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06

Internal model should not become a capital optimisation tool, says EIOPA

Open-access content Monday 8th June 2015 — updated 5.13pm, Wednesday 29th April 2020

The European Insurance and Occupational Pensions Authority (EIOPA) has warned against the use of internal models to reduce capital requirements under Solvency II.

2

Gabriel Bernardino, EIOPA's chairman, said there had been examples of this in the banking sector under different regulations but it would "kill the underlying idea of an internal model". 

Speaking remotely using video conference technology for the European Insurance Conference, organised by JP Morgan, Bernardino said: "Lessons need to be learned: internal models should not become a capital management and especially a capital optimisation tool. A race to the bottom will kill the underlying idea of an internal model."

Bernardino, who began his career as an actuary, said when applying for approval insurers needed to demonstrate their internal model meets a number of requirements such as the use test and statistical standards around quality, calibration, validation and documentation.

He also mentioned another aspect of Solvency II - the harmonisation of reporting requirements - and believed this would be beneficial for the industry. 

"This will allow huge economies of scale for the industry, especially for cross-border groups, and will create a basis for consistent risk-based supervisory analysis within the EU," Bernardino said. 

Bernardino said later this year firms would need to focus on preparatory reporting of the third quarter of 2015 as a "very important step for testing their processes and systems" ahead of reporting under Solvency II in 2016. 

He said: "The time has come to make a final push in preparing for the actual submission of information. Both the industry and supervisors will benefit from this last effort. The new reporting requirements will increase the quality of the data available in the companies, which is a fundamental element to upgrade risk management. 

"At the same time, supervisors throughout the EU will have access to better and more granular data on assets, liabilities and own funds of insurers, allowing for a quantum leap in terms of risk-based supervision."

Meanwhile, the Prudential Regulatory Authority (PRA) has published a document to explain the purpose of the directive.

The paper The prudential regulation of insurers under Solvency II gives an overview of Solvency II and draws out key features and benefits of the legislation.

The document outlines developments in a number of areas including accounting principles, quality of capital and capital requirements.

The paper explains the two capital requirements introduced by the directive: solvency capital requirement and minimum capital requirement. The PRA said the capital requirements "should improve the safety and soundness of insurers across Europe". 

This article appeared in our June 2015 issue of The Actuary.
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