rates ; estimating the impact of the combination of risks to which the insurer is exposed on its balance sheet across many different scenarios ; taking these outputs and converting them into a simpler set of equations – or proxy model – that relates the insurer ’ s net assets to a series of risk factor inputs. the purpose of estimating a proxy model is to make it tractable to run many more scenarios. the complexity of the underlying valuation models would make this impractical computationally. running hundreds of thousands of scenarios through the proxy model in order to generate a distribution of probable balance sheet outcomes over one year ; and this definition is based on the one in supervisory guidance on model risk management, sr letter 11 - 7, federal reserve board and office of comptroller of the currency, april 4 2011 all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx focusing on the tail of losses and estimating the 99. 5th percentile of the distribution to identify the minimum amount of capital necessary to protect the insurer against a ‘ 1 in 200 ’ scenario. ( see chart 1 ) the use of models in solvency ii is more ambitious than in banking regulation. comparing use of models in banking and insurance regulation : the insurance capital model framework encompasses the whole balance sheet whereas banking models focus on particular risks ( market, credit, counterparty ). in the case of credit risk, models are built for particular portfolios ; insurance models estimate overall capital requirements taking account of assumed diversification benefits across different risks whereas bank capital requirements are determined risk by risk and added together, with no diversification benefits across risks, although diversification is taken into account within risks ; regulation determines or constrains more elements of bank than insurance models ; in banking regulation, the standardised approach is calibrated to give higher capital requirements than internal models for a typical bank whereas in insurance the two approaches are calibrated to the same confidence level ; and it is more straightforward for banking supervisors to top up capital requirements using so - called pillar 2 of the bank capital framework. once an internal model has been approved under solvency ii, supervisors have more limited scope to apply capital add - ons, which can only be temporary. i make no apology therefore for the exacting nature of our internal model approval and change processes for uk insurers. models must meet the tests and standards set out in solvency ii. these are both quantitative –

in matching adjustment portfolios. proxy modelling and use of management actions two areas we have reviewed recently are proxy modelling and use of management actions in internal models. i mentioned earlier that life insurers build proxy models as an approximation of more complex valuation models. they use them to calculate and rank losses under a very large number of one - year scenarios, to create a distribution of possible losses, to identify the 99. 5th percentile loss and thus to calculate the regulatory capital requirement. if an insurer calibrates a proxy model poorly, regulatory capital will be wrong, even if the underlying valuation models are broadly correct. weaknesses could also lead to bad decisions in other contexts where insurers use proxy models, including capital allocation, pricing and risk management. for example, insurers often employ proxy models for stress and scenario testing. in may 2018, the pra issued a survey to a number of life insurers with a proxy model. the responses revealed that over the previous couple of years, some insurers had improved the quality of their proxy modelling considerably. others had not made the same investment. standards of validation also varied. the best firms had increased the number of validation tests by improving the speed of valuation models, were placing the validation tests at points carefully selected to challenge the proxy model calibration and were conducting more validation after the reporting date. another area that we have reviewed recently is what future management actions insurers assume when calculating their best estimate of reserves and internal model capital. typical management actions might include, for example, an insurer assuming that it can replace reinsurance following the default of a reinsurer or at policy renewal, or a life insurer assuming that it could reduce bonus rates on a with - profits fund if it was in financial distress. solvency ii allows insurers to assume management actions provided it would be reasonable to implement them in stressed market conditions. we found that some insurers, however, were inconsistent and insufficiently rigorous in their approach. good practice is to bring all future management actions together into a single document that, at least at a high level, the board can review. this plan should quantify each management action and show how it is used in the calculation of reserves, capital requirements or otherwise ( for example, in stress testing ). all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx model risk management i have focused so far on