FRM Part II · FRM Exam Part II · Risk Mitigation
Which practice best addresses moral hazard that arises once a bank has purchased operational risk insurance?
Deductibles and co-insurance reduce moral hazard because the bank still bears part of every loss, so it keeps its incentive to maintain strong controls. Full reimbursement would weaken that incentive.
- AEliminating deductibles so the bank is fully reimbursed
- BUsing deductibles and co-insurance so the bank retains part of each lossCorrect
- CBuying cover only after a loss has occurred
- DReducing internal controls to lower premiums
Explanation
Moral hazard is the incentive to take less care once covered. Deductibles and co-insurance keep the bank's own money at stake, preserving the incentive to maintain controls. Full reimbursement worsens the problem, and the other options are impractical or harmful.
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