Prudential Regulation Authority Rulebook

4.1

As part of their general governance and risk management, the PRA expects firms to put in place appropriate processes and procedures that would enable them to prepare for and manage the impact of a MTE on their business. To do this, the PRA expects a firm to consider in its planning the following factors (among others):

• how it would go about gathering initial estimates of exposures and possible losses, the speed at which it might be able to produce credible initial estimates, and the range of possible uncertainties it might face in collecting and compiling relevant data;
• how, in the event of significant uncertainty, it would look to parameterise or validate its initial loss estimates/assumptions (e.g. based on market share data, reverse stress testing, exposure profiles etc.);
• how its own resources might need to be mobilised to ensure a timely and joined-up internal response to a MTE; for example how it would ensure that it drew appropriately on expertise from teams dealing with claims, reserving and capital, reinsurance, financial reporting, and communications issues;
• what lessons might be drawn from previous events concerning a firm’s ability to calculate reliable loss estimates at different stages of the development of the loss;
• how it might use a dry-run scenario or reverse stress testing to test its likely financial and operational response to a MTE, including some of the factors mentioned in the following chapters;
• where firms are part of larger international groups, how any local response might need to be co-ordinated or managed as part of a wider group initiative; and 
• how it might respond if actions being taken across the market as a whole (e.g. simultaneous attempts at recapitalisation) affect its ability to act in the way it had originally planned.

4.2

After a MTE, the PRA would expect a firm to use all the tools at its disposal, including its understanding of its business model and the risks it faces, to help inform its analysis of the impact of the MTE and how it might respond. The PRA expects that, following a MTE, firms should consider appropriate methods for:

• assessing potential uncertainties around initial loss estimate(s);
• establishing and maintaining appropriate reserves for the loss event, and assessing the potential for future reserve deterioration;
• assessing any proposed revisions to an agreed business plan, including any potential implications for a firm’s economic or regulatory capital requirements of changes to business volumes or mix of business;
• assessing the ongoing appropriateness of a firm’s stated risk tolerances, risk appetites, or the appropriateness of its reinsurance programme;
• assessing the continued appropriateness of a firm’s investment strategy, given the potential for different MTEs to have different speeds of loss development and payment profiles; and
• informing any rating agency capital analysis, or the potential need for revisions to a firm’s ORSA or stress and scenario analysis. 

4.3

After a MTE, the PRA would expect a firm with an approved internal model to consider how it might use its model to help inform its analysis of the impact of the MTE and how it might respond. The PRA does not expect that the internal model would be the only tool that firms would use in such a scenario. Nevertheless, the PRA expects that, following a MTE, firms might consider using their internal models for a range of purposes including the matters listed in paragraph 4.2 above.

4.4

Firms with approved internal models are responsible for ensuring their internal models meet the required tests and standards on an ongoing basis, and for assessing whether model changes might be required in accordance with their approved model change policies. After a MTE, the PRA would expect firms to consider whether the event might prompt a need to review elements of an approved internal model. For example, a MTE might generate new data which might change firms’ assessments of the likelihood or severity of extreme events, or affect firms’ judgements on possible correlations or dependencies between risks. Depending on a firm’s model change policy, a model change might be triggered as a result of a change in a firm’s business plan following a MTE, or as a result of changes to a model’s methodology and/ or assumptions.

4.5

At the same time, the PRA recognises that it might take some time after a MTE for reliable data to become available which are sufficiently complete and accurate to enable the firm to undertake a robust assessment of whether (and, if so, how) a change to its internal model is needed and/or whether the internal model should be revalidated. The PRA has published in SS12/16 ‘Solvency II: Changes to internal models by UK insurance firms’ its expectations of firms in relation to internal model changes.^[7] This includes its expectations on how firms should liaise with the PRA to deal with any temporary deficiency in its internal model which might arise following an external event such as a MTE.

4.6

Following a MTE it is also possible that, should rates rise significantly, rate-driven premium increases may trigger premium thresholds in some firms’ model change policies without any underlying increase in exposure or change in model methodology. Firms may wish to consider amending existing model change policies to make clear that increases in premium levels that are driven solely by rate changes (without a corresponding increase in exposure or a change in model methodology), may not constitute a major model change automatically. Such changes to a model change policy could be considered by the PRA in advance of or alongside any planned model change application.