Www.pwc.com AABr Seminar De la dispense clignotant à l’utilisation des des modèles internes sous Solvency II 24 Novembre 2011.

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1 AABr Seminar De la dispense clignotant à l’utilisation des des modèles internes sous Solvency II 24 Novembre 2011

2 Agenda Introduction Risk Management & Clignotant
Date Agenda Introduction Risk Management & Clignotant Modèle interne sous Solvency II Comparaison Solvency II – Pillar 2 November 2011 Slide 2

3 Introduction 1999 : Création du clignotant : SCR avant la lettre
Date Introduction 1999 : Création du clignotant : SCR avant la lettre 2006 :Exemption du clignotant financier 2013 ou 14 : Solvency II November 2011

4 Date Introduction Ne confondons pas : moteur de projection et de calcul avec modèle interne dans le cadre de Solvency II. November 2011

5 CPA La circulaire CPA décrit des règles et des recommandations en matière de mise en place et de maintenance d’un système de Risk Management dans les compagnies d’assurance.

6 Cadre Général Objectif : niveau acceptable de prudence et cohérence des modèles Champ d’application : Tous les risques (vie et non-vie) Partout (filiales et autres implantations) Autres risques Constitution et mise à jour d’un dossier Evaluation du modèle par la CBFA et non certification CPA

7 Critères qualitatifs CPA-2006-1
Disposition d’un département de gestion des risques indépendant (des créateurs de risque). Rôle : Conception, mise en oeuvre et maintenance du système Documentation Système de limite Rapport Contrôle ex-post Stress testing Expertise adéquate Implication du CA et du plus haut organe de direction (politique, suivi, ressources, …) CPA

8 Critères qualitatifs CPA-2006-1
Intégration du modèle dans le processus de gestion des risques Documentation du modèle Rapport interne Utilisation du modèle Validation préalable et indépendante Live testing Contrôle périodique d’adéquation Audit interne régulier du département CPA

9 Critères quantitatifs
Méthodes stochastiques numériques (minimum 1000 scénarios) ou analytiques Projection sur la durée restante ou justification Niveau de confiance minimum 1-α(n) pour un horizon de stochasticité donné : α(n) = min [ γ ; 1 – (1- β)n] où β : niveau de confiance unilatéral fixé par la CBFA n = min(DM; h; θ) où DM = durée moyenne des engagements h = horizon de stochasticité γ et θ : facteurs correctifs déterminés par la CBFA Segmentation en lignes homogènes de taille suffisante Possibilité d’utilisation de model points Volatilité et corrélations des facteurs de risque CPA

10 Détermination des facteurs de risque
Inclusion dans le modèle des facteurs pertinents Pas de création de richesse fictive Facteurs de risque général de taux d’intérêt (courbe de taux, spread Facteurs de risque général sur titres de propriété (actions, immobilier) Facteurs de risque propres aux options (risque linéaire et non linéaire) Facteur de risque général pour position de change CPA

11 Détermination des facteurs de risque
Risque spécifique Risque sur les titres de créance et de propriété non expliqué par un mouvement de marché en général. Risque idiosyncratique (au moins celui-là) Event risk (ex : risque de défaut) R2, contrôles ex-post, … CPA

12 Détermination des facteurs de risque
Risque d’assurance Segmentation en fonction des couvertures offertes, des options pour le client, des conditions socio-économiques. Par gestion distincte ou mandat de gestion d’actifs Description détaillée des segments Hypothèses par segment sur base de l’expérience de l’entreprise ou du marché Pour la non-vie, méthode statistiques permettant d’inclure tous les facteurs pouvant influencer les cash flows futurs + distinction entre sinistres anciens et nouveaux, et entre sinistres normaux et exceptionnels. CPA

13 Détermination des facteurs de risque
Risque d’assurance Lois de rachats et de réduction en corrélation avec l’évolution des taux d’intérêt du marché. Délais des recours Frais compte tenu des plans de l’entreprise et inflatés Participations bénéficiaires projetées à tester sur le passé La réassurance (attention délais) Actualisation au taux sans risque CPA

