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'calibration test' is <strong>to</strong> assess whe<strong>the</strong>r <strong>the</strong> SCR derived from <strong>the</strong> model has <strong>the</strong> appropriate level of prudence. The burden of performing <strong>the</strong> computations that underlie <strong>the</strong> calibration test could be assigned <strong>to</strong> <strong>the</strong> undertaking, with <strong>the</strong> obligation of <strong>the</strong> supervisor <strong>to</strong> check <strong>the</strong> results. Due <strong>to</strong> <strong>the</strong> statistical uncertainties associated with 200-year-events, and difficulties in estimating and validating correlations, <strong>the</strong> desired absolute level of prudence can only be a target. It is more important <strong>to</strong> check whe<strong>the</strong>r <strong>the</strong> manner in which <strong>the</strong> SCR is derived from <strong>the</strong> internal model is comparable across undertakings. 11.37 It has been suggested that <strong>the</strong> undertaking is required <strong>to</strong> perform a quantitative analysis <strong>to</strong> ascertain its’ model’s performance against prescribed benchmarks. Depending on <strong>the</strong> calibration test <strong>the</strong> supervisor may require <strong>the</strong> undertaking <strong>to</strong> calculate and apply a recalibration fac<strong>to</strong>r, quantifying <strong>the</strong> extent <strong>to</strong> which an undertaking underestimates its risk – if at all. 107 CEIOPS will consider whe<strong>the</strong>r and how such a recalibration fac<strong>to</strong>r could be estimated in a reliable and consistent manner. The supervisor might <strong>the</strong>n be given <strong>the</strong> power (within certain limits) <strong>to</strong> increase <strong>the</strong> SCR under Pillar I <strong>to</strong> <strong>the</strong> proper level of prudence through multiplying <strong>the</strong> undertaking’s SCR estimate by <strong>the</strong> appropriate recalibration fac<strong>to</strong>r. The degree <strong>to</strong> which this flexibility should be limited and its implications for harmonisation would require fur<strong>the</strong>r discussion. 11.38 However, it should be noted that designing a calibration test which would provide a non-arbitrary recalibration fac<strong>to</strong>r is not a trivial task. Alternatively, a calibration test that results in a 'yes or no' answer may be easier <strong>to</strong> design than a measure of <strong>the</strong> correction <strong>to</strong> be made. It would be more consistent with <strong>the</strong> view that, in <strong>the</strong> context of internal models, <strong>the</strong> burden of developing an appropriate measure of <strong>the</strong> risk an undertaking is exposed <strong>to</strong> lies on <strong>the</strong> undertaking itself instead of <strong>the</strong> supervisor. Testing risk management 11.39 The overall aim of <strong>the</strong> use test is <strong>to</strong> assess whe<strong>the</strong>r <strong>the</strong> control loops associated with risk management function properly. The undertaking has <strong>to</strong> demonstrate that <strong>the</strong> actuarial model is genuinely relevant for and used within risk management and is in line with <strong>the</strong> overall policy on solvency capital (see para. 10.81). Fur<strong>the</strong>rmore, <strong>the</strong> undertaking has <strong>to</strong> demonstrate that proper processes are established, which ensure that <strong>the</strong> model remains useful, and that <strong>the</strong>se are applied consistently over time. 11.40 Among <strong>the</strong> auditing <strong>to</strong>ols that are widely used by audi<strong>to</strong>rs, consultants and supervisors are • visualizations of lines of responsibilities (organisation charts), 107 This is suggested in Jaschke, Stahl & Stehle (2005) - Value-at-Risk Forecasts under Stress – The German experience as an alternative <strong>to</strong> <strong>the</strong> Basel back-testing procedure. 124
• visualizations of flows of products and information along business processes (flow charts) and • visualizations of <strong>the</strong> most important control systems (control loops). 11.41 The two control loops identified in paras. 11.31 and 11.32 are <strong>the</strong> framework for identifying <strong>the</strong> actual business processes that an undertaking has established. Once <strong>the</strong> actual business processes in <strong>the</strong> undertaking are identified, <strong>the</strong> examination looks at whe<strong>the</strong>r processes are 'in control' and 'capable'. Safeguards 11.42 In its CfA, <strong>the</strong> <strong>Commission</strong> Services note that prudential aspects regarding <strong>the</strong> transition from <strong>the</strong> standard formula <strong>to</strong> internal models should be addressed, including <strong>the</strong> risk of modelling errors. Safeguards could be envisaged that ensure both supervisors and undertakings can begin <strong>to</strong> enjoy <strong>the</strong> benefits of internal models at an early stage, without undermining <strong>the</strong> objective of policyholder protection. In particular, <strong>the</strong> supervisor can be given <strong>the</strong> opportunity <strong>to</strong> test how an undertaking’s internal model performs in practice before allowing significant reductions in regula<strong>to</strong>ry requirements. 11.43 A period of parallel running might assist supervisors in determining whe<strong>the</strong>r <strong>the</strong> SCR calculated using an internal model is an adequate reflection of an undertaking's risk profile 108 . An undertaking would produce an SCR calculated under <strong>the</strong> standard formula alongside <strong>the</strong> estimate produced by its internal model. A supervisor would need <strong>to</strong> be reasonably satisfied that material differences in capital requirements resulted from risk characteristics that <strong>the</strong> standard formula would not be capable of capturing. The result of this analysis might be adjustment of <strong>the</strong> SCR estimate, requirement of changes <strong>to</strong> <strong>the</strong> model or withdrawal of model approval. 11.44 In <strong>the</strong> banking context, a descending floor has been used <strong>to</strong> smooth <strong>the</strong> transition between approaches <strong>to</strong> calculating regula<strong>to</strong>ry requirements. 109 Undertakings that wish <strong>to</strong> use <strong>the</strong> 'Internal Ratings- Based' approach for credit risk or <strong>the</strong> 'Advanced Measurement Approach' for operational risk must also calculate <strong>the</strong> equivalent requirements under <strong>the</strong> standardised approaches. In <strong>the</strong> first year of <strong>the</strong> Directive’s implementation, a floor of 95% of <strong>the</strong> equivalent standardised calculation is imposed on <strong>the</strong> internal calculation. This percentage falls <strong>to</strong> 90% and 80% in <strong>the</strong> second and third years. A similar approach could be considered for implementing Solvency II. 108 CEIOPS notes <strong>the</strong> transitional arrangements put in place for <strong>the</strong> Capital Reqirements Directive, where parallel running is possible before <strong>the</strong> Directive’s implementation. This gives supervisors <strong>the</strong> ability <strong>to</strong> recognise models at an early stage. 109 See Article 152 of <strong>the</strong> Capital Requirements Directive for credit institutions and investment firms. 125
