This point is composed of several sub-chapters which are treated separately due to the relatively large number of responses to this question. From the central database we know of six full and one partial model. According to the national reports, at least eleven internal models data were submitted38; a precise answer is not possible due to the confidentiality argument in some reports.
It is to be mentioned that the extent of answers to these questions does not coincide with the extent of data provided in the spreadsheets. Furthermore, several comments on risks and risk modules are treated in the corresponding chapters.
13.4.1 Risk measure used for internal model
Most respondents use the Value at Risk approach on a one year horizon. The confidence level lies in the range of 99.5 and 99.97 percent. Some of those that use a high confidence level (corresponding to AA rating by S&P for example) explain that for QIS3 purposes they (also) applied the 99.5 percent level in order to allow comparisons with the standard model.
38 Mind that most of the internal model submissions to the central database are also
13.4.2 Scope of the internal model
Most respondents argue that their model covers all group entities. Some, however, confine their assessment to material entities or to operating entities.
One respondent argued that the group model essentially consists of a sum of solo internal models.
13.4.3 Treatment of minority participations
Most respondents included their participations, in which case group SCR is limited to the proportional share that is owned by the group.
One respondent mentioned that no credit was taken for surplus within group calculations but deficits are taken into account.
13.4.4 Other financial services activities
With regard to other financial services activities the results are not as clear-cut.
There are groups that take those activities into account although most of them are not very informative with regard to their approach. Others still do not consider other financial services activities but, if applicable, plan to include them in the future.
13.4.5 Treatment of non-regulated entities
There is a wide variety of how groups include non-regulated entities in their model. It mainly depends on the structure of the group and the kind of non-regulated entities they contain, e.g. holding companies, special purpose vehicles (SPVs), etc. Hence, there are some groups that do currently not take account of any non-regulated entities in their calculations.
One respondent simply adds a surcharge for operational and business risk.
Another one includes SPVs in case they include or transfer insurance risk. A third one gives a detailed explanation of how it treats such entities. As such, the assets and liabilities of its holding companies were allocated to insurance companies and stressed according to the standard ICA methodology, while pension fund activity was taken into account by splitting it into national and non-national schemes.
13.4.6 Material risks covered in the internal model
As expected, all groups more or less completely cover all material risks, albeit the classification of risks and the focus may vary. For instance, operational risks may also cover group specific risks, interest rate and equities volatilities are
covered in the market risk module, etc. Moreover, the approach is not necessarily consistent with that of the standard model. For instance, one respondent stated that its internal model took into account all risks of the standard formula except revision risk which was said to be inapplicable. Another respondent did not take into account catastrophe risk. One respondent did not take into account concentration risk but contended that it was not material since its model covered default risks, and concentration risks are regularly monitored at group level. It added that it was unlikely that the threshold for any single counterparty would exceed the QIS3 limit.
13.4.7 Aggregation method at group level for internal model
The use of the correlation approach seems to be common industry standard although it has to be mentioned that the description strongly varies with respect to their degree of detailedness. Moreover, the correlation assumptions need not necessarily coincide with those of the standard model. They are defined on the basis of statistical tests of historical data or on best judgement.
Furthermore, the models vary in their concrete design. In one case this approach was not used at group level, the solo internal models were summed instead.
Others also took account of non-linear relationships between risk factors and extreme scenarios. Two groups explicitly use tail correlations within correlation matrices. There are also different approaches with respect to the steps of aggregation.
For instance, one respondent started by assessing the geographical diversification benefits at the lowest level of risks (e.g. interest rate risk); it then combined its aggregated VaR stresses for one year using a single covariance matrix. This respondent assumed no diversification between EU participating fund and other operations; and between operations in the same country (though it thinks both should be allowed).
Another was of the view that there was no explicit correlation between risk types though regional variables were correlated. This group also applied correlated
‘inflation shocks’ across business lines for both underwriting and reserving. The internal models assumed that credit risk was independent of other risk types (and operational risk is added on as a standalone amount).
