Prudential Regulation Authority Rulebook

8.1

The PRA’s quantitative framework falls within the context of the overall model review process which is structured around the T&S. The internal toolkit the PRA uses in its assessments is framed around those requirements so that the PRA is able to satisfy itself that the model meets the T&S. Within this structure, the PRA applies a series of qualitative and quantitative tools to help guide areas that are in need of greater review focus. One of those tools is the quantitative framework for model reviews, which includes the use of specific quantitative indicators (‘QIs’) where risks are sufficiently homogeneous.

8.2

The PRA’s decision-making process is built around assessing the T&S, building from a granular assessment of each of the criteria into broader requirement categories (eg ‘documentation’) through to a final approval or rejection decision. As part of this overall assessment, the PRA has used its risk-based approach to supervision to focus additional scrutiny on a firm-by-firm basis. In this assessment process the PRA uses a series of indicators to determine the focus of review scrutiny: these are both qualitative (eg a view on the embedding of the model from previous supervisory engagement) and quantitative. 

8.3

One of the T&S categories relates to the calibration standards, which are set out in Solvency Capital Requirement – General Provisions 3 and Solvency Capital Requirement – Internal Models 12. An assessment of these requirements is geared towards ensuring that the SCR produced by the model corresponds to the value at risk (VaR) of the firm’s basic own funds at the 99.5% confidence level over one year.^[14]

8.4

The PRA uses its quantitative framework as:

1. (a) a diagnostic tool to help assess model rigour and capital adequacy and hence highlight areas of potential concern;
2. (b) a prioritisation tool, to help inform where review teams should direct their attention, eg by identifying risks or correlations which may be under-calibrated; and
3. (c) one contributor to decision making as to whether a firm has met the T&S, and therefore whether its model should be approved.

8.5

Internal models are required to be calibrated to the standard specified in Solvency Capital Requirement – General Provisions 3.4. Where risks are homogeneous, a PRA quantitative assessment of the calibration of individual risks and their dependency structures can give an efficient diagnosis of whether there are areas of potential concern where the model has not been calibrated adequately to meet the T&S. Where the risks are largely (but not totally) homogeneous, the PRA has tailored its quantitative assessments to reflect a firm’s specific risk profile.

8.6

Quantitative tools are also important in helping the PRA to prioritise areas for early review where firms may not have calibrated their risks or correlations adequately. However, they are not determinative of the PRA’s final view of a model or model component. It is also worth noting that the PRA looks at the calibration of any model as a whole, as well as in its constituent parts, with particular consideration being given to whether the model remains appropriate in a range of conditions and over time when the balance of risks may change.

8.7

Finally, the outputs of this quantitative analysis constitute one of the many indicators that are taken into account by the PRA in concluding whether the model meets the T&S. Specifically, while the PRA’s quantitative analysis assists in verifying that the calibration standard in Solvency Capital Requirement – General Provisions 3 has been met it does not negate the need for other aspects of the model to be reviewed including SQS in Solvency Capital Requirement – Internal Models 11.

8.8

As set out above, the operation of the quantitative framework does not yield a mechanistic ‘pass/ fail’ decision. It is worth highlighting once more that model approval does not hinge on meeting any particular quantitative criterion, but on meeting the T&S. It must also be emphasised that the use of the tools underlying the PRA’s quantitative framework is always tailored having regard to a firm’s own risk profile.