Prudential Regulation Authority Rulebook

9.1

Firms with an approved internal model are required to have an approved model change policy.^{[15 ]}Following approval, the model change policy is expected to play a central role in the wider governance of a firm’s internal model. For example, it should help ensure that the internal model continues to reflect the risks to which a firm is exposed and meet the requirements of the Directive.

9.2

It is important that the model change policy is of a good standard. Firms should consider all the relevant Directive requirements and the EIOPA Guidelines when developing and maintaining their model change policy.

9.3

This chapter outlines some further expectations for firms on setting out their internal model change policy.

9.4

When defining the scope of the policy, firms are reminded to consider Guideline 6 (scope of the policy for model changes) of the EIOPA Guidelines on the use of internal models. It is important for firms to consider whether the scope of the model change policy and model change definitions are sufficiently broad and appropriately flexible to be able to capture any changes that could have a material impact on the SCR or to enable the firm to meet the T&S. For example, the policy recognises that a particular change to a technical provision model may be within scope if that change leads to an impact on the internal model SCR.

9.5

There may also be situations where firms consider it appropriate to exclude something from the scope of the model change policy. In these circumstances, it is good practice for firms to justify these exclusions clearly.

9.6

Firms should also be mindful of monitoring circumstances that might necessitate the need to change the scope of the policy.

9.7

It is important for firms to recognise that the need for model changes may arise from a wide range of potential sources. For example, model changes may be instigated through a firm’s model development plans, validation activities, the own risk and solvency assessment (ORSA) or evolving use of the model. In addition, changes in a firm’s own risk profile and factors external to the firm, such as the economic or commercial environment, may be potential triggers of model changes. A good model change policy would establish a robust process to identify, collate and manage all sources of potential model changes.

9.8

The EIOPA Guidelines on the use of internal models^[16] expects firms to develop and use a number of key quantitative and qualitative indicators for major changes.

9.9

In terms of quantitative indicators, the majority of firms define major changes based on a percentage change in the total SCR. An improved approach, adopted by some firms, specifies additional indicators at a more granular level, for example, indicators that relate to changes in the strength of the marginal risk distribution at certain percentiles or the amount of pre-diversified capital requirements for that risk.

9.10

It is important for the model change policy to include qualitative indicators for major changes. An example of a qualitative indicator is where a major change is triggered after a fundamental change in the methodology or a key expert judgement relating to a particular risk regardless of the impact that the change has on the SCR. Another potential qualitative major change indicator is if a proposed model change needs to be signed off at, or above, a certain level of seniority within the firm. Firms may also wish to consider what indicators might be appropriate to use to determine whether a major change might be triggered through ongoing model validation.

9.11

When developing major change indicators, the PRA encourages firms to consider the appropriateness of having different indicators or threshold levels for different risks or components of the model. For example, it may be desirable to include specific change thresholds for certain elements of the model that are of key interest because they are highly material, highly judgemental or have known limitations.

9.12

Finally, it is important that firms justify their choice of major change indicators including why any thresholds chosen are at an appropriate level for the ongoing supervision of the model. In this regard, it can be helpful if firms provide examples of model changes (eg past model changes) that meet their major change indicators in order to demonstrate the appropriateness of thresholds chosen.

9.13

Firms may struggle to articulate how they would define the circumstances in which a combination of minor model changes would constitute a major model change. Better model change policies have specified at least the following:

• how the impact of minor changes will be accumulated together;
• the time period over which these changes will be accumulated; and
• the indicators or thresholds used to determine when such an accumulation becomes a major change.

9.14

A reasonable starting point for each of these may be to:

• accumulate the absolute values of the impact of the minor changes together, unless it could be demonstrated why it would be reasonable to allow the impact of two minor changes to offset each other;
• accumulate changes from the date of the latest minor model change accumulation reset being, either at the end of an annual cycle (that firms may specify) or at the point of receiving a major change application (if that application is approved); and
• use indicators similar to those defined for single major changes, where considered appropriate.

9.15

A further consideration firms may wish to make is whether it is informative to group minor model changes together by risk or other common feature of the model.

9.16

The better model change policies clearly articulate the governance framework covering the internal process for identifying, approving and implementing the model changes. These included an articulation of how the model change policy fits in within the wider model governance, risk management and validation processes.

9.17

The PRA generally expects firms’ executive management to be responsible for the internal sign-off of major model changes and at least to be made aware of minor changes where appropriate.

9.18

It is important that firms also ensure that there is a robust governance process to agree whether changes should be classified as either major or minor, especially in cases where the classification is borderline or subject to judgement.

9.19

In addition to submitting major changes for approval, according to the EIOPA Guidelines on the use of internal models, firms are expected to provide a quarterly summary of minor model changes to the PRA. It may be helpful for the summary to group related changes together, for example by risk area or function of the model.

9.19A

The PRA expects firms with an approved internal model to submit their quarterly minor model change reports via the Bank of England Electronic Data Submission (BEEDs) portal.

9.19B

Documentation should be submitted as ‘occasional submissions’.

9.19C

The PRA expects firms with an approved internal model to submit their quarterly minor model change reports in line with the PRA Solvency II quarterly submission schedule^[17] for groups or more frequently where appropriate. Where possible the PRA encourages earlier submission to allow early engagement.

19.9D

The PRA has provided a template that firms can complete and submit, containing key information regarding minor model changes (Appendix).^[18]

9.19E

While the submission of the relevant information via the template is optional, the PRA encourages firms to submit information consistent with that outlined in the template as a minimum within their quarterly minor model change reports.

9.19F

Firms may wish to submit supporting quantitative and qualitative document with their template submission.

9.20

The PRA encourages firms to review the effectiveness of the model change policy on a regular basis to ensure that the internal model continues to reflect the firm’s risk profile and meets the T&S. Firms are also reminded that any change to the model change policy itself is subject to the PRA’s approval. Readers also are referred to SS12/16, ‘Changes to internal models used by UK insurance firms’.^[19]