Internal Models and Solvency II
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Partial Internal Models
Juan Antonio Lumbreras
Partial Internal Models
Foreword
Introduction
Balance Sheet, Capital Requirements and Internal Models
Partial Internal Models
The Internal Model Approval Process
Policy for Model Changes
Internal Models to Calculate the Group Solvency Requirement: The Perspective of the Home and Host Supervisor
Use Test: Challenges and Opportunities
Statistical Quality Standards: Challenges in Internal Model Implementation
Representation, Reality and the Solvency II Data Challenge
The Calibration Standards
Profit and Loss Attribution
Internal Model Validation: The Regulatory Perspective
Model Validation: An Industry Perspective
Solvency II Internal Model Documentation Requirements
How to Review External Models and Data Embedded in the Modelling Framework
The Limitations of Internal Models and the Supervisory Review Process
The Solvency II framework allows (re)insurance firms, both solo entities and groups, to calculate the solvency capital requirement (SCR) using either the standard formula or, subject to supervisory approval, their own internal model (either full or partial). Partial internal models can be used to model one or more of the standard formula risk modules or sub-modules, the capital requirements for operational risk or for the loss-absorbing capacity of technical provision for either the whole business or one or more business units.
From a firm’s perspective, choosing whether to opt for an internal model (either full or partial), or adopt the standard formula is an important and relevant consideration. For some firms, the decision is fairly clear-cut, as a partial model approach may offer an attractive solution that fits their risk profile while optimising the cost of capital. For others, the balance between the advantages and disadvantages is harder to assess, particularly given the various options between the standard formula and the internal model.
Taking into account firms’ difficulties in meeting internal model approved standards for all risks, legal entities and major
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