Prudential Regulation Authority Rulebook

14.1

1. (1) A firm must have in place a regular cycle of internal model validation which includes:
   1. (a) monitoring the performance of the internal model, reviewing the ongoing appropriateness of its specification and testing its results against experience;
   2. (b) an effective statistical process for validating the internal model which enables the firm to demonstrate to the PRA that the resulting capital requirements are appropriate;
   3. (c) an analysis of the stability of the internal model and, in particular, the testing of the sensitivity of the results of the internal model to changes in key underlying assumptions; and
   4. (d) an assessment of the accuracy, completeness and appropriateness of the data used by the internal model.
2. (2) The statistical methods applied for the purposes of (1)(b) must test the appropriateness of the probability distribution forecast compared to loss experience, all material new data and information relating thereto.
3. (3) In order to be able to demonstrate to the PRA that the resulting capital requirements are appropriate, a firm must:
   1. (a) compare the coverage of the internal model with the scope of the internal model; and
   2. (b) ensure that the statistical process for validating the internal model includes stress tests, including a reverse stress test, identifying the most probable stresses that would threaten the viability of the firm.
4. (4) Where a firm observes in accordance with 14.1(1)(c) and (d) that changes in a key underlying assumption have a significant impact on the SCR, it must be able to explain the reasons for this sensitivity and how the sensitivity is taken into account in its decision-making process. For the purposes of 14.1(1)(c) and (d) the key assumptions shall include assumptions on future management actions and assumptions set using expert judgements.

[Note: Art. 124 of the Solvency II Directive]

14.2

In order to ensure independence of the internal model validation process from the development and operation of the internal model, a firm must ensure that the persons or organisational unit shall, when carrying out the internal model validation process, be free from influence from those responsible for the development and operation of the internal model.