14 Détermination des facteurs de risque
Lien actif-passif Seulement les actifs représentatifs du segment + actifs libres liés Justification du picking des actifs Modélisation de la politique future de l’entreprise (règles de décision) Divers Démontrer que tous les risques matériels sont modélisés Montrer qu’il s’agit d’un modèle général et non opportuniste Back testing des modèles partiels CPA

15 Simulations de crise (stress testing)
Programme de stress testing rigoureux et adapté Test des “low-probability events” De tests de sensibilité à scénarios hypothétiques complexes Traitement du risque opérationnel, du risque de liquidité et du risque de crédit Réévaluation régulière Documentation Analyse et contrôle par le plus haut organe de direction Mention de tests spécifiques à effectuer CPA

16 Contrôle ex-post (back testing)
Partie intégrante du modèle de gestion des risques Comparaison périodique des risques estimés par le modèle avec la réalité Documentation détaillée des résultats L’entreprise doit pouvoir expliquer le résultat annuel Elle adapte le modèle aux variations observées La méthodologie mise en oeuvre doit permettre d’expliquer 95% des mouvements intervenus Sanction : refus du modèle dans le cadre d’exigences légales ou réglementaires CPA

17 Cas particulier : exemption de dotation au clignotant
CPA

18 Généralités Pour la provision du clignotant tant en vie qu’en accident de travail Pas pour le “clignotant mortalité” de l’accident de travail Dépôt d’un dossier à la CBFA avant le 1er octobre CPA

19 Critère de dispense CPA-2006-2
Exemption accordée pour un segment si la valeur actuelle des cashflows nets pour un niveau de probabilité α(n) si elle est négative est, en valeur absolue, inférieure à 4% PV * [MSC/MSAC] + PCt, segment Où PT = provision mathématique des contrats concernés MSC = marge de solvabilité constituée MSAC = marge de solvabilité à constituer PCt,segment = la provision du clignotant déjà constituée pour le segment concerné Pour la marge constituée ou retire les éléments de plus values latentes, de frais d’acquisition non amortis et de bénéfices futurs dans la mesure où ils sont pris en compte dans le modèle Le Commission peut disqualifier des éléments de la MSC s’ils n’ont pas assez le caractère « fonds propres » CPA

20 Critère de dispense n = min(GD; h) h = horizon de stochasticité
Pour α(n), on utilise γ=10%; β=0.5% et θ=+∞ , c’est-à-dire α(n) = min[10%; 1-(1-0,005)n] où n = min(GD; h) h = horizon de stochasticité GD = durée moyenne des engagements Segmentation répondant aux principes de la « circulaire modèles » CPA

21 Contenu du dossier CPA-2006-2 Etude par segment
+ étude globale par segment + étude par segment pour les contrats concernés par le clignotant mais pas par une demande Modèle de simulation répondant aux exigences de la « circulaire modèle » et en application du « modèle général » présenté à la CBFA (+ indication des adaptations du modèle à l’exercice spécifique) Info sur les actifs (composition, valeurs, durée résiduelle, …) La VC ne peut dépasser le montant des PT correspondantes (lors de la première demande ?) Stress testing : programme imposé et programme libre (adapté) + scénario au taux pivot VaR et TailVaR à 1, 5 et 10 ans (θ = 1, 5 et 10) Probabilité de ruine sur une période de 1, 5 ou 10 ans. C’est-à-dire nombre de scénarios où un problème intervient au moins une fois sur la projection (probabilité cumulative). CPA

22 Internal model in the Solvency II context
Date Internal model in the Solvency II context

23 Introduction: SCR – The standard approach
Date Level 1 Directive Introduction: SCR – The standard approach The standard formula is calibrated to ensure all quantifiable risks the entity is exposed to are captured, covering all existing business and all the business planned to be written within the next 12 months. The main purpose of the standard formula is to help insurers determine their SCR based on a calibration of the risk modules using a value-at-risk measure with a 99.5% confidence level over a one year period. The structure of the formula follows a modular approach. This means that the exposure to each risk category is individually assessed and aggregated at a later stage. 5 QIS to assess the technical provisions and calibrate the MCR/SCR on solo/group basis. November 2011

