Answers to the European Commission on the ... - Eiopa - Europa

individual undertaking is exposed and <strong>the</strong>refore act as a stimulus <strong>to</strong> <strong>the</strong>
development of internal models.
Output criteria for <strong>the</strong> actuarial model
11.27 The backtesting of VaR models for market risk in banking is based on
daily observations and <strong>the</strong>refore generates enough exceptions data <strong>to</strong>
test <strong>the</strong> adequacy of <strong>the</strong> calibration. This would not be appropriate in
<strong>the</strong> context of <strong>the</strong> (longer) time horizon and (more stringent)
prudential objective of <strong>the</strong> SCR. Forecast distributions are <strong>the</strong>refore
necessary <strong>to</strong> enable assessment of <strong>the</strong> actuarial internal model through
actuarial/statistical techniques.
11.28 If <strong>the</strong> method that produces <strong>the</strong> SCR estimate is considered as a
deterministic formula, <strong>the</strong>n it could result in a 'black box' that is nearly
impossible <strong>to</strong> validate. If, in practice, an undertaking uses a
deterministic formula for <strong>the</strong> computation of <strong>the</strong> SCR estimate, <strong>the</strong>n
this formula should be justified by reference <strong>to</strong> s<strong>to</strong>chastic models and
distributions. The distributions form <strong>the</strong> basis for dialogue between an
undertaking and its supervisor, offering a much more detailed source of
information than a single SCR number. As an example, <strong>the</strong> SCR
estimate may be computed using a scenario-based method on a day<strong>to</strong>-day
basis. But <strong>the</strong> choice of scenarios needs <strong>to</strong> be justified by
reference <strong>to</strong> <strong>the</strong> s<strong>to</strong>chastic modelling.
11.29 Certain 'difficult areas', especially long-tail non-life business, are
characterized by extremely high uncertainty about <strong>the</strong> likelihood of <strong>the</strong>
events that are relevant for <strong>the</strong> computation of <strong>the</strong> SCR. 104 Information
may be scarce in <strong>the</strong> sense that a limited number of independent
observations are available. While location and scale of such a
distribution can be well estimated, <strong>the</strong>re is virtually no information
about <strong>the</strong> far tail – <strong>the</strong> 200-year event – in <strong>the</strong> data. But allowing
undertakings <strong>to</strong> estimate a distribution at least provides <strong>the</strong> supervisor
with more information than <strong>the</strong> equivalent treatment under <strong>the</strong>
standard formula (i.e. a s<strong>to</strong>chastic model provides a confidence interval
for risk estimates, while <strong>the</strong> error of <strong>the</strong> standard formula may be
unknown.) The way <strong>the</strong> capital requirement is derived from <strong>the</strong>
distribution may reflect concerns over <strong>the</strong> robustness of <strong>the</strong> SCR.
SCR criteria
11.30 The capital requirement is produced by <strong>the</strong> application of a risk
measure <strong>to</strong> <strong>the</strong> forecast P&L distribution. To aid comparability (and <strong>to</strong>
secure a level playing field), this risk measure should use <strong>the</strong> same
underlying principles as <strong>the</strong> standard formula expressed in <strong>the</strong> answer
<strong>to</strong> CfA 10.
104 CEIOPS notes that 'difficult area for risk measurement' is often business with <strong>the</strong> greatest potential for
profit (as well as loss). To allow and encourage EEA insurance undertakings <strong>to</strong> remain competitive, <strong>the</strong> use
of <strong>the</strong> best available models in <strong>the</strong> high-margin business areas should be allowed and encouraged.
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