Managing Model Risk

Tjeerd Degenaar

In this chapter, we aim to familiarise the reader with the concept of model validation in the Solvency II environment. In the past, we have become familiar with this concept through the Basel II banking regulation. Solvency II regulation builds on Basel II regarding the process of validating its internal model. In order to have a proper understanding of the independent validation of Solvency II’s internal model, first we discuss relevant risks in all phases of internal model building, the so-called “model life cycle”. In the second section, we examine the general principles of the model life cycle, paying particular attention to the area of model validation. Once this is clear, we discuss the process of approving the internal model, before concluding with a look at the future challenges for model validation.

AN INTRODUCTION TO MODEL MANAGEMENT

Solvency II contains relatively limited guidance on how to manage the internal model. This chapter illustrates a framework that we believe is market practice and meets Solvency II requirements. In the various panels throughout the chapter, we provide lessons learned as well as guidance to cope with a number of challenges related to model

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