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CEIOPS-DOC-07/05 Answers</s
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Style convention The following has
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• Safety measures (CfA 9); • So
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sole purpose is to
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Call for Advice No. 7 Technical pro
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one year). Therefore, capital requi
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perhaps through an explicit additio
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Discounting 7.22 The present value
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exposed to risk fr
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insurance liabilities set by refere
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Profit sharing In practice, for uni
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future cash flows will have <strong
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Explanatory text S
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always have resources to</s
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developed. They would help
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8.28 A fourth option could be envis
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In principle, "the
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8.48 Three alternatives can be cons
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essential part of the</stro
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statistical estimate (with a level
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8.77 It may be argued that
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to use more sophis
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consequence on the
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8.105 In some cases, the</s
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This shall be reviewed, at least an
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ut the exposure <s
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Explanatory text M
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9.15 Solvency II could also employ
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9.28 The life formula yields itself
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underestimate them
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'Prudent person plus' approach 9.52
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Uniform or different rules for tech
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through a prescribed list. Lists ar
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addition a range of stresses so tha
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(including the Rei
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for review of the
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adjusted SCR. From a purely technic
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to be implemented.
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capital
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absolute floor (expressed in euros
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Bolkestein agreed to</stron
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16.14 Generally speaking, complianc
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appoint an additional person <stron
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16.28 It should also be noted that
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Time of application 16.41 The asses
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of the individual
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Background 17.1 This document aims
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Review Panel would be a permanent g
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• the developmen
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asis for considering improvements <
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(I) Regulatory arb
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(II) Capital requirements at group
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into a SCR at grou
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18.31 Additionally, it must be deci
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Capital requirements 18.39 The Fram
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(III) Supervisory Review Process of
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18.60 In view of the</stron
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new structure would need to
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future Framework Directive. CEIOPS
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18.94 Model validation in t
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the assumptions us
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Annexes Annex A (Call for Advice No
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pursuing a strategy which t
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Specific principles for non-life in
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Conformity, suitability and suffici
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• existence of significant insuff
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A.64 In the tests
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the rules on <stro
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TVaR1-α for Tail Value-at-risk. In
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Degree of personalisation B.24 Tran
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B.34 There are two approaches <stro
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Segmentation B.44 In general terms,
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technical technical technical techn
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B.61 The second alternative was cho
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Dutch supervisory authority for <st
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Market risk Equity risk this altern
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B.95 In a scenario-based approach,
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B.106 As an alternative one could t
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where: KTSA = the
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Results from the a
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Solvency ratio prior to</st
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Number of instances Risk group Deta
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Conclusion In general, the<
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where: TP gross = technical provisi
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premium risk, the
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“While proportional reinsurance t
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contribute with any additional info
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E.29 Another way <
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programmes on the
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