General Insurance Article - PRA consultation paper on SolvencyII approved internal model


In this consultation paper (CP), the Prudential Regulation Authority (PRA) proposes a supervisory statement setting out the PRA’s approach to monitoring model drift and expectations on firms with an approved internal model for the reporting formula Solvency Capital Requirement (SCR).

 As part of the PRA’s proposed approach to monitoring model drift, the draft supervisory statement sets out an expectation that firms with an approved internal model should privately report their standard formula SCR information on an annual basis. A template is provided as part of the consultation, which the PRA considers would make it simpler for firms to provide the information.

 The CP is relevant to all PRA regulated solo insurance and reinsurance undertakings within the scope of Solvency II which have approval to calculate their solo SCR by internal model (this includes undertakings where the solo SCR is calculated by a group internal model), and to the Society of Lloyd’s in respect of each of their syndicates and in respect of outputs of the Lloyd’s internal model. The PRA may also request information at group level, and firms would be notified of this request via their supervisory contact.

 Background

 The Solvency II Directive includes a provision that, where relevant, the SCR be calculated using an internal model that has been approved by the supervisory authority. This may create some risk that as models evolve over time, capital levels may drift downward and fail to adequately reflect the level of risk in the system. The PRA is proposing an approach to monitoring this risk at the level of individual firms, for sectors and the industry as a whole.

 These proposals should be read alongside PRA Supervisory Statement 25/15 ‘Solvency II: regulatory reporting, internal model outputs’. The proposals set out in this CP would enable the PRA to monitor changes in internal model results against measures that are external to the internal model.

 Summary of proposals

 The purpose of the proposed supervisory statement is to set expectations on internal model firms to report results of their standard formula SCR calculations to the PRA. The PRA proposes to use this information to monitor potential model drift. This includes the monitoring of the internal model SCR against objective measures of risk. These measures of risk, which may change over time, include the standard formula SCR, pre-corridor Minimum Capital Requirement (MCR), net written premium and best estimate liabilities.

 The PRA proposes to calculate model drift ratios from the point of model approval and re-base following a change in risk profile or major model change. This approach would ensure that any drift is identified consistently and monitored over time.

 The PRA does not intend any automatic supervisory action in response to any change in model drift ratios. However, changes may lead to a supervisory review to investigate the reasons for such changes.

 Responses

 This consultation closes on Wednesday 17 August 2016. Please address any comments or enquiries to CP22_16@bankofengland.co.uk.

 To download the Consultation paper click here

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