24 Use of Full and Partial Internal Models (I)
Date Level 1 Directive Use of Full and Partial Internal Models (I) As set out in Recital 68 and Article 112, in accordance with the risk-oriented approach to the SCR, it should be possible, in specific circumstances, to use partial or full internal models for the calculation of that requirement rather than the standard formula. In order to provide policyholders with an equivalent level of protection, such internal models should be subject to prior supervisory approval on the basis of harmonised processes and standards. A full internal model covers the whole business of the insurer and replaces the use of the standard formula in its entirety. A partial internal model has a narrower scope and is used to model certain elements of the business, with the SCR for the remainder of the business calculated using the standard formula. November 2011

25 Use of Full and Partial Internal Models (II)
Date Level 1 Directive Use of Full and Partial Internal Models (II) Under Article 112, an insurer can use a partial internal model to calculate the SCR for one or more of the following elements of the standard formula calculation: One or more risk modules, or sub-modules, of the Basic SCR; The capital requirement for operational risk; or The adjustment to the SCR for the loss absorbing capacity of technical provisions and deferred taxes. A partial internal model may be used to model either the entirety of the business for the chosen areas of the standard formula calculation; or one or more major business units. The use of partial internal models is discussed further below. November 2010

26 Use of Full and Partial Internal Models (III)
Date Level 1 Directive Use of Full and Partial Internal Models (III) While the decision to use an internal model is generally an option for insurers (subject to supervisory approval), Article 119 provides supervisors with the power to require a firm to use a full or partial internal model where it considers the risk profile of the firm to differ significantly from the assumptions underlying the standard formula calculation. The supervisor is required to inform the insurer of the reasons for its decision. Once an insurer’s internal model has been approved by the supervisor, the insurer cannot revert to using the standard formula to calculate its SCR either in whole or in part, except where the reversion is justified and has been approved by the supervisor (Article 117). However, Article 112(7) provides the supervisor the power to require an insurer with approval to use an internal model to also provide an estimate of the SCR calculated using the standard formula. The supervisor is obliged to inform the insurer of the reason for such a requirement being imposed. November 2011

27 Definition and Scope of the Internal Model (I)
Date Level 1 Directive Definition and Scope of the Internal Model (I) One aspect of the scope of an internal model is whether an internal model is a “full” internal model which calculates the SCR in its entirety or whether it is a “partial” internal model that is used in combination with some elements of the standard formula to calculate the SCR. However, another important aspect of the scope of an internal model is identifying which of an insurer’s processes are considered to constitute the internal model. Whilst the Directive and related proposed implementing measures set out extensive requirements around application, approval and use of internal models, they do not provide a definition of the internal model, and provide only limited guidance on the activities that would be considered to constitute an internal model. There is therefore significant judgement to be exercised by insurers in determining how their internal model is defined and what activities are considered to fall within its scope. November 2011

28 Definition and Scope of the Internal Model (II)
Date Level 1 Directive Definition and Scope of the Internal Model (II) Insurers looking to use internal models to calculate their SCR will therefore need to clearly define the scope of the activities that constitute the internal model in terms of systems, processes, policies, controls and other aspects of the business that may constitute part of the model. The following definition of an internal model was produced by the International Association of Insurance Supervisors (IAIS): “… internal model refers to “a risk management system developed by an insurer to analyse the overall risk position, to quantify risks and to determine the economic capital required to meet those risks. An internal model may also be used to determine the insurer’s regulatory capital requirements on the basis of the insurer’s specific risk profile and the defined level of safety of the solvency regime.” Source: Guidance Paper on the Use of Internal Models for Risk and Capital Management Purposes by Insurers, 2007 November 2011

29 Definition and Scope of the Internal Model (III)
Date Level 1 Directive Definition and Scope of the Internal Model (III) Determining those activities and processes that constitute an internal model can have a significant impact, since this scope is used to determine: the elements that must be subject to approval; which elements may be used to calculate the SCR; which elements are subject to public disclosure; and which elements must be subject to ongoing validation and governance, including the reporting and approval of changes to the model. Insurers are likely to seek to strike a balance between ensuring that the model is sufficiently widely defined that it demonstrably meets all the requirements to which an internal model must adhere (for example to allow the insurer to demonstrate a variety of uses and therefore meet the use test) whilst not including any superfluous elements. November 2011

