Keeping Solvency II Risk Models Relevant

Large companies are each paying around £200m for the required system and business changes required to comply with Solvency II, while Lloyd’s of London alone estimated its expenditure on compliance to be £300m.

Included in this expenditure has been the creation of sophisticated risk models which assess the inherent ‘riskiness’ of each business and the resulting capital levels required to support solvency. However, there is still further to go to create real business value from these internal models.

The IRM is helping to coordinate the industry to deliver potential solutions to meet some of these challenges. Last year, the Institute set up the cross-industry Internal Model Industry Forum (IMIF) to produce a collaborative industry view of best practices around the use and validation of internal models.

The main purpose for creating the IMIF was to ensure models create value in decision making, are well understood, and gain the confidence of boards and regulators. The IMIF now has over 300 members, plus support from key consultancies, representatives from the industry regulator, the UK’s Prudential Regulatory Authority (PRA), the Institute and Faculty of Actuaries (IFA) and operational risk consortium ORIC International.

Last month saw the first fruits of this collaboration, with the publication of IMIF study‘The valuation cycle: developing sustainable confidence and value’. It was produced by a working group of industry practitioners led by Rob Merry, HSBC’s global head of independent model review, insurance and pensions with support from Barney Wanstall, insurance consulting director at PwC.

Five-step process

IMIF’s first guidance proposes that insurers implement a ‘validation cycle’ to ensure capital models remain fit-for-purpose on an ongoing basis. Ultimately, the validation cycle is a resilient and sustainable process designed to maintain the confidence of the board and regulators and based on the following building blocks and steps:

  •  Identifying and evaluating potential ‘trigger events’ that could require model re-validation.
  •  Planning and executing the validation to ensure a cost-effective process.
  •  Assessing the outcomes of the validation exercise.
  •  Identifying lessons learned from the process.
  •  Communicating and acting upon the validation findings.

Furthermore, the IMIF is not stopping there. Later this summer it will publish two more guides respectively entitled Diversification benefit: understanding its drivers and building trust in the numbers and Modelling Operational Risk.

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