1. Internally developed risk capital models can serve many useful purposes and are increasingly becoming a core part of many insurers’ risk and capital management processes.
2. Capital models can vary considerably in their structure, calibration and application.
STRESS TEST AND CAPITAL MODELS
1. stress scenarios eliminates discussion around probability of certain events, allowing companies to focus and evaluating then risk and prioritising events for further study
2. Capital model provide an ideal source for developing and calculating your stress results, provided the model allows for deterministic runs.
3. Most capital models should allow for sensitivity testing of the parameters and distributions, and can work with stressing the same distributions.
4. The model should also be capable of running a specific scenario through the financial statements and results.
5. Using the same model for both stochastic simulations and deterministic stress tests will ensure consistency between the calculations.
6.The distributions and parameters developed for the capital model should be an input to the scenario development process.
7. Does not have to be a stochastic capital model.
STANDARD CAPITAL MODELING PROCESS
1. A stochastic capital model will already include integration of the economic scenarios with the asset results and the liabilities.
2. Model logic should allow for sensitivity testing and entering stress scenarios in addition to running stochastic scenarios.
INTEGRATION OF THE SCENARIO
1. Liability scenarios need to include effects on the premiums and expenses and not just losses to most accurately reflect the stress. The integration process is as follow from item 2. to 6.
2. Baseline - Develop the baseline business assumptions
- Premiums
- Reserves
- Asset Holding
3. Parameterize - Parameterize model distributions
- Premiums
- Losses / Reserves
- Stress Scenarios
4. Run model - Model run with base assumptions and scenarios
- Stochastic Runs
- Stress Scenarios
5. Analysis - Review model and scenario results
- Leadership
- Subject matter experts
6. Decisions - Management actions based on model results
- De-risking / Risk transfer
- Assumption changes
INTEGRATION WITH THE CAPITAL MODEL
1. Economic scenarios can be generated and compared with selected stress scenarios.
2. Eliminates duplication of effort for calculating model results.
3. Provides consistent processes for inputs and output managements.
4. View the scenario in context with the simulated resultS.
5. Provide management with more context around both the scenarios and the simulated results.
THOUGHTS
1. Stress tests are a useful tool for evaluating how a company will perform in a specific scenario.
2. They will tell you how much capital you need to survive the specified scenario.
3. They will not tell you how much capital you need to hold therefore a stochastic capital model along with management risk appetite is necessary.
4. The stress scenarios can be used to test events and scenarios that may not be common in a simulation, they also can provide year-to-year consistency.
5. They should be included as part of any capital modelling and risk management program at a company.
6. ORSA reports rely heavily on scenarios for communicating results even in the capital model is not stochastic.
