Partial Internal Models

Juan Antonio Lumbreras

The Solvency II framework allows (re)insurance firms, both solo entities and groups, to calculate the solvency capital requirement (SCR) using either the standard formula or, subject to supervisory approval, their own internal model (either full or partial). Partial internal models can be used to model one or more of the standard formula risk modules or sub-modules, the capital requirements for operational risk or for the loss-absorbing capacity of technical provision for either the whole business or one or more business units.

From a firm’s perspective, choosing whether to opt for an internal model (either full or partial), or adopt the standard formula is an important and relevant consideration. For some firms, the decision is fairly clear-cut, as a partial model approach may offer an attractive solution that fits their risk profile while optimising the cost of capital. For others, the balance between the advantages and disadvantages is harder to assess, particularly given the various options between the standard formula and the internal model.

Taking into account firms’ difficulties in meeting internal model approved standards for all risks, legal entities and major