Staying on top of scenario modelling

Companies: Moody's Analytics

Colin Holmes, Managing Director, Insurance Solutions, discusses how Moody's Analytics is helping insurance firms address Solvency II requirements and improve stress and scenario analyses

Colin Holmes, Managing Director, Insurance Solutions, Moody's AnalyticsWhat aspects of model validation should firms be focusing on in 2018?

Internal model validation teams and regulators usually focus on the technical details of models – and making sure those details are correct is important. But firms and regulators could benefit from taking a step back and looking at what the firm is trying to achieve with the model.  Are the assumptions well thought through? How will the outputs change if different assumptions are made? Moody's Analytics has invested heavily in our assumptions, justifying them in depth.

Are there any challenges remaining on regulatory reporting?

Firms that have not industrialised the regulatory reporting process are still finding it a challenge, two years after Solvency II went live. Solvency II regulatory reporting is now another business process that firms need to go through, and it's a business process that firms need to make less expensive and less time-consuming.

A second point is that while firms have implemented their Solvency II solutions, Eiopa continues to make changes to the reporting requirements, sometimes at short notice as with  the "XBRL taxonomy hotfix" issued in November.  Moody's Analytics made sure our software was updated quickly. If firms have not industrialised regulatory reporting, this kind of change can be very challenging.

What best practice for stress testing and scenario analysis have most firms not yet implemented?

Firms have invested significantly in their actuarial modelling – they should leverage this to provide management with actionable insights. They should be able to answer senior management's "what if" questions quickly and easily. However, at many firms this takes two or three weeks, and has substantial costs associated with highly skilled actuaries. Often, the final analysis is of limited value because it was created in an ad hoc manner.

With industrialised solutions, such as Moody's Analytics RiskIntegrity™ Insight, senior management can quickly and consistently receive answers to "what if" questions, and they can track how the answers change over time.

How do organisations create insights into their business with scenarios and stress testing? 

We work with a large government organisation, where we combine our economics team's insights with forward-looking economic scenarios. The organisation then uses the combined forecast as part of their stress and scenario testing risk model, and they combine that with our quantitative modelling capability to provide their management with a number of different scenarios about the potential future of the economy. This process helps the organisation understand how different scenarios would impact its level of risk and funding. Moody's Analytics is able to help them with this process, because we provide a unique combination of economic content, stochastic modelling, actuarial modelling and software. 

How are economic scenario generator (ESG) practices changing?

ESGs have been commonly used for some time now.  However, emerging standards and regulations continue to drive evolution in this area. For example, IFRS 17 is currently a very hot topic.  With the principles-based approach, auditors will be challenging firms on their model assumptions and the models' ability to give market consistent and appropriate answers.  I think IFRS 17 is going to put a real premium on the content that goes into the models. Moody's Analytics expertise in this area – for example our credit risk expertise – can help the industry deal with this challenge.

How will the way firms approach ESGs evolve over the next five years?

Firms are looking to accelerate time lines and reduce costs by using the cloud to scale up actuarial modelling processes, including scenario generation. We see a lot of actuarial teams who are thinking about moving, or have moved, their production onto the cloud. The industry is going to the cloud for calculations, reporting, and analytics, and we are ready to support these firms.

What is your key prediction for the industry for 2018?

The focus on IFRS 17 is significant for the large number of firms around the world who are impacted. It will change financial reporting, and impact actuarial, technology, and finance departments. Firms need to bring together these teams to address this challenge. At Moody's Analytics, our core capabilities in software, actuarial modelling, and reporting mean that we are well positioned to support firms through that change.