Internal Model approval and pre-application process

Under Solvency II insurers will have the choice between using a standard formula or an internal model for calculating the Solvency Capital Requirements (SCR). While some insurers will opt for the standard formula, which is a standard calibration for all (re)insurers including underwriting, market, credit default and operational risk modules, others will prefer a company specific internal model for the calculation of their SCR. Internal models have the advantage that they are more risk-sensitive, capture individual risk profiles more adequately and consequently reduce the capital requirements. Therefore, internal models are expected to produce a lower SCR than the standard model.

These models need to be compliant with the Solvency II confidence level of 99.5% over a one-year period and are subject to supervisory approval. The procedures that an insurer must follow to acquire internal model approval will be detailed in the Commission’s implementing measures. For example, one fundamental requirement to qualify for the internal model approach is that the model is "widely used and plays an important role” in the course of conducting an insurer's regular business (also known as the ‘use-test’). CEIOPS will also publish the first three Level 3 papers on internal models in November. The papers intend to provide advice on topics such as the use-test, validation policy and profit-loss attribution.

Internal model approval is a crucial element of Solvency II implementation for most UK firms and will include a pre-application process, which intends to give supervisors a view on how prepared an insurer is to submit an application. The FSA have set high expectations by setting out criteria for entering their “pre-approval” process. FSA are clearly making significant efforts to scale up their capacity to deal with a significant number of applications and potentially provide approval for insurers to use internal models from day 1. However, there are some concerns that this amounts to accelerated implementation of Solvency II.

 

Furthermore, firms who intend to apply to use an internal model must take part in QIS5. For ‘first wave’ firms this implies a June 2011 deadline, as compared with a January 2013 implementation date for Solvency II. Firms wishing to use an internal model from day one of the implementation date are requested to submit their formal application between November 2011 and April 2012.

 

Further information to the internal model approval process is available on the FSA website at: http://www.fsa.gov.uk/Pages/About/What/International/solvency/imap/index.shtml. Detailed information to the FSA pre-application qualifying criteria (PAQC) is available at:

http://www.fsa.gov.uk/pubs/international/imap_preapp_entry.doc.