In April, the PRA hosted an industry workshop for life insurers intending to use an internal model for Solvency II purposes that highlighted the regulator's ongoing concerns with credit, longevity and market risk modelling practices currently in use. But companies increasingly feel the requirements asked of them are unreasonable.

 

David Stevenson, Edinburgh-based actuary in Standard Life's UK capital and risk management team, commented: "The PRA wants to ensure that insurers understand the risks to which they are exposed and make appropriate allowances for these risks in their models."

 

Stevenson further said that a balance had to be struck between the use of the model, the relevance of the data, practicality and theoretical purism. "No model is absolutely perfect and users have to aware of limitations and apply judgement and their own experience in their decision-making."

 

A particular topic raised in the PRA workshop was credit risk modelling, the processes by which insurers identify, assess and score the default and downgrade risks in their asset portfolios. The regulator says that firms are challenged by the need to reconcile short- and long-term views of their credit risk and complained of "insufficient attention" being placed on the documentation and validation of asset models used as inputs to credit models.

 

On the first issue, insurers still see long- and short-term views of credit risk as "chalk and cheese", according to Tim Wilkins, senior consultant at Towers Watson in Redhill.

 

"The solvency capital requirement (SCR) is focused on the one-year view of risk and, in terms of credit, that is dominated by market risk. The long-term view, meanwhile, filters out the market risk to focus on default and downgrade risk. I don't think anyone has really cracked the problem of how to reconcile them", he added.

 

Standard Life's Stevenson claims that Solvency II's matching adjustment will help insurers in the future link up these two separate views.

 

One reason the PRA is ramping up its scrutiny of credit models may be life companies' growing interest in investing in illiquid assets where the credit risk may not be as well understood. "With infrastructure assets, insurers need to divide up the spread into the separate components relating to credit risk and illiquidity premium", said Wilkins.

 

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