No. 7 of 2006 - Prudential Standard GPS 110 - Capital Adequacy
Operational riskOperational risk
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Operational risk
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As well as measuring financial risks, an insurer’s model for measuring capital adequacy must take into account the various operational risks that it also faces, i.e. the risk of financial loss occurring through error, fraud or failure to perform activities in a timely manner as a result of breakdown of people or systems, internal controls, corporate governance and external events. These risks, although difficult to quantify, have the potential to impose significant costs upon, and possibly seriously jeopardise, the financial soundness and on-going business of the insurer. An insurer’s capital measurement model will therefore need to include a measure of operational risk within its capital.
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An additional risk that needs to be considered and taken account of is the risk that the model itself has failings. An insurer must have procedures for independent review of assumptions and parameters used in the model. Such procedures must focus on finding and limiting errors associated with known model weaknesses and must also include credible on-going efforts to improve the model’s performance.