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ICSNEWLevel 1 and Level 2 texts7. Capital requirement – Other Methods7.3.5 General provisions on the use of partial internal models (PIM)

7.3.5 General provisions on the use of partial internal models (PIM)

7.3.5.1 Framework for partial internal models

  • L1-178. An IAIG may use an internal model if the requirements specified in earlier sections are met. The internal model is considered as partial if at least one of the conditions below are met:
    • • The scope of the model does not cover all quantifiable risks identified; and
    • • The scope of the model does not cover the entire insurance business within the group. For instance, a specific portfolio, or an entity is not covered.

7.3.5.2 Justification of the scope of partial internal models

  • L1-179. An application for approval of a PIM includes the evidence of such compliance, as well as a proper justification for the limited scope of the model.
  • L2-440. The IAIG explains how the capital requirement resulting from the PIM reflects more appropriately the risk profile of the IAIG.
  • L2-441. In case the model is partial in terms of business coverage, the explanation provided specifies the reasons for excluding certain business from the internal model and demonstrate that the overall risks to which the group is exposed are not underestimated by using a partial internal model (eg cherry-picking).
  • L2-442. When assessing an application for the use of a PIM, the GWS considers at least the following:
    • • the materiality and risk profile of the business excluded with respect to the risk profile of the IAIG; and
    • • the appropriateness of the standard approach for the calculation of the capital requirement of both the business included in the scope of the internal model and for the business excluded from the scope of the internal model. In particular, the GWS should assess whether the exclusion of a business could lead to:
      • o an inadequate capital requirement in relation to the risk profile of the group;
      • o an improper allocation of own funds based on the capital requirements of the excluded business rather than on its contribution to the risk profile of the IAIG; and
      • o weaknesses in risk management of the IAIG and its business resulting from the limited scope of the internal model.
  • L2-443. When assessing an application for the use of a PIM that only covers certain risks, or part of the business of an IAIG, the GWS may require the IAIG to develop a realistic transitional plan to extend the scope of the model. The transitional plan should set out the manner in which the IAIG plans to extend the scope of the model to other risks, portfolios or entities, in order to ensure that the model covers a predominant part of their insurance operations with respect to that specific risk module. In such case, the GWS should consider whether mitigation measures are necessary until the transitional plan is completed, such as terms and conditions or a capital add-on.

7.3.5.3 Integration of partial internal models

  • L1-180. The capital requirement resulting from a PIM is fully integrated into the capital requirement obtained from the standard approach and vice versa.
  • L2-444. In the case of a PIM, it might be more appropriate to calculate the capital requirement for different risk components separately and integrate them directly into the standard approach without further aggregation in the internal model use. For instance, the PIM could cover the market risk module and the non-life underwriting risk module, which are not integrated under the same probability distribution but directly integrated to the standard approach.
  • L2-445. The integration technique used is considered part of the PIM and should be approved by the GWS.
  • L2-446. As a default integration technique, IAIG should consider the correlation matrices and formulas of the standard approach set out in the ICS Technical Specifications
  • L2-447. If the IAIG demonstrates to the GWS that it would not be appropriate to use the standard approach correlations, an alternative technique can be submitted for approval to the GWS. The IAIG should demonstrate the appropriateness of the integration technique proposed. The integration technique used should ensure a level of protection for policyholders in line with the ICS risk measure and time horizon. It should also reflect the IAIG’s risk profile.
  • L2-448. The assessment of the integration of PIM results should be regularly validated by the IAIG, in particular when there is a material change to the PIM or to the IAIG’s risk profile.
  • L2-449. The annual reporting to the GWS should allow identifying the capital requirements stemming both from the PIM and from the standard approach in a way that allows the estimation of the diversification benefit obtained from the integration of both parts.

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7.3.4 Additional considerations1. Background information