Internal models for Solvency II must be understood at all levels, according to the Prudential Regulatory Authority (PRA).
Andrew Bulley, director of life insurance at the PRA, said: "The last thing we or the architects of Solvency II want is models to operate as black boxes wholly impenetrable to those outside the actuarial department and perhaps barely penetrable to many within it."
Speaking this morning at the European Insurance Conference in London, organised by JP Morgan, Bulley expected senior executives to have an adequate but not a detailed understanding of the model.
"Let me say definitively that we are not expecting all board members to understand the intricacies of the Gaussian copula," he said. "To my mind, a firm distinction needs to be drawn in the following way: understanding and using the model in decision making is distinct from being a technical modelling specialist."
The regulator expected the internal model to be "intelligible to a wider range of people" but that in general, executives should have a "more detailed understanding" than non-executives.
The PRA also expected all board members, both individually or as a collective unit, to be "rigorously inquisitive, critical and challenging" of the model by questioning its strengths and limitations.
Bulley also asked firms to assess what modelling assumptions and judgements would be applied, how capital would be affected if those assumptions and judgements were changed and whether the accuracy, scope and integrity of the data feeding into the model would be satisfactory on the "garbage in, garbage out" principle.
Lastly, Bulley mentioned a PRA requirement that internal model firms have a model change policy, which should be part of the approval process. This is to ensure the internal model continues to meet the requirements of Solvency II after approval.
Bulley said: "We are acutely conscious of the risk that model integrity deteriorates over time or that, post approval, key model assumptions or calibrations are adjusted imprudently. For that reason, Solvency II applies stringent requirement on model change policy and disclosure."
