Mar 12, 2015

U.S. Insurers Tackle Model Risk Management

In advance of formal regulation, Alex Marion, Vice President of Client Solutions Group for Insurance at Numerix discusses the best practices U.S. insurers are utilizing to manage model risk. With the introduction of capital markets models alongside traditional actuarial models, as well as real-world and risk neutral dynamics, Alex also discusses new complexities insurers are having to face as they look to build-out a sound enterprise model risk management framework

 Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section. - See more at: http://blog.numerix.com/#sthash.jage9MzH.dpu
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Video transcript:

Jim: Hi, welcome to Numerix Video Blog, your expert source for derivatives trends and topics.  I’m your host, Jim Jockle. 

US insurers are under pressure to ramp up modeling framework as the use of models is coming under increased scrutiny, as reported by Louie Woodall of Insurance Risk Magazine.  While internal models are at the heart of insurer’s Solvency II capital calculations in the Europe, in the US concerns continue to build over model risk management practices.  

Joining me today to discuss this is Alex Marion, Vice President of Client Solutions Group here at Numerix.  Hi Alex, How are you?

Alex: Good, how are you Jim?

Jim:  With the exception insurers who have deemed SiFi’s that are under the purview of the US Fed, insurance regulators in the US are behind their foreign counterparts in terms of setting forth explicit guidelines for model risk management.  But many insurers large and small have been working on implementing best practices around model risk.  In advance of formal regulation, what are the insurers doing to manage model risk and what are some of the best practices they are utilizing.

Alex: Sure, so as you said, a lot of insurers don’t require independent assessment of their models and there really isn’t a definite guidance on what these insurers should be doing. The model validation or model risk management ranges anywhere from just having a peer review with some documentation to having some control process where there is a documented model approval process, but really no model risk assessment. Some firms have gone beyond that where they’ve actually have an independent assessment of their models.

Everything is documented, but what I think firms are really pushing to get towards is best practices having a robust model risk management framework, that’s part of their enterprise risk management framework, where there is an official governance framework. The board gets involved and it’s a life cycle of model validation from defining the model, implementing it, and reviewing it periodically.

Best practices include: having a model validation policy, having defined roles and responsibilities, having an independent assessment – that could be an outside party or another group inside the company that is assessing the models – and having, like I said earlier, a well-documented governance framework in place.

Jim: Well one of the trends we’ve seen post crisis has been really around the introduction of capital markets type models alongside traditional actuarial models.  What kind of complexity is this introducing into the insurers model risk frameworks?

Alex: It varies, depending on the insurance or the type of products that they are selling, they could range from having to validate catastrophe risk models, they’ll have models for reserving, they’ll have capital market models if they have capital market risk or derivatives.  If you look at the experience of a lot of variable annuity firms during the financial crisis - many firms have actually had to exit the business completely because their models didn’t perform the way they thought they would during the crisis, and their hedging programs didn’t perform. 

And a lot of that has resulted in companies taking a new look at how they validation and manage the risk inherent in these models.  Again, having these frameworks in place that address not just capital models and reserving models, but market risk models as well all under a risk management framework is part of the ERM groups is I think where the best practice is heading.

Jim: Well one of the conversations that you and I have talked about many times has been around market consistent modeling versus real world.  And obviously, post crisis, those ERM systems that were solely based on market consistent practices as compared to the introduction to real world had some significant challenges.  And some of those that actually left the business.  What kind of complexity, or what should insurers be thinking about as they look a real world and risk neutral?

Alex: Well I think you can get some guidance from some of the other regulation or regulators in place who have already put forth guidance. Under Solvency II companies that use an internal model for economic capital have to go through an approval process through the Solvency II regulator to use that model.  A number of other firms, International Actuarial Association has put out guidelines on best practices for validating not just risk neutral models but real world models. A lot of it just hinges on being able to prove that these models are credible and that the results downstream are credible as well. 

So if you are using a certain type of model to produce an economic capital calculation.  That economic capital calculation has to be credible, you have to have a process in place to validate that.  And it’s not just international regulators.  In the US, S&P has a process where they do an ERM review.  And companies that pass this high level ERM review actually may be able to reduce their RBC Capital requirements under the S&P.  So they put forth some guidance on how companies can achieve this rating and go through the process of proving to S&P or other rating agencies that their Economic capital framework is credible.

Jim: Well Alex thank you so much for joining us and shedding some light on this topic. The goal of Numerix video blog is to examine topics that you want to talk about and we want to really keep the conversation going.   So please join us on LinkedIn or Twitter @nxanalytics, and for industry news and updated, blogs, videos research and technical papers you can always follow us on LinkedIn or visit numerix.com. Thanks for joining.
 

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Video Transcript: - See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Video Transcript: - See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.

Video Transcript: - See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.
- See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.
- See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section.
- See more at: http://blog.numerix.com/#sthash.jage9MzH.dpuf
Blog Post - Jan 18, 2012

Looking Forward: What Trends Will Impact Model Risk Management in 2012?

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