30 The Application Process
Date Level 1 Directive The Application Process Insurers wishing to use an internal model to calculate the SCR are required to submit an application complying with certain minimum standards. Article 112(3) requires any insurer wishing to apply for internal model approval to submit, as a minimum, documentary evidence that the internal model fulfils the requirements of the “six tests” set out in Articles 120 to 125 of the Directive. Insurers must also be able to demonstrate to the supervisor that their systems for identifying, measuring, monitoring, managing and reporting risk are adequate. All conditions applicable for approval of a full internal model apply equally to approval for a partial internal model. November 2011

31 Supervisory Assessment of Applications
Date Level 1 Directive Supervisory Assessment of Applications Articles 112(4) to 112(6) give supervisors responsibility for assessing insurers’ applications for internal model approval. To approve the application, the supervisor must be satisfied that the systems that the insurer has in place to identify, measure, monitor, manage and report risk are adequate, and in particular that the internal model fulfils the six tests. Supervisors are required by Article 112(4) to consider and decide on an application for internal model approval within six months of the receipt of the completed application. Where the supervisor decides to reject an application, the supervisor must state the reasons for rejection. November 2011

32 The Six Tests for Internal Model Approval
Date Level 1 Directive The Six Tests for Internal Model Approval The six tests for internal model approval are set out in Articles 120 to 125. Any internal model for which approval is sought must satisfy all the tests. Each test must be applied separately, so an insurer cannot offset poor results against one test with good results against another. Under Article 126, no exemption is provided for internal models which use either a model or data provided by a third party (Cf below), so the tests must be satisfied in the entire model, including any external models and data. The six tests are summarised here below: Use test Statistical quality standards Calibration standards Profit and loss attribution Validation standards Documentation standards November 2011

33 The six tests for internal model approval Use Test (Article 120)
Date Level 1 Directive The six tests for internal model approval Use Test (Article 120) The use test requires an insurer to demonstrate that the internal model is widely used in, and plays an important role in, the system of governance, in particular the risk management system and decision-making processes; the assessment and allocation of economic and solvency capital including the ORSA. In order to achieve the use test, the frequency with which the internal model is used to calculate the SCR must be consistent with the frequency with which it is used for other purposes in the system of governance. As a part of the use test, the management body of the insurer are responsible for ensuring the ongoing appropriateness of the design and operations of the internal model, and that the internal model continues to reflect appropriately the risk profile of the insurer. November 2011

34 Risk-management system Decision-making process
Date Level 1 Directive The six tests for internal model approval Use Test (Article 120) – illustrations The following areas of the undertaking’s system of governance are highlighted as particularly important: System of governance Risk-management system Decision-making process Economic capital assessment Economic capital allocation Solvency capital assessment Solvency capital allocation November 2011

35 Date Level 1 Directive The six tests for internal model approval Statistical Quality Standards (Article 121) (I) The statistical quality standards test requires the internal model, and in particular the probability distribution forecast underlying it, to comply with certain criteria. The methods used to calculate the probability distribution forecast should be based on adequate, applicable and relevant actuarial and statistical techniques, and should be consistent with the methods used to calculate technical provisions. The information on which the methods are based should be current and credible and the assumptions should be realistic. An insurer should be able to justify the assumptions used to their supervisor (Cf Article 121(2)). The data used for the internal model should be accurate, complete and appropriate, and the data sets used in the calculation of the probability distribution forecast should be updated at least annually (Cf Article 121(3)). November 2011

36 Non-life underwriting risk; Life underwriting risk;
Date Level 1 Directive The six tests for internal model approval Statistical Quality Standards (Article 121) (II) Whilst there is no particular method prescribed for the calculation of the probability distribution forecast, the ability of the internal model to rank risk must be sufficient to ensure that the internal model is widely used in, and plays an important role in, the system of governance enabling the insurer to pass the use test. The internal model must cover all of the material risks to which the insurer is exposed, including, as a minimum, the following: Non-life underwriting risk; Life underwriting risk; Health underwriting risk; Market risk; Credit risk; and Operational risk (Cf Article 121(4)) November 2011

