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In contrast, stochastic modelling often involves simulating very large numbers of scenarios in order to
reflect the likely distributions of the capital required by, and the different risk exposures of, the insurer.
Where the internal model is used for regulatory capital purposes, the insurer would be expected to
There are numerous
methodologies which demonstrate why it has chosen a particular risk measure. It should also account for any differences
an insurer could use between the criteria used in the model for its own risk and capital management and those set by the
regulator.
Consider this…
What are the dangers if capital adequacy requirements for insurance companies are incorrect?

C3 Capital adequacy and solvency control levels

A regulator’s goal in establishing solvency control levels is to safeguard policyholders from loss due to
an insurer’s inability to meet its obligations.
The solvency control levels provide triggers for action by the insurer and regulator so are set at a level
that allows intervention at a sufficiently early stage in an insurer’s difficulties for the situation to be
rectified.
A solvency regime would also be expected to impose a market-wide nominal ‘floor’ to the regulatory
capital requirements, based on governance and the need for an insurer to operate with a certain minimal
critical mass (amount of capital). The nominal floor might vary between lines of business or type of
insurer and is particularly relevant in the context of a new insurer or line of business.

Be aware
In this context, a market-wide nominal floor may, for example, be an absolute dollar minimum amount of capital required to be held
by an insurer in a jurisdiction.

The figure below illustrates the concept of solvency control levels:

Figure 9.1: Solvency control levels and regulatory capital requirements

Prescribed capital
Capital
resources requirement (PCR)
(CR) Required
capital Minimum capital
requirement (MCR)
Required
margin
(RM)
Technical
provisions
(TP) and
other Current
liabilities estimate
(CE)

Insurer’s Regulatory
9 financial requirements
capital
Chapter
position
C3A Monitoring and intervention

Regulators need to ensure that the standards, including capital requirements, are being maintained.
Regular monitoring is therefore an important aspect of the regulator’s work and insurance companies
must prepare and submit information, as part of the monitoring process.
If the monitoring process identifies problems the regulator can and would intervene, for example if a
company failed to comply with the regulators’ requirements – such as failing to maintain adequate
solvency margins. A regulator can also intervene where, for example, the company has departed
significantly from its original business plan.