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Internal models: a reinsurance perspective – New publication from the Reinsurance Advisory Board (RAB)
The Reinsurance Advisory Board (RAB), a group of Europe’s largest reinsurers (including SCOR), has published an overview of the benefits of insurers’ use of internal models.
Adapting to a rapidly changing risk landscape and identifying emerging risks lie at the heart of reinsurers’ business models. Reinsurers play a crucial role in the real economy. They expand insurers’ capacity to assume risks from businesses and individuals, supporting sustainable growth. By pooling a large number of diverse risks (both in terms of type and geography), reinsurers benefit from diversification, since not all risks will materialise at the same time.
The large variety, complex interdependencies and joint impact of risks require correspondingly sophisticated models. For this reason, most RAB firms, including SCOR, already use their own internal models. Models for natural catastrophe risk started to be developed in the 1980s. Reinsurers have invested extensively ever since, particularly over the last 20 years, in developing models that are aimed at the holistic measurement of risk and the effects of diversification.
Internal models have proved crucial for sound risk management and business steering. This is because they create the right risk incentives and promote a better internal and external dialogue about risk exposures, thereby improving risk resilience.
Internal models have a number of benefits, making the risk profile of companies more transparent and enriching the dialogue between the supervisor and the undertaking. Internal models analyse risk in more detail so that the output of the model more closely reflects an undertaking’s risk profile.
RAB members are involved in a dialogue with supervisors to demonstrate the rigorous design, appropriate calibrations and robust governance underpinning their models. The paper explains why the development of simplistic supervisory tools such as benchmarking or indicators is an inappropriate way to assess reinsurers’ internal models.
This new RAB publication is intended to support those discussions. It addresses the supervisory criticisms that have been levelled against internal models and explains why, for reinsurers, internal models remain the most accurate measure of risk, the best driver of good risk management and the most appropriate basis for comparing risks between companies.
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