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Capital

This page sets out the PRA’s approach to capital for the UK insurance sector. Further information is available in the PRA’s approach to insurance supervision.

In line with the requirements of Solvency II, the PRA expects insurers to take responsibility for maintaining at all times, an adequate level and quality of capital, taking into account the risks to which they are exposed, and consistent with their safety and soundness and the protection of policyholders. Capital should be sufficient to absorb unexpected losses, including those arising from uncertainties about provisions and valuations, in a wide range of severe but plausible stresses, both market-wide and firm specific.

The PRA expects insurers to manage their capital so that the Solvency Capital Requirement (SCR) is not breached under normal day-to-day activities. This overall approach is designed to maintain the confidence of an insurer’s creditors and ensure the protection of its policyholders, even in stressed circumstances.

Firms can calculate their SCR (eg internal model, standard formula or standard formula with undertaking specific parameters) by adequately reflecting the particular risks they are exposed to.  The PRA’s view is informed by the insurer’s own assessments but also reflects its views of the risks to its objectives.

Internal models

Internal models should help meet the capital objective by enabling insurers to take account of their risk profile in a more bespoke way than the standard formula can offer.

There is a great deal of modelling flexibility within the internal model framework. There are significant legal and regulatory requirements to be met before an internal model can be approved for calculating regulatory capital requirements. The test and standards laid out in the Solvency II Directive are that internal models should:

  • ensure that policyholders are provided with an adequate level of protection;
  • allow firms to develop a model that reflects their risk profile and is integrated with their risk management and decision-making processes; and
  • ensure consistency across Europe.

Internal model change policy

All internal model firms are required to have a model change policy. The policy needs to be submitted as part of the full or partial internal model application. Following approval of the full or partial internal model, the model change policy is expected to play a key role in the wider governance of a firm's internal model. For example, it helps ensure that, on an ongoing basis, the internal model appropriately reflects the risks to which a firm is exposed and that it continues to meet the requirements of Solvency II.
 
It is important that the model change policy is of a good standard, however, the PRA has seen a wide variation in the quality. On 7 May 2015, the PRA published its observations regarding a number of key aspects of model change policy. This is not an exhaustive list and firms should consider all the relevant Solvency II requirements and Guidelines when developing their model change policy.  See the internal model change policy on the Solvency II materials page.

Application process

Pursuant to regulation 48 of the Financial Services and Markets (The Solvency II Regulations 2015) (‘the Statutory Instrument’) a firm or group may apply to the PRA for approval of:

a)   a full or partial internal model, a model change, or major changes to an approved internal model; and a full or partial internal model, a model change, or major changes to an approved internal model; and

b)   the policy for changing an approved internal model.

Firms seeking approval for either major changes to an approved internal model or changes to the policy for changing an approved internal model, should see the supplementary information forms on the Solvency II approvals page.

The European Insurance and Occupational Pensions Authority published the Common Application Package (‘CAP’) for Internal Models (see External links) which contains the instructions and templates for firms intending to submit a formal application to use an internal model.

All firms intending to submit a formal internal model application to the PRA should use the EIOPA Self-Assessment Template which is part of the CAP. The PRA recommends that firms also submit a completed Solvency II approval application form, available on the Solvency II approvals page, as part of their application.

Regulation 48 of the Statutory Instrument requires that the PRA must give a decision on an application within six months of the receipt of a complete application.

Standard formula

Standard formula is the methodology that most firms across the EU are expected to use to calculate their SCR.

There is no approval process for the use of the standard formula. Firms must be able to demonstrate that it is appropriate and that any deviations from the assumptions underlying the standard formula are not significant. 
 
In the event of significant deviations, firms should consider possible consequences of this deviation and options to address the issues. This should be detailed in the own risk and solvency assessment (ORSA).
 
The options available include a number of Solvency II-related approvals for which standard formula firms may apply, such as undertaking specific parameters (USPs), see the Solvency II approvals and waivers page.

Partial internal models and the standard formula

Some firms intending to use the standard formula may need to consider the use of a partial internal model to calculate their SCR if the result of the standard formula is not appropriate for their firm. Firms using a partial internal model will still be expected to uphold the requirements of the standard formula for the risk areas for which they are using the standard formula, and to meet the relevant tests and standards.

Further information on partial internal models can be found on the Solvency II approvals and waivers page.

Matching adjustment

Ahead of the implementation of the Directive, the PRA published materials to help firms prepare to make an application for the matching adjustment. These documents are now available on the Solvency II materials page as a reference.

Solvency II balance sheet, technical provisions and own funds review

Larger Solvency II firms, and those firms which participated in the PRA’s internal model application process before the Solvency II Directive was in force, adopted the PRA’s suggested two–step review to help the PRA gain assurance on their Solvency II balance sheets. The PRA published Solvency II balance sheet feedback in June 2015, in addition to earlier published information on the review of the balance sheet from February 2015 and October 2014. See the Solvency II materials page.

PRA publications

Readers can also find more information on Capital in the PRA Publications section of the website – see Related links. Select Insurance policy publications, and click on the ‘Topic’ drop down and select ‘Capital’.

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