FSI 5-Calculation of SCR using a Full or Partial Internal Model Flashcards
Outline the requirements to obtain and maintain an internal model to calculate SCR? (5)
- Insurers must have an effective system of governance for the internal model
- Insurers must demonstrate that the model is widely used and plays an important role in the system of governance
- Insurer must meet the requirements regarding to statistical quality, data quality, model calibration and validation
- Insurer must adequately document the design and operation details of their model
- Partial models may be approved provided they are sufficiently justified and integrated
Outline the responsibilities regarding internal models? (3)
- Where an insurer chooses to adopt an internal model approach the board of directors are responsible that appropriate approval is obtained from the PA
- The board must also approve key methodologies used in the internal model and is responsible of the results of the SCR calculation
- The HAF is responsible to provide an opinion to the board of directors regarding the accuracy of the calculations as well as the appropriateness of the assumptions underlying the internal model
How frequent should a calculation be done using an internal model? (1)
• A complete SCR calculation should be done quarterly using the approved internal model
Describe the aproval process for an internal model? (5)
- First the insurer should notify the prudential authority of their intension and complete the pre-application process
- Subject to the PA being satisfied with the pre-application process an insurer can submit an application to use the internal model
• In addition for a partial internal model the insurer must satisfy the PA
o The limited scope of the application is properly justified
o The results SCR appropriately reflect the risk profile of the insurer
o The model design allows integration with the standardised formula approach
o There is no ambiguity which assets, liabilities and risk are applicable to the internal model
- Insurers must develop and maintain a model change policy that sets out the process and controls that they will adhere regarding changes (this will be required in the application to the prudential authority)
- Any material changes to policy that is integral to the use of the model needs approval from the prudential authority
Outline the requirements for an effective governance framework relating to the internal model? (5)
o Establish, implement and maintain effective cooperation, internal reporting and communication of information relating to the internal model
o Be robust with well-defined, clear, consistent and documented line of responsibility across organisation
o Ensure that senior management and personnel responsible have appropriate expertise and experience
o Comprehensive documentation of the internal model
o Include adequate process and controls for development, review and use of internal model
Outline the various responsibilities of the board of directors regarding the internal model? (9)
o Approving the application for approval to use internal model
o Deciding on the roles and responsibilities in relation to model governance
o Deciding on the strategic direction of the model
o Agreeing on major changes in advance
o Aligning the model design and operation with the risk profile and operations
o Sufficient resources available to develop monitor and main the model
o Monitoring on-going compliance with requirements for the internal model approval
o Ensuring there are adequate internal review procedures around design, operation and validation
o Ensuring outputs are aligned with the use
What are the roles and responsibilities regarding the operations of the internal model? (7)
(Governanace)
o Design and implementation of the internal model
o Testing and validation of the internal model
o Documenting the internal model and changes
o Analysing the performance of the internal model
o Suggesting areas for improvements
o Liaising closely with the users of the outputs
o Developing an on-going two-way communication with the actuarial function
List the various areas of use of the internal model as part of the use test? (4)
o Decision making process
o Business planning
o Risk management
o Capital assessment and allocation
o ORSA
The board of directors should have an understanding of the following aspects of the model? (8)
o Structure of the model including alignment with business and integration with risk management
o The scope and purpose of the internal model as well as the risks covered by the internal model
o General methodology of the internal model regarding calculations
o Limitations of the internal model
o Where model components rely on expert judgement the significance of the judgement on outcomes
o Diversification affects taken into account in the model
o Influence on decision making
o Model development plan
Describe the probability density forecast in the internal model? (6)
- The use of an internal model will typically involve the generation of a probability distribution forecast which assign probability to changes in own funds from a wide range of future events
- Any methodology that evaluates the financial impacts of events must meet the statistical quality in these standards
• The probability distribution forecast should ensure:
o The exhaustive set of mutually exclusive events should reflect the risk profile of the insurer
o Forecasts should be based on relevant information
• The methods used in the calculation of the probability distribution forecast should be:
o Based on adequate, applicable and relevant statistical and actuarial techniques
o Consistent with the calculation of technical provisions according to FSI 2.2
o Based on current and credible information
o Based on realistic assumptions
- Where the is insufficient data for extreme events then internal model will be based on key points from probability forecast
- A internal model that only generates key points of probability distribution forecast will be subject to stricter validation and governance
outline the requirements regrding risk coverage and ranking from an internal model? (5)
• Insurer should be able to rank all material risk and satisfy the following principles:
o Coverage-include all risk in the internal model
o Resolution-allow appropriate differentiation in classification such that appropriate decisions can be made
o Congruence-Ranking should be based on a risk management system
o Consistency- Ranking of risks over time should be consistent with their nature
• The internal model should include all material risks that the insurer is exposed to and for a minimum include all risk covered in the standardised formula
outline the recognition of diversification effects in the internal model? (1, 6)
• The insurer can allow for diversification and dependencies in their model provided they can be measured adequately
• At a minimum the internal model when measuring diversification must:
o Identify key variables driving dependencies
o Provide support regarding existence diversification effects
o Justify assumptions underlying the model
o Consider extreme scenarios and tail dependencies
o Take into account robustness of the system on a regular basis
o Take diversification effects into account in decisions
State the recognition of risk mitigation in the internal model? (1)
• The recognition of risk mitigation is that they are the same as in the standardised formula approach
Ouline the allowance for options and guarantees regarding the internal model? (2)
- The insurer must accurately assess the risks associated with guarantees and contractual options
- The key features of guarantees and options should be considered as well as the impact of financial and non-financial conditions on the exercise of the option
Describe the allowance for future managemnt actions in the internal model? (4)
- The implications of future management actions should be considered taking in to account the implementation of the options as well as the significance of the action
- This should be consistent with the requirements provided in FSI 2.2
• Assumptions regarding future management actions must be and approved by the board including
o Identification of actions incorporated in the model
o Circumstances where insurer would reasonable carry out actions and when not
o The order and governance associated with future management actions
o Description of on-going work to ensure that insurer is required to carry out these actions
o Description of how future management actions have been reflected in probability distribution forecast
o Description of internal reporting procedure to implement future management plan
• Deviations from planned management actions could have a significant impact on SCR and must be reported to PA including the reasons for the deviations