Prudential Regulation Authority Rulebook

11.1

A firm must ensure that its internal model and, in particular, the calculation of the probability distribution forecast underlying it, complies with 11.2 to 11.8.

[Note: Art. 121(1) of the Solvency II Directive]

11.2

The methods used to calculate the probability distribution forecast must be:

1. (1) based on adequate, applicable and relevant actuarial and statistical techniques;
2. (2) based upon current and credible information and realistic assumptions; and
3. (3) consistent with the methods used to calculate technical provisions.

[Note: Art. 121(2) of the Solvency II Directive]

11.3

A firm must be able to justify the assumptions underlying its internal model to the PRA.

[Note: Art. 121(2) of the Solvency II Directive]

11.4

1. (1) Data used for the internal model must be accurate, complete and appropriate.
2. (2) A firm must update the data sets used in the calculation of the probability distribution forecast at least annually.

[Note: Art. 121(3) of the Solvency II Directive]

11.5

Without limiting the operation of 11.2, irrespective of the method chosen to calculate the probability distribution forecast, the ability of the internal model to rank risk must be sufficient to ensure that it is widely used and plays an important role in the system of governance of the firm, in particular in its risk-management system and decision-making processes, and capital allocation in accordance with 10.1.

[Note: Art. 121(4) of the Solvency II Directive]

11.6

The internal model must cover all of the material risks to which the firm is exposed, including at least the risks set out in Solvency Capital Requirement – General Provisions 3.3(1).

[Note: Art. 121(4) of the Solvency II Directive]

11.7

In its internal model, a firm must:

1. (1) accurately assess:
1. (a) the particular risks associated with financial guarantees and any contractual options, where material; and
2. (b) the risks associated with both policyholder options and the firm’s contractual options,
2. taking into account the impact that future changes in financial and non-financial conditions may have on the exercise of those options; and
3. (2) take account of all payments to policyholders which it expects to make, whether or not those payments are contractually guaranteed.

[Note: Art. 121(7) and (9) of the Solvency II Directive]

11.8

A firm’s internal model must only take into account:

1. (1) as regards diversification effects, dependencies within and across risk categories, if the PRA is satisfied, as part of the internal model approval, that the firm’s system for measuring those diversification effects is adequate;
2. (2) the effect of risk-mitigation techniques, if and to the extent that credit risk and other risks arising from the use of risk-mitigation techniques are properly reflected in the internal model; and
3. (3) future management actions, if and to the extent that:
1. (a) they are future management actions that the firm would reasonably expect to carry out in specific circumstances; and
2. (b) the firm makes allowance in its internal model for the time necessary to implement those actions.

[Note: Art. 121(5), (6) and (8) of the Solvency II Directive]