5
Allowance for diversification between pension scheme risks and a firm’s other risks in the calibration of an internal model
5.1
Firms should consider carefully the extent to which correlations exist and can be justified between the risks posed by a pension scheme and other risks that the firm faces. Relevant considerations include the extent to which:
- correlations exist owing to the firm and the pension scheme holding similar assets or assets whose values are expected to be correlated; or
- the pension scheme exposes the firm to demographic risks that are similar to the underwriting risks run by the firm. A particular example of strong correlations would be where a firm’s insurance business exposes it to longevity risk.
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5.2
Where correlations between risks are not perfect, Solvency II permits this diversification benefit to be reflected in the calibration of an internal model.[13] However, the PRA expects the firm to justify robustly any allowance that has been made in an internal model for diversification between the risks associated with a pension scheme and the other risks faced by the firm.
Footnotes
- 13. Solvency Capital Requirement – Internal Model 11.8(1) in the PRA Rulebook.
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