Under Solvency II, the regulatory framework for EU-based (re)insurance companies, the use of risk-based capital requirements was introduced as were internal models for the calculation of these capital requirements. The objectives of Solvency II are adequate protection of policyholders and beneficiaries, financial stability and fair and stable markets, the further development of the Single Market, and effective supervision and transparency for policyholders. This research project concentrates on how the risk-based capital calculation with internal models as prompted by regulations and applied in practice, matches with the objectives of the Solvency II legislation.
The practice of development, validation and use of an Internal model for steering of a (re)insurance company is expensive and complicated. However, the possible reward for applying an internal model is that a company has a lower capital requirement than when applying the SF and can use the free capital to obtain higher returns. Other benefits of applying an internal model are better steering possibilities and a better-developed understanding of the risks taken by the company.
(Re)insurance companies have a degree of freedom in building internal models as long as they demonstrate that the model is a fair representation of the risks taken by the company. Because the insurance portfolios of a company (of which the model is a representation) too can vary widely across the industry, this can make it difficult to compare financial positions and outcomes of companies. The supervising authorities have to judge whether the capital held and the development and use of an internal model are adequate for the risks the company takes, whether the data quality demands are met, whether the validation process meets the applicable standards, and whether the model is used correctly and responsibly. While also upholding the level playing field within the Single Market.