These are more acute where the event – for example, a credit default or a windstorm – being modelled happens infrequently and historical data is therefore scarce, where events cluster rather than occur independently or where the underlying process behind the event – for example the structure of the economy or the natural environment – may have changed, so that history is an unreliable guide to the future. In such circumstances, significant uncertainty about model outputs may call for a more prudent approach. And the temptation to add additional parameters, making models more and more complicated, can often have the perverse effect of weakening model performance. This is why, in addition to scrutinising the technical components of models, we also look at the way they are used within firms. Only a good model can play an important role in a firms’ system of governance. Our expectations of their quality are high as Solvency II specifies that they become an embedded part of the risk management system of a firm. It is therefore not only important for us to rigorously assess them but that senior management have ownership of these models and continuously do the same. The Bank of England takes model approval very seriously indeed and we will not hesitate to hold back approval for the use of models where there are risks that cannot credibly be modelled or data are insufficient.
To echo the Governor’s words from his speech to the Institute and Faculty of Actuaries in September “Insurance is at the core of the new Bank of England”…we have over 200 supervisors and 50 actuaries engaged in the implementation of Solvency II, not to mention the contribution from numerous dedicated policy experts. In addition, with insurance supervision now embedded in the Bank, supervisors benefit from the support of monetary policy experts, credit risk analysts and macro-financial analysts. The insurance sector plays a key role in the financial system and the economy. It protects companies and individuals from perils they could not otherwise shoulder, managing and spreading risk globally. Insurers are vital to efficient allocation and overall provision of capital, they provide alternative sources of funding, increasing the diversity in the system. The PRA has two primary statutory objectives: to promote the safety and soundness of all banks, insurers and major investment firms and, a specific objective for insurers, of contributing to the securing of an appropriate degree of protection for policyholders. These objectives are the guiding principles that ultimately underpin our implementation of Solvency II. The core objective of the new regime is greater policyholder protection. Solvency II is a welcome modernisation of European regulatory standards. You will be familiar with the UK’s ICAS regime. Solvency II recognises many of the principles that form the basis of that regime, and therefore introduces a level playing field with the rest of the EU. Risk-based capital standards and robust valuation practices ensure resilience against unexpected losses.