Solvency II: Standard or Internal Model?

Solvency II is entering the critical phase.Time is running out!

But...., as a wise proverb states:

"When The Actuaries Get Tough,

The Tough get Actuaries"

However, the market for actuarial resources is limited and Solvency II Actuaries that  combine strategic and technical knowledge with 'common sense' are like  white ravens.

In the case of Solvency II, actuaries and models are moving forward in a particular way.

Standard Model
Originally, the 'standard model' was foreseen as a simple model for small and mid-size insurers (apart from very small insurers that were excluded). Big insurers, with more developed actuarial models, larger scale and more resources, were expected to work out a more sophisticated 'internal model'.

As the Solvency II Time Pressure Cooker gets up steam, things start turning.

Small and mid-size insurers found out that the 'standard model' was highly inefficient and the wrong instrument to steer adequately on risk management and to determine adequate solvency levels in their company.

Just because of their limited size and product selection, small and mid-size insurers often already have a well tuned risk management system in place and implemented throughout the organization. The manager, actuary (being the risk manager as well) and CFO of such companies therefore have enough time to develop a formal Solvency II 'internal model' that could be easily implemented throughout their organization.

Internal Model
Quit the opposite happens in the world of big insurers.

Big insurers coordinated Solvency II at Holding level and started to challenge their business-units around 2009 to develop and implement Solvency II programs on basis of an 'internal model'.

Collecting homework at the Holding in 2010, it became clear that a lot of technical issues in the models were still unclear. Moreover, models were not integrated (= condition)  in the business and counting up several 'internal models' showed up several consolidated inconsistencies. 

The complexity of developing a consistent risk model turned out to strong. Some big insurers are now considering to fall back on the 'standard model' (or partial model) before it's too late: the shortest errors are the best.

Looking back it's not surprising that big insurers need more time to operationalize a fine tuned risk model. It took specialist Munich Re 10 years to implement an internal model.

This development is also an indication that some big insurers are strongly over-sized. In order to keep up with the speed of the market, big insurers have to be split up into a manageable and market-fit size.


Related Links:

- Surviving Solvency II (2010)
- The influence of Solvency II on an insurer’s strategic policy
- White Ravens and Black Swans (Math Fun)

Actuarial Chess?

As actuaries we often have to explain HOW variables like profits, mortality, investments or costs will develop in the future.

In doing so, it would really help and strengthen our credibility if we were able to explain also WHY these variables developed in the past as they have developed, as a result of certain circumstances (other 'explaining' variables).

On basis of these WHY-arguments and the specific expected future circumstances, we could increase the credibility and diminish the volatility of our predictions.

This HOW-WHY-Insight urges us for example to analyze "medical developments" in case of predicting longevity and to study "economic developments" with regard tot predicting future costs, inflation or investment rates.

Moreover this understanding obliges us to develop our capabilities and competence to explain certain given outcomes like "increasing longevity" and "increasing stock return volatility".

Test Your 'Outcome Explanation Competence'

This 'Outcome Explanation Competence' (OEC) is key in actuarial science. No actuary can do without!

To test your OEC level, solve the next chess problem.

Black has made the last move... Which move?

You'll find the solution of this chess problem as a part of the next 5 minute 'Thinking Out of the Box' test ( on SCRIBD)......

5 Minute 'Thinking Out of the Box' Test

Just like in 'climate change predictions', our OEC (the 'competence to explain past phenomena') is necessary for us actuaries to be confident about our theories and predictions about the future.

However, developing OEC might not be enough as the explanations of the past could turn out to be fundamentally invalid with regard to the future. New techniques  like High-frequency trading (HFT) might come up. Or... in chess vocabulary: 'A pawn may promote to a Bishop' (frequency: 0.2%)

The conclusion must be that Actuarial predictions are a kind of 'Actuarial Chess':
So start practicing as an Actuarial Chess Master by Explaining the past and Guiding the future.

In control through better communication!

End of November 2010 the Dutch Regulator (DNB) met with certifying actuaries as well as external auditors. Both meetings were dominated by the theme of "accuracy of reporting" for pension funds, an important DNB monitoring theme.

DNB stressed that all pension fund reports are a key source of surveillance information. With confidence, every Pension Fund stakeholder should be able to rely on the accuracy and completeness of the information in pension fund reports. In practice, this is not always the case. DNB will increasingly hold pension fund boards, certifying actuaries and accountants responsible for taking appropriate actions and - if  necessary - DNB will enforce action.

Topics
Main topics on the accountant-Actuary table are:
- the valuation of technical provisions
- the valuation of the required equity and
- compliance with the prudent person rule.

In control through better communication

The introduction in 2011 of so called 'multi-party meetings' (ie consultation between pension fund management, actuary, accountant (auditor) and regulator DNB) with some larger pension funds will certainly help to improve communication between all concerned parties.

This excellent initiative will also certainly help pension funds to increase control.
Key issue is that the pension Board has (to keep) final responsibility and DNB has to take care that they do not implicitly take over part of this responsibility. Secondly DNB is responsible for an efficient and clear regulation/governance structure. Too many informal consultation meetings might not be efficient and bear the risk of unclear responsibilities. 


Sources:
- Newsletter Pensions DNB (Dutch, 2011)
- Source: Four leaved clover Coin