Solvency II is not short of documentation, with the output of Brussels and Frankfurt being better measured in inches rather than pages. But it is often light on practical guidance. One area where guidance is certainly required relates to the use and understanding of catastrophe models.
This is not just an issue for companies planning to use internal models to calculate their regulatory capital. The ORSA element of Solvency II requires all insurers to stress test their capital calculation, be it calculated by standard formula or an internal model, and document/defend their risk control processes. Clearly catastrophe models will be a key element of this for any catastrophe exposed (re)insurer.
Therefore an initiative, sponsored by the Association of British Insurers (ABI) but with the UK regulator’s involvement, to produce a “Good Practice” guide for catastrophe modelling is welcome and was a major topic of discussion at last week’s annual ABI Solvency II conference in London.
Recognizing the importance of the initiative, Willis Analytics joined other industry professionals in helping to draft the document. You can read our takeaways on the report here and in our press release.
A Financial Services First?
Note that the paper defines good practice rather than best practice, or indeed current practice. The document may be less welcomed by some, who see it as an additional burden for already hard-pressed modelling teams. In truth the 68-page document contains little that is new, rather melding current market practice with the additional requirements of perhaps 500 pages (a good inch and a half) of Solvency II legislation.
The issue will be how regulators react to this document and the “good practices” within it. Clearly regulatory supervision needs to be proportionate, processes should be appropriate for the size and nature of an organization and the risks it writes.
Although only a UK initiative, the authors hope that the document will gain greater currency throughout Europe. It is, arguably, the first time any financial services sector has worked collectively to understand how best to manage modelling processes and model methodologies.
It is certainly the first time in over 20 years of catastrophe modelling that a definitive consensus approach has been established. The authors of the report include representatives from all three major reinsurance brokers, all three major modelling companies, leading reinsurers, leading insurers and the Corporation of Lloyd’s.
The ABI Report in a Nutshell
The report considers nine areas:
Three general principles:
- Governance around catastrophe risk modelling
- The use of third party service providers
- Catastrophe modelling documentation
Four operational principles:
- Use and management of catastrophe modelling
- Model selection and model change policy
- Options and settings of catastrophe models
- Catastrophe model validation
Two technical considerations:
- Multi-modelling approaches
- Treatment of uncertainty in catastrophe modelling output.
Willis will closely watch the development of this initiative. We will maintain our stance of positive engagement with regulators to seek to ensure that our clients’ concerns are addressed and their interests protected.