Applying EIOPA’s preparatory guidelines: Pre-application of internal models

Amit Lad contributed to the writing of this blog post

2013 saw confirmation that Solvency II will become reality from 1 January 2016. EIOPA published its preparatory guidelines and, in response to this, the Prudential Regulation Authority (PRA) released a Supervisory Statement. It is no longer sufficient for Solvency II to sit on firms’ agendas; action must now be taken and progress demonstrated.

Here we focus on the PRA’s comments on the guidelines surrounding the pre-application for using internal models. The key message is that internal model work should largely continue as it has been. In this blog, we will outline some of the other themes in the guidelines, what these mean for insurers and how we can help.

Who is impacted by these guidelines?

The guidelines are clearly pertinent for all firms that are currently in the Internal Model Approval Process (IMAP). Firms that are not currently engaged in the IMAP, but who intend to apply for entry to the process at a later date should also find the guidelines relevant.

Key messages in PRA supervisory statement

The PRA did not make any surprising or unexpected comments in their statement; the underlying theme was that internal model work should continue as it has been doing.

The PRA did draw attention to the following themes that have been present in the PRA’s prior communications to the industry:

Pre-application ≠ Pre-approval

The PRA stressed that the pre-application process is just one stage of the internal model approval process. Firms are reminded that participating in the pre-application process does not automatically mean that their model will get pre-approved. All firms should be prepared for the scenario that their internal model does not get approved for use.

Proportionality

The principal of proportionality in EIOPA’s guidelines is consistent with the judgement-based approach that the PRA is already applying when engaging with firms

Use test

Despite internal models not yet being approved, much work has gone into them. If internal models are developed to the stage where they are sufficiently stable, firms should begin to demonstrate their use within their business. At this stage, firms can also be using their current experience to refine the model.

Governance

The PRA is anticipating that firms, which are using their sufficiently stable internal model, will be demonstrating adequate governance of their model. This can be done by testing the controls and processes surrounding the implementation of the model. For example the model change policy can be tested when using recent experience to refine the model.

Good communication

Good communication makes any process run more smoothly. The PRA would like firms to discuss significant changes to their internal models at an early stage of the process.

Current timescales

Due to the individual nature of the pre-application and model approval process, many of the timescales are specific to each firm and will be communicated to them via their supervisory contact.

How can Barnett Waddingham help?

• Building internal model
• Assist your teams in building or completing your internal model.
• This would include the surrounding controls and processes as well as the model itself.
• Perform a gap analysis to identify areas of your internal model which still require further work. We can then assist you with drawing up implementation plans to address the gaps identified.
• Validation of internal model
• Provide 3rd party independence and expertise to validate your internal model.
• If validation is done internally, we can review it to identify areas where it can be improved and provide you with comfort and assurance that your validation meets expectations.
• Resources
• Preparing for Solvency II can be a very resource intensive process. Our team offers a wide range of services and expertise; we can assist you with your Solvency II preparations in any areas where your resources may have become strained.