Under the Solvency II directive, insurance companies are required to calculate their Solvency Capital Requirement (SCR) in order to prove to supervisors, policyholders and beneficiaries that they have a high enough level of funds to absorb significant losses and to make payments as they fall due. They have a choice between a standard formula and an internal model in calculating their SCR. Many companies favour internal models as they are more risk-sensitive, capture individual risk profiles and therefore reduce the capital requirements placed on insurance companies by Solvency II. However, internal models are subject to approval by supervisory bodies. Insurance companies need to demonstrate that their internal model meets the use test, statistical quality standards, calibration standards, validation standards and documentation standards. Internal Models and Solvency II clarifies the requirements for practitioners and senior executives by providing regulatory and practical insight into internal models.
Perspectives from both the supervisory and industry side gives unique insight into the spirit and rationale of the requirements, and are complemented by practical solutions to the daily challenges faced when reviewing and implementing internal models. Edited by Paolo Cadoni, currently Technical Head of the Insurance Policy Department at the Prudential Regulation Authority, this book provides support and solutions for the managers charged with implementing and validating their companies' internal models, helping readers to ensure the compliance of their models. Insurance supervisors will also be able to use this book to clarify the requirements when reviewing internal model applications. Internal Models and Solvency II gives readers a wider understanding of the history, challenges, philosophy, and future prospects of Solvency II internal models.
Paolo Cadoni Paolo joined the PRA (formerly FSA) in 2004 where he has held a succession of posts both in banking and insurance. He is currently a Technical Head of Department in the Prudential Policy Division leading on PRA's input into the European Insurance and Occupational Pensions Authority's (EIOPA) Solvency II Committees and the International Association of Insurance Supervisors' (IAIS) Solvency and Actuarial Issues Subcommittee. Since March 2013 Paolo has been the Chair of the IAIS ComFrame Field Testing Task Force which is leading the development of the IAIS Global Capital Standards. Paolo has also chaired the EIOPA Internal Models Committee since 2009. Until March 2009 he was also responsible for the FSA's policy development and implementation of the internal model method (IMM) for counterparty credit risk for banks and investment firms. He also represented the FSA in the Overall Capital and Quantitative Impact Study Working Group of the Basel Committee on Banking Supervision and led the FSA's work on QIS5. Prior to becoming a regulator Paolo worked as a financial modeller in the oil and power sector. He holds a Ph.D. in Finance from the ICMA Centre and an MSc in Econometrics from Southampton University
Foreword Gabriel Bernardino (Chairman of the European Insurance and Occupational Pensions Authority) Introduction Paolo Cadoni 1. Balance Sheet, Capital Requirements and Internal Models Paolo Cadoni 2. Partial Internal Models Juan Antonio Lumbreras 3. The Internal Model Approval Process Stefano Pasqualini 4. Policy for Model Changes Christian Kerfriden 5. Internal Models to Calculate the Group Solvency Requirement: the Perspective of the Home and Host Supervisor Regis Weisslinger, Agnieszka Groniowska and Perrine Kaltwasser 6. Use Test: Challenges and Opportunities Christopher Chappell, Elliot Varnell and Coomaren Vencatasawmy 7. Statistical Quality Standards: Challenges in Internal Model Implementation Markus Bellion, Christopher Lotz and Peter Muller 8. Representation, Reality, and the Solvency II Data Challenge Dean Buckner 9. Calibration standards Ishtiaq Faiz 10. Profit and Loss Attribution Andrew Candland and Christopher Lotz 11. Internal Model Validation - the Regulatory Perspective Ravi Bharos, Christian Kerfriden and Vesa Ronkainen 12. Model Validation: An Industry Perspective Ben Carr 13. Solvency II Internal Model Documentation Requirements Dermot Marron 14. How to Review External Models and Data Embedded in the Modelling Framework Asa Larson 15. The Limitations of Internal Models and the Supervisory Review Process Paolo Cadoni and Christian Kerfriden