The Institute of Risk Management’s Internal Model Industry Forum has published a guidance document based on its research into the effective validation of risk models created by the insurance industry to comply with the requirements of Solvency II.
The guidance, entitled ‘the valuation cycle: developing sustainable confidence and value', supports the potential for risk models to add value to businesses, beyond purely meeting regulatory requirements.
It was produced by a work stream of industry practitioners led by Rob Merry, HSBC's global head of independent model review for insurance and pensions, with support from Barney Wanstall, insurance consulting director at PWC.
The insurance industry has spent millions complying with the Solvency II regime, with large companies each paying around £200m for the required system and business changes required.
Lloyd's of London alone estimated its expenditure on compliance to be £300m.
Included in this expenditure has been the creation of sophisticated risk models that assess the inherent ‘riskiness' of each business and the resulting capital levels required to support solvency.
However, IRM believes there is still further to go to create real business value from these internal models.
To address this issue, IRM set up the cross-industry IMIF in 2014 to produce a collaborative industry view of best practices around the use and validation of internal models.
The IMIF now has more than 300 members, plus support from key consultancies, representatives from the industry regulator, the Prudential Regulatory Authority, the Institute and Faculty of Actuaries and ORIC International.
IRM Chairman and IMIF Founder, José Morago, pictured, said: "Insurers increasingly rely on sophisticated models to navigate a challenging and changing financial environment. Making sure models create value in decision making, are well understood, and gain the confidence of boards and regulators, has never been more demanding or challenging.
"IMIF's first guidance is the result of input and experience from over 300 industry experts. It will help firms make the important decisions needed to keep their models fit-for-purpose. Further guidance will follow on other aspects of the use of models."
The guidance document proposes that insurers implement a ‘validation cycle' for the financial models established for Solvency II.
This validation cycle is a control mechanism to ensure models remain effective as the risk environment evolves. The validation cycle is billed as "a resilient and sustainable process" designed to maintain the confidence of the board and regulators.
The guidance document proposes a validation cycle that includes the following stages: Identifying and evaluating potential ‘trigger events' that could require model re-validation; Planning and executing the validation; Assessing the outcomes of the validation exercise; Identifying lessons learned from the process; Communicating and acting upon the validation findings.
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