March 30th, 2010

Solvency II - Approval of Internal Models: Part I, Introduction & Prerequisites for Approval

Posted at 10:00 AM ET

Eddy Vanbeneden, Managing Director
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The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) published many consultation papers in 2009 focusing on Level 2 implementation measures for Solvency II. Consultation Paper (CP) 37 addressed the procedures for approval of internal models. It was followed by a final paper entitled “CEIOPS Advice for Level 2 Implementing Measures on Solvency II ‘The procedure to be followed for the approval of an internal model’”, published in October, 2009.

This series reviews the implementation measures described in the final papers. Implementation measures for the use of partial internal models are briefly described in these two CEIOPS papers. A separate consultation paper, CP 65, proposed specific implementation measures for approval of a partial internal model when it is used in conjunction with the Solvency II Standard Formula. Those specific implementation measures will be covered in a future briefing.

1. Introduction

The development of internal models for the calculation of the Solvency Capital Requirement (SCR) for Solvency II was initially discussed in the Level 1 text (Solvency II Directive). This initial directive was discussed in Guy Carpenter & Company, LLC’s earlier briefing, “European Regulators’ Approach to Internal Model Review,” February 2009.

Several articles of the Level 1 text referred to internal models. The key articles were:

  • Article 100: General Provisions
  • Article 101: Calculation of the Solvency Capital Requirement
  • Article 112: General provisions for the approval of full and partial internal models
  • Article 113: Specific provisions for the approval of partial internal models
  • Article 114: Implementing measures
  • Article 115: Policy for changing the full and partial internal models
  • Article 116: Responsibilities of the administrative, management or supervisory bodies
  • Article 231: Group internal model

Additionally, Articles 120 to 125 described the testing procedures required for approval of full or partial models.

2. Prerequisites for the approval of internal models

Consideration of the global risk approach of the (re)insurer must be included in the internal model approval process. The (re)insurer must prove that it has an effective risk management process in place that includes an agreed-upon risk appetite and procedures for identification and classification of risk.

The (re)insurer must demonstrate that a procedure is in place for accurate reporting of internal model results.

Additionally, the (re)insurer needs to demonstrate that an adequate system of internal controls has been put in place. The level of skills and objectivity of the people responsible for the internal model are also important prerequisites.

Submission of an internal model to the regulator for approval should be accompanied by the results of the most recent Own Risk Self Assessment (ORSA).

The scope of the model approval process is not limited to the development and implementation of an adequate analytical platform, but consists of a broad set of procedures and analyses.

CEIOPS is encouraging (re)insurers and their regulators to begin implementation of the Solvency II regime prior to its formal implementation date. This early engagement, preferred by many (re)insurers, provides an opportunity for the (re)insurer to refine its internal model.

CEIOPS is encouraging the introduction of a pre-application stage because, in addition to providing benefits to the (re)insurer, it allows the regulator to adjust its level of expertise and staff as it learns resource level requirements for Solvency II. It appears that this pre-application phase will eventually not be open to all (re)insurers due to limited regulatory resources in some countries.

Contact Information
This series was prepared by Guy Carpenter’s Financial Intelligence Team (FIT). Questions regarding this briefing may be directed to any of the FIT members, listed below.

Susan Witcraft, Managing Director, Minneapolis         +1 952 832 2143
Frank Achtert, Managing Director, Munich                   +49 89 28 66 03 361
Eddy Vanbeneden, Managing Director, Brussels         +32 2 674 98 11
David Flandro, Senior Vice President, London             +44 (0)20 7357 3267
Benoît Butel, Vice President, Paris                               +33 1 56 76 48 26
Sebastien Portmann, Vice President, Zurich                +41 44 285 9322

 The information contained in this internal briefing is proprietary and confidential and is intended for the use of employees of Guy Carpenter & Company, LLC and its affiliates (collectively, “Guy Carpenter”). If you are not an employee of Guy Carpenter, you are hereby notified that any disclosure, copying, distribution or the taking of any action in reliance on the contents of this internal briefing is strictly prohibited. If you have received this internal briefing in error, please immediately notify Guy Carpenter to arrange for return of the original documents to us.

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