09 January 2019

Insurance Europe: Europe’s largest reinsurers explain the supervisory benefits of using internal models

A group of Europe’s largest reinsurers, the Insurance Europe Reinsurance Advisory Board (RAB), has published an overview of the benefits of insurers’ use of internal models, titled Internal models: a reinsurance perspective.

Adapting to a rapidly changing risk landscape and identifying emerging risks lie at the heart of reinsurers’ business models. Reinsurers play a crucial role in the real economy. They expand insurers’ capacity to assume risks from businesses and individuals, supporting sustainable growth. By pooling a large number of diverse risks (both in terms of type and geography), reinsurers benefit from diversification, since not all risks will materialise at the same time.

The large variety, complex interdependencies and joint impact of risks require correspondingly sophisticated models. For this reason, most RAB firms already use their own internal models. Models for natural catastrophe risk started to be developed in the 1980s. Reinsurers have invested extensively ever since, particularly over the last 20 years, in developing models that are aimed at the holistic measurement of risk and the effects of diversification.

Internal models have proved crucial for sound risk management and business steering. This is because they create the right risk incentives and promote a better internal and external dialogue about risk exposures, thereby improving risk resilience.

Internal models have a number of benefits, making the risk profile of companies more transparent and enriching the dialogue between the supervisor and the undertaking. Internal models analyse risk in more detail so that the output of the model more closely reflects an undertaking’s risk profile.

Mandating the use of standard formulas or imposing supervisory overlays would threaten the progress that has been made in risk management in the insurance sector and the increased harmonisation in the way supervisors and companies look at risk.

Full publication

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