37 Date Level 1 Directive The six tests for internal model approval Statistical Quality Standards (Article 121) (III) The internal model may take account of dependencies within and across risk categories. If this is the case, the insurer must be able to satisfy their supervisor that the system used for measuring those diversification effects is adequate (Cf Article 121(5)). The internal model may take full account of the effect of risk mitigation techniques; provided that any credit or other risks arising from the use of the risk-mitigation techniques are properly reflected in the internal model (Cf Article 121(6)). The internal model must include an accurate assessment of the particular risks associated with any material financial guarantees and contractual options (both policyholder options and contractual options for other insurers). The assessment must take account of the impact that future changes in financial and non-financial conditions may have on the exercise of any options (Cf Article 121(7)). The internal model may take account of any future management actions that the insurer would reasonably expect to carry out in specific circumstances, making allowance for the time necessary to implement the actions (Cf Article 121(8)). November 2011

38 Date Level 1 Directive The six tests for internal model approval Statistical Quality Standards (Article 121) (IV) The internal model should take account of all payments to policyholders and beneficiaries that the insurer expects to make, whether or not those payments are contractually guaranteed (Cf Article 121(9)). November 2011

39 Date Level 1 Directive The six tests for internal model approval Calibration Standards (Article 122) (I) An insurer must be able to use the outputs of the internal model to calculate the SCR in a manner that provides policyholders and beneficiaries with a level of protection equivalent to that prescribed for the SCR in Article 101, being a 99.5% VaR of basic own funds over a one year period. Providing that the outputs can be used in this manner, the internal model does not itself need to use the risk measure or time period of 99.5% over a one year period. Wherever practicable, the SCR should be derived directly from the probability distribution forecast generated by the internal model, using a confidence level of 99.5% over a one year period. If the SCR cannot be derived directly from the probability distribution forecast, an insurer may seek supervisory approval to use approximations providing it can demonstrate that the resulting SCR provides an equivalent level of protection (Cf Article 122(2) & (3)). November 2011

40 Date Level 1 Directive The six tests for internal model approval Calibration Standards (Article 122) (II) Article 122(4) provides the supervisor with the power to require an insurer to run its internal model on benchmark portfolios and using assumptions based on external data, in order to verify the calibration of the internal model and to check that its specification is in line with generally accepted market practice. November 2011

41 Date Level 1 Directive The six tests for internal model approval Calibration Standards (Article 122) – illustrations If the SCR cannot be derived directly from the probability distribution, the undertaking shall: • Explain how it rescales risks and justify that the bias introduced when doing so is immaterial. • Explain the shortcuts used to reconcile the outputs of its internal model. • If considering a longer time horizon than the 1 year period, show due consideration of the solvency position at the earlier time horizons. • If considering a different time horizon than the 1 year period, justify the particular assumptions made in order to properly take into account the dependencies between consecutive time steps. November 2011

42 Date Level 1 Directive The six tests for internal model approval Profit and Loss Attribution (Article 123) At least annually, an insurer must review the causes and sources of profits and losses for each major business unit, and must demonstrate how they are explained by the categorisations of risk chosen for the internal model. The categorisation of risk and attribution of profits and losses should reflect the risk profile of the insurer. November 2011

43 Different options could be considered:
Date Level 1 Directive The six tests for internal model approval Profit and Loss Attribution (Article 123) – illustrations The Level 1 text does not set out on which definition of profit and loss the Profit and loss attribution should take place. Different options could be considered: Internal definitions for profits and losses, consistent with the variable underlying the probability distribution forecast (Article 121), Profits and losses reported on an IFRS basis in the accounts MCEV profits and losses as reported in addition to the accounts by some undertakings November 2011

