Balance Sheet, Capital Requirements and Internal Models

Paolo Cadoni

This chapter will lay out the foundations for the Solvency II internal modelling framework. The first section provides a high-level review of the Solvency II balance sheet, illustrating how assets and liabilities are to be valued under this framework. The following section explains the role of the solvency capital requirement (SCR), describing how it should be derived as a difference between the net asset values of the balance sheet at the valuation date (pre-stress) and one year forward (post-stress). In the absence of an explicit definition, the third section then attempts to define what an internal model is in the Solvency II framework, while the next two sections analyse the potential costs and benefits of an internal modelling approach for both firms and supervisors. The concept of proportionality is then discussed, with an assessment of what this means for firms intending to use internal models. Finally, we draw some conclusions.

A PRIMER ON SOLVENCY II

Solvency II, which will come into effect from January 2016, is fundamentally redesigning the capital adequacy regime for European insurers and reinsurers. The new rules continue the trend, placing demanding requirements