The assessment should address extreme unexpected loss events, rather than expected events.
The assessment process should be conducted at a frequency consistent with the rate of change in the organisations risk profile, in order to reflect significant changes.
There are two main approaches to assessing syndicate capital requirements for ICA purposes, namely:
- Stress and scenario tests, which may be used for all risk groups.
- Economic capital models (normally stochastic), which may be used where appropriate distributions are known, and which are most often used for insurance risk, credit and market risk.
Consideration should be given to the level of complexity required. The degree of sophistication of the organisation's capital assessment should be commensurate with the materiality of the underlying risks and the maturity of any stochastic modelling that is being developed. It should be noted that:
- It takes approximately 24 months to develop a stochastic model that is sufficiently sophisticated and robust.
- It is important that management fully understands and 'buys in' to any models used and their output.
- In time, all organisations will be expected to used some degree of stochastic modelling supplemented by stress tests.
Where stochastic modelling is used, organisations should demonstrate checks or reasonableness tests, such as stress and scenario tests, have been performed on the outputs in addition to the detailed review of model inputs. Stress and scenario tests are used. Where reliance is placed on internal controls when assessing capital requirements, objective evidence is needed to justify that the organisation is in control and that the controls have been effective.
An appropriate aggregation tool is needed to aggregate the results of stress and scenario tests and stochastic modelling, with a clear justification of the subjective correlations and dependencies selected by franchisees. As a minimum, a correlation matrix approach should be used.