44 Monitoring the performance of the internal model;
Date Level 1 Directive The six tests for internal model approval Validation Standards (Article 124) An insurer must put in place a regular cycle of internal model validation, which must include the following: Monitoring the performance of the internal model; Reviewing the ongoing appropriateness of the specification of the internal model; Testing the results of the internal model against experience; Analysing the stability of the internal model, in particular testing of the sensitivity of the results of the internal model to changes in key underlying assumptions; and Assessing of the accuracy, completeness and appropriateness of the data used by the internal model. The validation process must include an effective statistical process which enables the insurer to demonstrate to their supervisor that the capital requirements produced by the model are appropriate. The statistical process must test the appropriateness of the probability distribution forecast not only to loss experience but also to all material new data and information. November 2011

45 Examples of the areas of the internal model that need to be validated:
Level 1 Directive The six tests for internal model approval Validation Standards (Article 124) – illustrations The validation does not only apply to the calculation kernel to calculate the SCR, but shall encompass the qualitative and quantitative processes of the model. Examples of the areas of the internal model that need to be validated: Data Methods Assumptions Expert judgement Documentation Systems/IT Model governance Use test Examples of validation tools: Testing results against experience Testing the robustness of the internal model Stress and scenario testing Profit and loss attribution November 2011

46 Date Level 1 Directive The six tests for internal model approval Documentation Standards (Article 125) An insurer must document the design and operational details of its internal model, at a sufficient level of detail to provide the following: A demonstration of the compliance of the internal model with the other five tests; A detailed outline of the theory, assumptions and mathematical and empirical bases underlying the internal model; An indication of any circumstances under which the internal model does not work effectively; and A description of any major changes to the internal model which have been approved by the supervisor (Cf below). November 2011

47 Design and operational details
Date Level 1 Directive The six tests for internal model approval Documentation Standards (Article 125) – illustrations (I) Design and operational details The documentation itself may consist of different levels of granularity of information, for example: Methodology Formulas and parameters, Methods for estimating and testing parameters IT implementation Past developments of the internal model Data management Audit trail, … November 2011

48 Circumstances under which the internal model does not work effectively
Date Level 1 Directive The six tests for internal model approval Documentation Standards (Article 125) – illustrations (II) Circumstances under which the internal model does not work effectively If any specific features of the internal model that present potential concerns beyond what would reasonably be expected. For instance: Limitations in risk modelling and the cover of risk captured. The nature, degree and sources of uncertainty surrounding the results of the internal model and sensitivity to key assumptions. Shortcoming and/or deficiencies in input data. If insufficiencies in IT-systems, governance and related controls surrounding the internal model. Major changes Past figures shall be recalculated with the new approach to show the impact of the model change. November 2011

49 Date Level 1 Directive The six tests for internal model approval Non-Compliance with the Six Tests If an insurer with an approved internal model subsequently ceases to comply with any of the six tests, Article 118 requires it to submit a plan to the supervisor without delay demonstrating how compliance will be restored within a reasonable period of time. Where the effect of noncompliance is immaterial and the insurer can demonstrate this fact to the supervisor, a plan to restore compliance does not need to be provided. If the insurer does not implement the plan to restore compliance, the supervisor may require the firm to revert to using the standard formula to calculate the SCR. November 2011

50 Date Level 1 Directive The six tests for internal model approval The Use of External Models and Data Insurers may make use of external models or data within their internal model. However, under Article 126 the use of external models or data does not exempt an insurer from the requirement to meet any of the six tests. November 2011

51 Specific Provisions for Partial Internal Models (I)
Date Level 1 Directive Specific Provisions for Partial Internal Models (I) Where an insurer is seeking approval for the use of a partial internal model, Article 113 imposes additional conditions which the model must fulfil before it can be approved by the supervisor: The insurer must properly justify the reason for the limited scope of the partial internal model (Cf Article 113 (1) (a)). The SCR calculated using the partial internal model must reflect the risk profile of the company more appropriately than the standard formula, and must comply with the general principles for the calculation of the SCR set out in Articles 100 to 102 (Cf Article 113 (1) (b)). November 2011

