Aon Benfield, a global reinsurance intermediary and capital advisor of Aon Corporation, is calling for a simplified Internal Model Approval Process (IMAP) for natural catastrophe risk that would encourage insurers to better quantify these exposures under Solvency II.
Under the current Solvency II framework, insurers have the option to use either a standardized scenario approach or develop a partial internal model for natural hazard risks. The latter would allow re/insurers to benefit from the higher quality data used in the vendor models to calculate their natural catastrophe exposures. This should in turn be the logical foundation for the corresponding solvency capital requirements.
However, a partial internal model approval process can be costly and onerous for both regulators and re/insurers. Under the current QIS 5 rules this could lead to some re/insurers, particularly smaller companies without the resources, to adhere to the simplified Standard Formula approach – despite resulting in misleading capital requirements. This is because the Standard Formula fails to account for catastrophe model improvements over the past 15 years, which include greater location granularity and increased differentiation by occupancy or construction.
Aon Benfield is lobbying the European Insurance and Occupational Pensions Authority (EIOPA) for a change to the current process, which would allow more re/insurers to realize the benefits of a partial internal model.
The tests for natural catastrophe internal model approval would still apply but the firm is proposing a simplified approval process focused on data quality, data benchmarking and the internal process. It would be more efficient for the catastrophe model vendors to provide information to regulators once to validate the model assumptions and technology, rather than many insurers undertaking this process.
Standardized documents from the model vendors, included in the overall approval submission, would outline how the design and parameterization of the natural catastrophe model meet the requirements of Solvency II. This would allow insurance companies to focus purely on input data requirements and providing the regulator with information on how the chosen model is applicable to their business.
The proposal is in line with the request from the European Commission to EIOPA to simplify the Solvency II requirements, which could lead to a win-win situation for regulators and the industry.
Paul Miller, head of international catastrophe management at Aon Benfield Analytics, said: “The use of CRESTA zone data in exposure calculations was common 15 years ago, but now most insurers and reinsurers use far more detailed data. The Solvency II Standard Formula does not recognize this evolution so re/insurers receive a higher risk profile and more onerous capital requirements. Our new proposal to EIOPA allows for effective risk management and more appropriate choices for reinsurance strategies.”
Marc Beckers, head of Aon Benfield Analytics for Europe, Middle East & Africa, added: “We’ve been working with clients and regulators to devise the best way for insurers and reinsurers to better understand their risks, justify their views to regulators and reap the benefits of a partial internal model.
In addition to these goals, the proposed simplified approach will ensure a level playing field between smaller and larger insurers under Solvency II and allow significant cost savings for both the insurance industry and the supervisory bodies. The next step is for EIOPA to liaise with the model vendors on how this can effectively work in practice.”