A third one explained that they use several correlation matrices to aggregate risk at group level. First they aggregate the entities per risk type using a specified correlation matrix between the entities. Subsequently, they aggregate the different risk types using a specified correlation matrix between the risks. They also use a factor in order to correct for violations of the normality assumption when this is needed.
In another example a bottom up approach is followed, i.e. each business unit submits a capital requirement which is then aggregated together to calculate the group internal model capital requirement. Allowance is made, via a simple add-on, for any situation where the largest single risk faced by the business unit was greater than the overall capital requirement. However, at the group level, this is not reflected in the data used and is instead applied as an add-on to the group capital requirement.
13.4.8 Allocation of diversification benefits to solo entities
Basically, we see two approaches. Many respondents keep the diversification benefits at group level. In emergency cases the capital is then downstreamed to the respective entity. Those that redistribute the diversification benefits to the subsidiaries use a proportional allotment. This proportional approach is mainly used due to its simplicity (not only on a computational point of view but also for internal communication, planning and target setting).
13.4.9 Data used to feed the internal model
Below is a synopsis of the responses:
− Consolidated data were used to feed the models.
− Calculations at solo level were combined using correlation matrices at group level.
− Group internal model was based on the sum of the solo internal models.
− Aggregation was performed simultaneously at entity and group levels.
− Group aggregated the components of the solo SCRs.
− Group result was calculated by combining the outputs from the regional standalone models. Each model was linked to a tying variable, ensuring that the combined results were calculated using consistent economic assumptions.
13.4.10 Treatment of internal reinsurance
There is no industry-wide opinion on how to treat internal reinsurance. Many respondents do not apply a capital charge for internal reinsurance because they argue that internal reinsurance is simple a vehicle for relocating risk from one business unit to another within the same group. One respondent argues that internal reinsurance is included in the sense that entities are considered with their internal reinsurance and that the difference between external and internal reinsurance is quantified and allocated to the internal reinsurer in the internal
the ceding entity (exposure treated on an arm’s length basis for the purposes of solvency requirements). At group level, internal reinsurance cancelled out and there was no additional requirement.
On the other hand there are also cases that charge the internal reinsurer for the embedded credit risk. In that sense there is not made a distinction between external and internal reinsurance.
There is an example where individual business units calculated their internal model capital requirement using the net position in relation to risk ceded to the captive reinsurer. It added that the exposures to the captive were subject to the reinsurance credit risk stress test.
13.4.11 Barriers to transferability
The general consensus seems to be that barriers to transferability of capital between entities were not considered in any significant sense. The main exception to this was with-profit funds where it was broadly assumed that capital was not transferable within the groups. However, the reasons for not paying much attention to possible barriers to transferability of capital varied widely.
In fact, some respondents assumed that there were no particular barriers to transferability of capital. One group which had experienced stress chose to sell the subsidiary and claimed that the value realised by the sale was significantly greater than net asset value. It therefore felt that the key issue was the price that could be obtained for the sale of an entity. This effectively negated any need to think about possible barriers to transferability and enabled the group to assume full capital fungibility.
However, that situation is hardly concealable with a perspective in an ongoing situation. In fact, from a supervisory perspective, it can also be expected that the group will try to solve the problems while keeping its unity. Furthermore, the Solvency II framework is built on diversification Thus for example, because of diversification the sale of one entity reduces the group SCR by less than the solo SCR of the subsidiary that is sold.
14 Areas for further work
The third quantitative impact study has been a success in terms of participation.
The number of participants doubled and that of small enterprises almost tripled in comparison to QIS2. Overall, the feedback from the industry is positive.
Nevertheless, during the process several questions have arisen which merit to be answered to improve the specifications in view of the next quantitative impact study.
Please find below a non-exhaustive list of issues that have been raised by participants during the exercise:
14.1 General
− Tax issue: During QIS3, the question arose as to how to deal with taxes under Solvency II as in practice this may strongly influence the comparability of results. It has been stated that Solvency II is neutral and agnostic with regard to any accounting or tax issues, but as this is an issue that would exceed the scope of Solvency II, a political decision may need to be taken on this.