52 Specific Provisions for Partial Internal Models (II)
Date Level 1 Directive Specific Provisions for Partial Internal Models (II) Articles 100 to 102 require the SCR to be: calculated at least annually on a going concern basis which reflects both existing business and new business expected to be written in the next 12 months; to be calibrated at a confidence level of 99.5% VaR of basic own funds over a period of 1 year; and to cover all quantifiable risks including at least : Non-life underwriting risk; Life underwriting risk; Health underwriting risk; Market risk; Credit risk; and Operational risk. The design of the partial internal model must be consistent with the general principles for the calculation of the SCR set out in Articles 100 to 102, in order to allow the partial internal model to be fully integrated into the standard formula (Cf Article 113 (1) (c)).. November 2011

53 Date Level 1 Directive Specific provisions for partial internal models Modifications to the Six Tests for Partial Internal Model Approval Where an insurer seeks approval to use a partial internal model, the six tests set out in Articles 120 to 125 of the Directive must be adapted to take into account the limited scope of the application of the internal model (Cf Article 114(2)). November 2011

54 Date Level 1 Directive Specific provisions for partial internal models Transitional Plans for Partial Internal Models The supervisor may require an insurer to submit a transitional plan in two situations: When the supervisor wishes the scope of a group internal model to be extended to cover additional entities; and/or When the supervisor wishes the scope of a solo partial internal model to be extended to cover additional sub-modules of a specific risk module of the standard formula, additional business units, or parts of both. The power for the supervisor to require a transitional plan is derived from Article 113(2) in the case of a solo partial internal model and from Articles 231 and 233(5) in the case of a group partial internal model. Article 113(2) provides that the transitional plan must set out how the model will be extended to ensure that it covers a predominant part of the insurer’s business with respect to the specific risk module. November 2011

55 Governance over Internal Models
Date Level 1 Directive Governance over Internal Models Articles 115, 116 and 120 of the Directive impose governance requirements on any insurer wishing to use a full or partial internal model for the calculation of the SCR. The governance requirements specific to the internal model fall into 3 categories: The responsibility to put in place systems which ensure that the internal model operates properly on a continuous basis (Article 116). The requirement of Article 120 (Use test), that “the administrative, management or supervisory body shall be responsible for ensuring the ongoing appropriateness of the design and operations of the internal model, and that the internal model continues to appropriately reflect the risk profile of the insurance and reinsurance undertaking concerned”, sits alongside this requirement; The requirement for the management body to approve formally any application for internal model approval and any application for approval of any subsequent major changes to the model (Article 116); and The establishment and approval of a policy for making major and minor changes to the model (Article 115). November 2011

56 Date Level 1 Directive Governance over internal models Systems to Ensure the on-going proper Operation of the Model Under Article 116, the management body of an insurer is responsible for putting in place systems to ensure that the internal model operates properly on a continuous basis. November 2011

57 Governance over internal models Changes to the Internal Model
Date Level 1 Directive Governance over internal models Changes to the Internal Model Under Article 115, the management of an insurer are required to put in place a policy governing changes to the model, including a specification for minor and major changes. The policy must be submitted to the supervisor and approved by them as part of the application for internal model approval. The application for internal model approval and any subsequent application for approval of a major change to the model must be approved by the management body of the insurer. Once the policy has been approved, minor changes, provided they are developed in accordance with the policy, do not require supervisory approval (Cf Article 115). Where an insurer makes major changes to the internal model, or changes the change policy, the change must be documented and approval obtained from the supervisor. To obtain approval, the insurer must submit information in respect of the change equivalent to that required for approval of the internal model (Cf above). November 2011

58 Solvency II – Three Pillar Approach
Governance Pillar 1: Quantitative capital requirements Pillar 2: Qualitative supervisory review Pillar 3: Market discipline Market-consistent valuation Own funds Economic risk based capital requirements minimum (MCR) solvency (SCR) Groups Internal controls and risk management Required functions Own risk and solvency assessment (ORSA) Supervisory review Capital add-ons Transparency Disclosure Solvency and financial condition report (SFCR) solo group This slide it to show where the ORSA fits into the Solvency II framework Compliance and Audit 58 58

