FRM Part II · FRM Exam Part II · Risk Mitigation
A bank wants to reduce its capital requirement by recognizing insurance as a mitigant under an advanced internal modelling approach. Which feature of the insurance policy would most weaken the recognition it can receive?
A short residual term with a brief cancellation notice period weakens recognition most. Supervisors need confidence that coverage will remain in force and pay out, so short-dated or easily cancelled policies attract haircuts or no capital relief, whereas strong insurers and relevant coverage support recognition.
- AThe insurer has a strong credit rating
- BThe policy has a residual term of less than one year with a short cancellation notice periodCorrect
- CThe policy is held with a third-party insurer
- DThe policy covers events included in the bank's loss data
Explanation
Supervisory recognition of insurance requires reliable, enforceable coverage; short residual terms and short cancellation notice reduce certainty that cover will be in place, so haircuts apply. A strong insurer, an unaffiliated insurer and relevant coverage all support recognition.
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