UK life insurers have taken advantage of the delays to the Solvency II timetable to make broad refinements to the ways in which they assess and measure risk within internal models, a Towers Watson study has found.
In its annual study of risk calibration methodologies, covering 21 of the UK’s life insurers that employ internal models, the consultancy found that, in contrast to last year, most companies rated their risk validation as ‘Final’ or ‘Almost final’ and also indicated progress on risk dependencies. The areas of greatest concern were credit risk and counterparty default risk where, in both cases, a third of life insurers said a lot of work remained.
Credit risk resulted in the biggest area of diversity observed in modelling approaches, with a broad range of asset classes singled out for special analysis by individual companies. Recent developments have included an increasing number of firms choosing to model bond spreads from financial and non-financial institutions separately. The trend towards larger holdings of non-standard credit-related assets has also been reflected in a growing number of companies choosing to develop new modelling approaches for areas such as residential and commercial property and infrastructure loans/bonds.
Tim Wilkins, a senior consultant at Towers Watson, commented: “As companies increase the detail in their modelling, they are going to face additional challenges in calibrating and validating their models.”
Firms were split on the merits of applying their various models to publish details of their economic capital, including a number who remain undecided on the issue.
Nonetheless, the progress made has encouraged more than half of insurers to say they plan to participate voluntarily in ICAS+, the transitional phase between the current ICA regime and Solvency II proposed by the Prudential Regulation Authority. Of those firms, the majority report that they already use or plan to use most aspects of their Own Risk Solvency Assessment (ORSA) and some aspects of internal models, including risk calibration and aggregation methodologies.
Despite many firms having scaled down their specific Solvency II projects for the time being, or transferred them to ‘business as usual’, the Directive will still loom large in their thoughts, according to Towers Watson.
John Rowland, Global Head of Life Capital Modelling, said: “After a period of months where it has sometimes seemed as if Solvency II has slipped off the agenda, we expect to see a refocusing of resources as internal model approval processes start. Despite benefitting from the hiatus, some key areas of model validation remain to be resolved in many life companies.”
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