David Rule: Model use and misuse

Speech by Mr David Rule, Executive Director of Insurance Supervision of the Bank of England, at the Association of British Insurers Prudential Regulation Seminar, London, 14 May 2019.

The views expressed in this speech are those of the speaker and not the view of the BIS.

Central bank speech  | 
14 May 2019

I would like to start by thanking the ABI for the invitation to make this keynote address. Today I want to talk about insurance models and the growing importance of model risk management. In doing so, I will describe some recent findings from the PRA's work to guard against weakening over time of capital requirements calculated from internal models or 'model drift'.

A model applies theories, techniques and assumptions to process input data into quantitative estimates for a particular purpose. Make that purpose providing insurance and it is close to a definition of what insurers do. No surprise therefore that insurers are big users of models. But models can go wrong. They might have fundamental errors. Probably more commonly, they can be misused: for example, because management do not understand the limitations of a model. In insurance, a model going wrong might mean under-pricing of products, under-reserving against risks or treating certain customer groups unfairly. In the particular case of internal models used to calculate regulatory capital requirements, it could result in insufficient capital to protect policyholders.