“I think everyone in the industry would be interested in reducing the complexity of models, making things more transparent and thus easier to understand,” stated Markus Stricker, Director of the Willis Economic Capital Forum (WECF), the latest initiative from the academic and analysis arm of Willis Group Holdings.
The insurance industry needs more dynamic and not more complex economic capital models if it’s going to avoid suffering again some of the problems that were exposed during the financial crisis four years ago. “We ought to have learnt in the years since the financial crisis that our economic capital models need to be more dynamic and more insightful,” Stricker added, also indicating that he thinks that Solvency II has become more complicated and that its benefits will not be fully realized.
The WECF was announced in July last year and is based at Georgia State University. It aims to support the insurance industry’s development and use of economic capital models and is part of the Willis Research Network. Stricker explained that it will seek to advance applied research on the topic of internal economic capital models in a number of ways. One of the biggest challenges that insurers and regulators face, which the Forum will seek to overcome, is to validate their models.
He noted that “looking at economic capital in a very static manner is not all that helpful, in particular if many of the parameters only have a marginal impact on the economic capital requirements. We need to develop simpler, more dynamic models that give us more insight.
“At the moment a standardized process does not exist for validating economic capital models. This creates a number of issues such as their limitations and evolution over the years is usually not well documented, the comparability of their results between years and between companies is difficult to assess and last but not least the validation process is often inefficient.
“These issues could be addressed by a widely recognized and structured validation process. This would introduce more transparency and efficiency for all stakeholders: Insurance companies, regulators and brokers.”
He also indicated that “we can learn a lot from looking at other industries. Airplane manufacturers, for example, run standardized stress tests so they know how much pressure they can put on a wing before it breaks off. Meanwhile pharmaceutical companies have a rigorous, structured process to get a medication validated.
“I think we need a similar set of standard procedures to validate the methods that financial companies use to calculate solvency related key figures. The WECF can make a big difference in this area.”
Source: Willis Research Network