April 2nd, 2010

Solvency II - Approval of Internal Models: Part III, The Approval Timeline, Approach for Group Internal Models & Conclusions

Posted at 9:30 AM ET

Eddy Vanbeneden, Managing Director

This series continues its review of the implementation measures described by CEIOPS regarding procedures to be followed for the approval of an internal model.

4.   Approval timeline

When the application package for internal model approval is submitted, the regulator will have six months to approve the model or reject it. This period starts on the date when the application is considered complete and will be suspended while the regulator waits for any additional information or for any minor adjustment. It will be stopped when the regulator asks for any major or new modification or when the company decides to withdraw its model from the approval process.

During the approval process and the application of the internal model after the approval, regulators may perform on-site examinations of the model, processes and organizational aspects related to the model.

At the end of the six-month period, the regulator may approve, deliver a limited approval or reject the internal model. A limited approval may be granted when the regulator is looking for further development of the model but considers the current model appropriate for some circumstances, such as a satisfaction of the parts which satisfy the Level 1 text requirements. The approved parts are then considered to be a partial internal model. For limited approvals, a future development plan and timeline may be agreed between the regulator and the (re)insurer. All decisions by the regulator must be documented. The final implementation measures consider that if no decision is communicated at the end of the six-month period, the application will not be considered approved by the supervisory authorities, contrary to what was stated previously in CP 37.

CEIOPS considers the public disclosure of the regulatory documentation related to the models, at least to an interested stakeholder, to be good practice. However, it also recognizes that some negative decisions or reserves could impair the business of the (re)insurer, exacerbating the level of the observed problem, especially during periods of market turmoil CEIOPS supports public disclosure of the information to interested parties. In these instances, the (re)insurer and the regulator will make the final decision on a case by case basis.

When an internal model has been approved, the (re)insurer may start to calculate its SCR based on this model. The use of the model is then considered to be a “going concern.”

5.    Specific approach for group internal models

The group internal model approval process follows the main aspects of the approval process for single companies. However, in view of the additional complexity, CEIOPS has published an additional paper that discusses implementation measures for groups.

The group internal model should cover all insurance entities of the group located in the European Economic Area (EEA) and it is recommended that it cover non-EEA entities as well. The internal model may also be partial and only cover some of the entities in the group.

The application package for approval should be submitted to the group regulator who will then contact the other relevant regulators to advise them of the plans of the (re)insurance group to develop an internal model. It is preferred that all regulators work on the approval process but regulators other than the group supervisor may opt out of the process. Ideally, the regulators should work together on the application package and CEIOPS recommends definition of a clear division of tasks relating to review of the approval form.

The approval process also applies to group internal models. The national regulators corresponding to the local subsidiaries are invited by the group regulator to be associated with this approval phase. This collaborating group is referred to as a “college.” CEIOPS proposes that it be invited to work cooperatively with the college during the six month approval period. The college may choose to not invite CEIOPS to participate. If CEIOPS has not been involved and the college cannot reach an agreement by the end of the approval period, CEIOPS could join the college to work with the regulators to facilitate a final decision. The approval period will then be extended by two months.

Specifically for groups, the application package should also report on the group structure and intra-group transactions including group internal reinsurance transactions. When a (re)insurer or business unit is excluded from the internal model, the rationale for this choice and the alternative method used to assess its risk must be provided.

6. Conclusions

Development of internal models will have different impacts on different Guy Carpenter clients. Looking at the Level 1 requirements and latest CEIOPS recommendations for the approval of internal models, the development of internal models should not only influence the way the SCR will be calculated, but how it also will impact the data quality and the decision process. The efficiency of risk transfer should also be reviewed in line with the impact on the internal model.

In the first two years of the use of internal models for SCR calculations, (re)insurance companies will also have to provide results to the regulators according to the Standard Formula. This formula does not recognize the impact of all non-proportional reinsurance to the same extent that internal models do.

The process for the development and approval of an internal model is intensive and time consuming. Important changes to an internal model also need to go through a new approval process. An important impact of these requirements on (re)insurers may limit their flexibility to develop new and alternative reinsurance products.

Generally, internal models should make the benefits of risk transfer more transparent and should help the definition and placement of adequate solutions. Some companies are already engaged in the pre-approval process and can begin to review their needs in response to regulatory feedback received.

Guy Carpenter’s MetaRisk® is a good solution for internal model development and for developing risk mitigation structures that improve SCR. The most recent release of MetaRisk® allows users to model the different risks of a (re)insurance portfolio on a twelve-month time horizon and with the results, provide a comprehensive risk management picture of the portfolio. With the Decision Rule capability, MetaRisk® supports real dynamic risk modeling. It offers a key benefit when compared with alternative standard products.

Click here to learn more about Guy Carpenter’s MetaRisk® »

Click here to read Part I:  Introduction & Prerequisites for Approval >>

Click here to read Part II:  The Approval Process >>

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

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