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FRM Part II · FRM Exam Part II · Risk Mitigation

A bank's operational risk team is evaluating whether to buy insurance against losses from employee theft and fraud. Which feature of insurance as a risk transfer tool should the team recognise as a key limitation?

Insurance creates exposure to the insurer. The bank still faces the risk that the insurer cannot pay, delays payment, or disputes coverage. It does not fix controls, lower event frequency, or eliminate reputational harm, so it only partly mitigates operational risk.

  1. AInsurance eliminates the underlying control weakness that caused the loss
  2. BInsurance converts the operational risk into credit exposure to the insurer, which may fail to pay or dispute the claimCorrect
  3. CInsurance reduces the frequency of loss events in the business line
  4. DInsurance removes the reputational impact of a fraud event entirely

Explanation

Transferring risk through insurance replaces part of the operational loss exposure with counterparty and coverage risk: the insurer may become insolvent, contest the claim, or pay late. Insurance does not fix control weaknesses, does not reduce frequency, and does not remove reputational damage.

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