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The Solvency II Directive includes a provision that, where relevant, the SCR be calculated using an internal model that has been approved by the supervisory authority. This may create some risk that as models evolve over time, capital levels may drift downward and fail to adequately reflect the level of risk in the system. The PRA is proposing an approach to monitoring this risk at the level of individual firms, for sectors and the industry as a whole.
The purpose of the proposed supervisory statement is to set expectations on internal model firms to report results of their standard formula SCR calculations to the PRA. The PRA proposes to use this information to monitor potential model drift. This includes the monitoring of the internal model SCR against objective measures of risk. These measures of risk, which may change over time, include the standard formula SCR, pre-corridor Minimum Capital Requirement (MCR), net written premium and best estimate liabilities.
The PRA proposes to calculate model drift ratios from the point of model approval and re-base following a change in risk profile or major model change. This approach would ensure that any drift is identified consistently and monitored over time.
The PRA does not intend any automatic supervisory action in response to any change in model drift ratios. However, changes may lead to a supervisory review to investigate the reasons for such changes.
This consultation closes on Wednesday 17 August 2016.