Solvency II model assurance. 12 April 2012

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1 Solvency II model assurance Zdeněk Roubal, Manager 12 April 2012

2 Solvency II assurance Organizations might want or even need to obtain assurance that their design and Solvency II implementation is on track. Mandatory assurance Internal model validation Requests by the regulators Areas to be covered Internal model assurance Embedding risk management Systems and data ORSA Reporting Group considerations Internal model validation General technical assurance (technical provisions, own funds ) Internal model approval process General Solvency II programme assurance 1

3 Solvency II control framework Internal control framework Basis of the organization s process around Solvency II Strategic Management Process Business Planning Risk Appetite Assurance both for individual areas and a framework as a whole Who is able now to assess independently the general control framework? Calculation kernel Methodology Data Assumption setting Asset & Liability Management Governance Business & Operations Capital management Risk & Financial operating model Reporting Finance MI Validation Planning & Control Performance Management Risk MI Systems & ICT Risk Management Assessment & Steering ORSA Use test Pillar I Pillar II Pillar III 2 2 2

4 Solvency II model assurance Model validation Validation is a key component of internal model governance First line: Day-to-day business operations Modelling team Risk and control Control environment Assessment of risk Validation processes and tools Governance around the model can be based on the 3 lines of defence framework First line: Controls over business as usual Second line: Functions responsible for the design and implementation These functions may lack necessary independence Third line: Independent assurance for specified areas Independence is a key consideration of internal audit in Solvency II framework Second line: Oversight Risk management function Risk committee Third line: Independent assurance Internal audit, Independent external providers Risk and control Validation policy Guidance Monitoring Improvement ideas Validation report Risk and control Challenge of model and validation audit committ tee Board and 3

5 The scope of validation should go beyond internal model itself Asset Data Accounting Data Internal Model Governance Sample scope of Internal Model Potential scope of validation Generally areas of debate Policy Data Valuation Methods Best Estimate Assumption s Calibration Process Calibration Data Calibration Methods Calculation Kernel Calculation Method Calculation Assumptions Aggregation Process Aggregatio n Data Aggregation Method Likely out of scope Tax Calibration Assumptions Aggregation Assumptions Heavy models SCR Results IT & Systems Solvency II Balance Sheet Internal Model Validation Framework P&L Attribution ti Documentation Internal Model Reporting Internal Model Application Procedures Use 4

6 What would internal audit need to cover? Major components are... The IC framework for the calculation process performed on a regular basis Step 1: Data input Step 2: Data manipulation and grouping Step 3: Assumption setting and model update Step 4: Performance of calculation Step 5: Validation of model operation and assessment of results Step 6: Preparation of results and reporting IC framework for model change and validation Performance of model changes Model validation Validation of model operation & assessment of results Preparation of results and reporting Model changes Data input Data manipulation and grouping The assessment on the calculation kernel can focus on... Various types of models and calculation, on the economic balance sheet as well as on risk capital requirement Key risk drivers of the model, e.g. major assumptions and data input with respect to the absolute level of economic capital the volatility of calculation results Efficiency of the calculation process and integrated tools Robustness und effectiveness of the IC framework Performance of calculation Assumption setting and model update 5

7 Implications for the internal audit Need for more resources and different skill sets within internal audit (eg. credit and market risk experts and individuals with actuarial and other quantitative skill sets). Need to develop reporting that supports Internal Focus of the Model. internal audit will shift to the technical skills New training required and need to develop competency framework in relation to new work. Linking audit planning to risk and regulatory capital assessment Potential need for new tools and technology to provide assurance over Solvency II programme and areas of the organisation not previously audited (eg. actuarial models). Establish and communicate Internal Audit s redefined role within new governance structure including how internal audit interacts with risk and compliance functions. 6

8 Modelling component key questions Sub processes Important areas of attention Key management questions Assumption setting and model update (cont.) Performance of calculation Validation of model operation and assessment of results Preparation of results and reporting Stability and robustness of the technical calculation needs to be ensured Reconciliation between related calculation steps is essential for providing reliable results The possibility of re-performance has to be ensured The assessment of results requires a critical review based on the full understanding of the underlying business, related economic environment and interactions between risks (solo and group level view) Effective interfaces between calculation kernel and reporting need to be implemented Appropriate p description of results und underlying assumptions is required to ensure that results can be understood Does the management on the one hand and does the model actuary on the other hand have the right feeling about the possible impact of changes of assumptions? Is there sufficient transparency and documentation about the assumptions and updates? Are model results robust with respect to assumption changes? Is there an audit trail implemented in the technical calculation steps that would allow the management to reconcile the derived model results end-to-end, if necessary? Are the differences between the group model and model approaches on local level well known? Is the calculation tool a black box or exists transparency on used methodology, coding and model limitations? Is there an overview of links and interfaces between submodels on group- and on solo level? Does management on local level know major limitations and approximations of the group model approach if it is also used (in parts) for solo purposes on local level? Are the received results plausible compared to plan or prior year calculation? Is this assessment performed on solo and on group level? Can significant deviations be explained by changes of data basis, assumptions or models? Is there reliable drilling-down of changes and deviation available, if required? Is there an adequate level of automation at the interface to the reporting requirements? Do the model actuaries have the right understanding of underlying reporting requirements when preparing their results and vice versa for accounting staff? 7

9 Thank you Zdeněk Roubal KPMG Česká republika Tel.:

10 2012 KPMG Česká republika, s.r.o., a Czech limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Printed in the Czech Republic. The KPMG name, logo and cutting through complexity are registered trademarks or trademarks of KPMG International Cooperative (KPMG International).

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