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The Reinsurance Advisory Board (RAB) of Insurance Europe, the European insurance and reinsurance federation report finds that prescriptive approaches and formulas are in many cases inappropriate for global reinsurers and less suited to cope with the continuously evolving risk landscape. On the other hand, internal models can measure risk factors more appropriately in relation to the respective exposure. They can capture the relationships between risks which will, for example due to geographical diversification, not all materialise at the same time. As a result, the output of internal models reflects a firm's risk profile more accurately.
Inga Beale, CEO of Lloyd’s of London and chair of the RAB, commented: “European reinsurers are in no doubt that internal models are an integral part of modern risk-based solvency regimes, such as Solvency II. They deliver benefits not just for regulated firms, but also for the authorities that supervise them. By elaborating these benefits in the report Internal Models: A reinsurance perspective the RAB hopes to begin a constructive dialogue with supervisors on the important role that internal models play and on the risks associated with regulatory initiatives that constrain their use.”
The report addresses supervisory criticisms that have been levelled against internal models. It explains the benefits of using internal models for prudential purposes and why, for many reinsurers, internal models remain the most appropriate basis to compare risk profiles of different firms.
The report urges supervisory authorities not to threaten the significant progress that has been made in risk management in the insurance sector by mandating the use of standard formulas, or by imposing supervisory requirements on top of existing models.
Beale added: “The diversity of internal model approaches, compared with a framework where all insurers and reinsurers are obliged to use a standard model approach, also increases financial stability.”