Thursday, 30 June 2011

Society of Actuaries in Ireland - response on Market Consistent ESGs discussion paper

In the interests of being prepared to scrutinise internal models to the letter of the existing text, I have spent more examining the hot topics on Pillar 1, and the SOA have provided an excellent response paper to the Central Bank of Ireland's ongoing discussion on market consistent black boxes.

I have tried to pick out the key themes in the absence of having detailed knowledge!
  • Difficulty is calibrating market-consistent ESGs where deep and liquid markets don't exist
  • Risk margin consideration appears and reappears throughout - the SOA advocate clarity and methodology disclosure wherever a risk margin is allowed for (which in my head would be an area the risk function could then scrutinise when validating the Internal Model)
  • Process of converging insurance pricing with market-based pricing will involve considerable expert judgement (problematic for pure Risk functions to validate I suspect).
  • Easier to use the ESG for interpolation as opposed to extrapolation - organisations need to be able to "show its work" when extrapolating beyond the region of the data (another good area for would-be validators to focus on)
  • Also need to be careful when accounting for margins (implicit, explicit, illiquidity premia) that they are also appropriately extrapolated.
I suspect I will be referring back to this as the Level 2s and 3s make there way into their final form, as I found it a reasonably accessible pointer for potential Internal Model weaknesses (and I make no apologies for misinterpretations as a non-mathematician!).

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