Internal model – Clients profit from Munich Re’s experience

The solvency ratio can only be optimised by managing risks actively – and by greater transfer of risks. Once Solvency II has been introduced, internal models and reinsurance will have a more vital role to play. Munich Re is already using an advanced internal model.

The approval of internal models poses new challenges for both companies and supervisors because the approval process for each internal model involves a considerable amount of work for all concerned.

Munich Re commenced development of holistic internal models at a very early stage. Robert Lempertseder, who is responsible for the internal model in our Integrated Risk Management Division, explains that the motivation to develop an internal model came initially from within: “We have been modelling and calibrating our model for around 10 years. As a (re)insurer with global operations we need to have a uniform view of the whole Group, so we adopted an economic approach to our risk modelling from the outset.”

Making risks transparent and comparable

Making risks comparable across country boundaries and jurisdictions posed a challenge for the modellers. As Robert Lempertseder put it, “Over the years, we have continuously enhanced the model to make risks more transparent and thus facilitate their control and assessment in the context of our value-based management.” The requirements of Solvency II increasingly flowed into the internal model: “We welcome the Solvency II approach. Many of the principles we adopted for our modelling are now relevant for Solvency II: the market-consistent valuation of assets and liabilities, and other calibration methods such as the 12-month horizon for risk measurement and the depiction of the longer risk horizon using the cost-of-capital approach, which is used to calculate the risk margin.”

On the long road from its beginnings to the creation of the internal model, Munich Re’s modelling team have introduced numerous changes and refinements. Lempertseder: “Looking back, incorporating in the model at a very early stage aspects that were not included in the Solvency II discussions when they started, but which we thought likely to arise, has paid off.”

Internal model depicts reinsurance structure appropriately

From a solvency point of view, the ideal reinsurance structure will be heavily dependent on whether a company will in future be using the standard approach or its own internal model to calculate risk capital. In Lempertseder’s opinion, “Insurers will not be able to avoid developing at least partial models if they are to depict the risk-capital effect of innovative (re)insurance products or non-proportional reinsurance programmes appropriately.” Otherwise, they will have to accept that the regulatory risk capital requirement calculated will not correspond to their actual risk profile.

Lempertseder: “For this reason, we recommend that our clients use internal models specific to their business which can reflect the reinsurance structure in an appropriate way.” Clients benefit both from the rigorously solution-oriented approach to development of an internal model and from the knowledge edge that Munich Re has acquired by going through the pre-application phase: Munich Re supports clients in making the best possible use of the Solvency II requirements to manage their business, be it by analysing their risk capital requirements, providing customised risk transfer solutions or offering courses and seminars.