The insurance industry needs more dynamic and not more complex economic capital models if it’s going to avoid suffering again some of the problems that were exposed during the financial crisis four years ago. This was the view expressed by Markus Stricker, director of the Willis Economic Capital Forum (WECF), the latest initiative from the academic and analysis arm of Willis Group Holdings.
“I think everyone in the industry would be interested in reducing the complexity of models, making things more transparent and thus easier to understand,” said Stricker. “We ought to have learnt in the years since the financial crisis that our economic capital models need to be more dynamic and more insightful.”
Instead, Stricker thinks that Solvency II has become more complicated and its benefits will not be fully realised.
The WECF was announced in July last year and is based at Georgia State University. It aims to support the insurance industry’s development and use of economic capital models and is part of the Willis Research Network.
Strickler added “Looking at economic capital in a very static manner is not all that helpful, in particular if many of the parameters only have a marginal impact on the economic capital requirements. We need to develop simpler, more dynamic models that give us more insight.”
Speaking about the WECF, Stricker said it will seek to advance applied research on the topic of internal economic capital models in a number of ways. One of the biggest challenges that insurers and regulators face, which the Forum will seek to overcome, is to validate their models, he said.
“At the moment a standardised process does not exist for validating economic capital models. This creates a number of issues such as their limitations and evolution over the years is usually not well documented, the comparability of their results between years and between companies is difficult to assess and last but not least the validation process is often inefficient.
“These issues could be addressed by a widely recognised and structured validation process. This would introduce more transparency and efficiency for all stakeholders: insurance companies, regulators and brokers.
“We can learn a lot from looking at other industries,” he continued. “Aeroplane manufacturers, for example, run standardised stress tests so they know how much pressure they can put on a wing before it breaks off. Meanwhile pharmaceutical companies have a rigorous, structured process to get a medication validated.
“I think we need a similar set of standard procedures to validate the methods that financial companies use to calculate solvency related key figures. The WECF can make a big difference in this area.”
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