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Erin McKnight
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Time to go beyond compliance with internal models for insurance enterprise risk management

Algorithmics sets out steps, challenges and benefits of building an internal model in new white paper

In its latest insurance white paper, Algorithmics, an IBM company, argues that internal models serve a more important purpose than just regulatory compliance. Insurance firms that use internal models see broader business benefits, such as optimized levels of economic and regulatory capital, more effective risk management and faster, higher quality financial reporting. As Solvency II equivalent legislation begins to emerge worldwide, it is expected that internal models will increasingly become a global phenomenon. Even US insurers are already moving towards internal models for their enterprise risk management (ERM) requirements and this is expected to accelerate as the ORSA under the US Solvency Modernization Initiative gains traction.

The white paper, ‘Internal Models for Insurance Companies: Components, Considerations and Benefits’, sets out the key issues insurers face in developing an internal model and discusses ways to address these challenges. The paper is targeted at insurers around the world who are looking to develop internal models, whether this is to address regulatory compliance or with an eye on the bigger prize of achieving more significant business benefits.

Curt Burmeister, Vice President, Risk Solutions, Algorithmics, an IBM company, commented: “We’ve worked with and continue to work with many of the biggest insurers in Europe as well as major US insurers who want to derive real value for their business from their investment in Solvency II, Economic Capital and ERM projects using an internal model approach. A strong internal model promotes a common risk culture throughout the organization, allowing the insurer to align activities to optimize results. Over time, an insurer that is using internal models can transform its business process and gain significant competitive advantages. One client expects to see a reduction in its capital charge of approximately 20%.”

Burmeister continued, "The simple fact is that with an internal model, insurers have a single model that can be applied to many different uses, whether this is calculating economic and regulatory capital, conducting ALM (asset and liability management) or enabling ERM. This means that they can realize a broad range of business outcomes way beyond just regulatory compliance. This paper is intended to help them understand the issues and to help them get started on this journey."

The paper lists the challenges of developing an internal model as defining the model, managing organizational matters and creating the most appropriate model architecture. It sets out the benefits of using this approach as:

  • Capital savings
  • Capital allocation
  • Risk transparency
  • Risk-based decision making.