Today, the European Insurance and Occupational Pensions Authority (EIOPA) published an update on Internal Model Consistency Projects to strengthen supervisory consistency and convergence in the European Union. The activities are part of the follow-up on the Opinion on the preparation for Internal Model applications issued in April 2015.
EIOPA has recently implemented three internal model consistency work streams:
- Market and Credit Risk Benchmarking Study,
- Modelling of Sovereign Exposures
- Modelling of Dynamic Volatility Adjustment.
The Market and Credit Risk Benchmarking Study analysed relevant aspects of risk associated with interest rates, credit spread, equity and real estate and compared the calibrations of different aspects of market and credit risks of undertakings with internal models that include market and credit risks. The national competent authorities (NCAs) are currently reviewing the position of their undertakings within the benchmarking analysis to decide on follow-up actions. EIOPA plans to publish the results of this study in the first quarter 2018.
The second work stream focused on the quantitative and qualitative aspects of the modelling of sovereign exposures based on the information provided by NCAs and selected undertakings. The results show that where sovereign exposures were being modelled in an internal model, the modelling was by and large consistent with the approach taken for similar, non-sovereign instruments. The results are now being reviewed by NCAs. The follow-up of these quantitative observations is being included in the follow-up of the Market and Credit Risk Benchmarking Study. In the third work stream EIOPA analysed quantitative and qualitative aspects of dynamic modelling of the Volatility Adjustment. Different approaches were observed and follow-up discussions with NCAs are continuing with the aim towards a common view taking into account theses different approaches to modelling a dynamic VA as well as the related risk management implications.
To monitor and further enhance supervisory practices EIOPA plans to conduct comparative studies on market and credit risk monitoring annually. The data request for the next study will be launched by the end of this year.
For more information, please view the update published on EIOPA's website.
EIOPA in its Opinion on the preparation for Internal Model applications recommended that NCAs should carry out comparative studies on the NCA level and contribute to and make use of corresponding studies on the EU level coordinated by EIOPA. Furthermore, provision for comparative studies, where undertakings are required to run their models on relevant benchmark portfolios, is included in Article 122 of the Solvency II Directive.
The Volatility Adjustment is one of the measures introduced in the Solvency II valuation of insurance contracts with Long-Term Guarantees (LTG) via the Omnibus II Directive (2014/51/EU). It aims at stabilising the Solvency II balance sheet during short periods of high market volatility by adding an extra spread component to the discount rate used for the calculation of technical provisions.
When it comes to internal models, there are currently two approaches to take the Volatility Adjustment into account in the calculation of the Solvency Capital Requirements. In the first one the Volatility Adjustment is allowed to move in line with credit spreads during the one year forecast (dynamic Volatility Adjustment) and in the second one the Volatility Adjustment is held constant (constant Volatility Adjustment).