59 Article 45 Own risk and solvency assessment
1. As part of its risk-management system every insurance undertaking and reinsurance undertaking shall conduct its own risk and solvency assessment. That assessment shall include at least the following: (a) the overall solvency needs taking into account the specific risk profile, approved risk tolerance limits and the business strategy of the undertaking; (b) the compliance, on a continuous basis, with the capital requirements, as laid down in Chapter VI, Sections 4 and 5 and with the requirements regarding technical provisions, as laid down in Chapter VI, Section 2; (c) the significance with which the risk profile of the undertaking concerned deviates from the assumptions underlying the Solvency Capital Requirement as laid down in Article 101(3), calculated with the standard formula in accordance with Chapter VI, Section 4, Subsection 2 or with its partial or full internal model in accordance with Chapter VI, Section 4, Subsection 3. 2. For the purposes of paragraph 1(a), the undertaking concerned shall have in place processes which are proportionate to the nature, scale and complexity of the risks inherent in its business and which enable it to properly identify and assess the risks it faces in the short and long term and to which it is or could be exposed. The undertaking shall demonstrate the methods used in that assessment. 3. In the case referred to in paragraph 1(c), when an internal model is used, the assessment shall be performed together with the recalibration that transforms the internal risk numbers into the Solvency Capital Requirement risk measure and calibration. 4. The own-risk and solvency assessment shall be an integral part of the business strategy and shall be taken into account on an ongoing basis in the strategic decisions of the undertaking. 5. Insurance and reinsurance undertakings shall perform the assessment referred to in paragraph 1 regularly and without any delay following any significant change in their risk profile. 6. The insurance and reinsurance undertakings shall inform the supervisory authorities of the results of each own-risk and solvency assessment as part of the information reported under Article 35. 7. The own-risk and solvency assessment shall not serve to calculate a capital requirement. The Solvency Capital Requirement shall be adjusted only in accordance with Articles 37, 231 to 233 and 238.

60 Comparison Solvency II Directive CPA1
Date Comparison Solvency II versus CPA1 Comparison Solvency II Directive CPA1 Choice of model Three options: Standard formula Partial internal model Full internal model The supervisor has power in decision. No specification of the type of model: no standard formula is provided Approval of the model Internal model subject to prior supervisory approval Approval if used for regulatory of legal purposes (for example CPA2) Scope Insurers define scope of the included activities & processes All risks to which it is exposed for all their juridical and operational entities Definition No clear definition Documentation Clear rules related to what is expected (part of the six tests) Clear rules related to what is expected November 2011

61 Comparison Solvency II Directive CPA1
Date Comparison Solvency II versus CPA1 Comparison Solvency II Directive CPA1 Application Documentary evidence that the internal model fulfils the requirements of the “six tests” Demonstrate that their systems for identifying, measuring, monitoring and reporting risk are adequate Document describing how all qualitative and quantitative criteria have been met The CBFA will perform spot checks to check whether all described methods are actually applied by the insurance company Supervisory assessment of applications Deadline: within 6 months When the model is rejected, the reasons for rejection should be given No deadline specified No information about rejections November 2011

62 Comparison Solvency II Directive CPA1
Date Comparison Solvency II versus CPA1 Comparison Solvency II Directive CPA1 Tests to be performed Use test Statistical quality standards Calibration standards Profit and loss attribution Validation standards Documentation standards Stress Testing Back Testing The CBFA will perform spot checks to verify whether all described methods are applied by the company Non-compliance with the six tests Submit a plan to supervisor without delay. If the plan is not implemented, the supervisor may require the firm to revert to using the standard formula No explicit information in CPA1. However, the non-compliance will result in a lower score. November 2011

63 Comparison Solvency II Directive CPA1
Date Comparison Solvency II versus CPA1 Comparison Solvency II Directive CPA1 Governance Internal model should operate on a continuously basis Management body should approve any application for internal model approval and any application of approval of any subsequent major changes to the model. Establishment and approval of a policy for making major and minor changes to the model Internal model should be closely integrated in the risk management process. The results of the model should influence the planning, follow-up and control of the risk profile of the company. Data Quality The data used for the internal model should be accurate, complete and appropriate, and the data sets used in the calculation of the probability distribution forecast should be updated at least annually Specific requirements with respect to data used to determine risk factors (section III.2) If model points are used, the company has to verify the accuracy November 2011

64 Date Contents

65 Internal model validation plan : example
Date Internal model validation plan : example November 2011

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