01 May 2012

Risk.net: Slow progress on Solvency II internal model validation threatens approval, FSA warns

Insurers are at risk of their Solvency II internal capital models not being approved because they are falling behind in their model development plans, the UK Financial Services Authority (FSA) has warned.

Slow progress in validating the model, weak supporting documentation and underdeveloped policies for managing changes to the model were putting some insurers at risk of being ejected from the FSA’s internal model approval process. The FSA has now completed a significant part of its review of firms’ progress in the development of their internal models prior to the formal submission of the application for model approval.

“What we are starting to see, though, is a number of firms falling behind on their own implementation plans, and this is beginning to cast doubt in some cases on their ability to achieve their [internal model] submission slots”, said Julian Adams, director of insurance supervision, prudential business unit at the FSA in a speech in London.

Weak or underdeveloped supporting documentation was also an issue for some firms. Some firms were also placing undue reliance on the concept of expert judgement to avoid properly justifying aspects of the internal model, such as its parameters and assumptions.

Adams warned that insurers would not be allowed to submit an application for approval of an internal model if they had not advanced sufficiently in their model development. “If we do not believe that a firm has made sufficient progress during pre-application to be able to provide a reasonably viable submission to us, we will cease to work with the firm and not allow it to continue in the internal model process in the run-up to implementation”, Adams said.

He added: “This clearly is not a decision we will take lightly, not least because we are aware that the repercussions for some firms of not achieving model approval are potentially severe. But equally it is one that we are perfectly prepared to take, and we have been clear with firms that we expect them to have contingency plans in place to deal with a situation where their model is not approved.”

The FSA will begin to assess firms that intend to use the standard formula for calculating their capital requirements later in the year, Adams added. “We will work with them to assess their approach, and the extent to which their use of the standard formula is appropriate”, he said.

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