Profit and Loss Attribution

Andrew Candland and Christopher Lotz

Profit and loss (P&L) attribution is an important tool of model risk management that has a long history. It is very well known in banking circles, especially in the area of traded markets, and the concept of analysis of movement is widely used in insurance. Much can be learnt about the risks of an undertaking by closely studying its P&L, because this incorporates all the effects that have materialised over a given horizon from all the risks that the undertaking faces.

With the advent of Solvency II, especially Article 123 of the directive, regulators have required firms that use an internal model to carry out a P&L attribution at least annually.11 For further details, see European Parliament and the Council of the European Union (2009). This formalises the link between P&L and risks and means it has a permanent position in the armoury of techniques of any insurance undertaking seeking approval for an internal model under Solvency II.

P&L attribution is the process of analysing the change between two valuations, linking this to the developments of their causes and sources (risk drivers) between the two valuation dates. The two valuations in question can be two balance sheets

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