model use and misuse speech given by david rule, executive director of insurance supervision association of british insurers prudential regulation seminar 14 may 2019 i am grateful to the following for contributions to this speech : liam clarke, chintan patel, paul collins, amanda istari, brian howell, sarah o ’ sullivan, anu ralhan, peter mcintyre and david phillips. all speeches are available online at www. bankofengland. co. uk / publications / pages / speeches / default. aspx 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. 1 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. insurance capital models let us start with capital models. solvency ii allows insurers to apply to the pra for permission to use a model to calculate their capital requirements. the purpose of these models is to estimate the amount of capital needed to protect the insurer against losses in a ‘ 1 in 200 ’ scenario over one year. they are highly complex. taking the example of a life insurer, a typical model might involve : producing a base balance sheet. many assets and liabilities can be valued without models : for example using market prices. but other valuations are themselves based on models ; estimating a distribution of outcomes over one year for the material risks to which the insurer is exposed : such as, changes in interest rates, credit spreads, inflation, property prices, longevity, etc ; assessing to what extent these risks are inter - dependent : for example, asset prices are related to interest

public ﬁnances on a sound footing while times were good, and is also currently proving that it can be a ﬂexible tool during crises, providing [UNK] ﬁscal leeway. in recent years, some economists have changed their perspective on the debt brake. given the low level of interest rates and the foreseeable need for high investments, greater scope for borrowing will be required. i do not share the harsh criticism directed at the debt brake by some. it is not an impediment to forward - looking investment and a modern state. when it comes to structural government expenditure, which corresponds to roughly half of economic output and which reaches record levels in the budget plans calculated excluding interest expenditure, this appears, to me, to be rather a question of setting priorities. this does not mean that any adjustment to the ﬁscal rules should be rejected fundamentally. yet measures should remain in place to reliably guard against high levels of government debt. i would advise against either relying on interest rates remaining low indeﬁnitely or overestimating the growth effects of government actions. experience has shown that we often end up being disappointed when we have such expectations. of course, it is important not to scale back government support measures too quickly now. in view of the persistent uncertainty regarding the evolution of the pandemic and its economic impact, it is appropriate to take a cautious approach. the coronavirus crisis should not serve as a pretext to jettison, once and for all, ﬁscal rules that some dislike. although accommodative budgetary policy with high deﬁcits may be popular in the short term, a return to stable public ﬁnances should not be continuously put off. this is also important from a monetary policy perspective : monetary and ﬁscal policy are currently working in concert. though i believe this will not remain the case. tensions are likely to resurface when the pandemic - driven crisis has been overcome. monetary policy is committed to the objective of price stability in the euro area and its reins will have to be tightened again if required by the inﬂation outlook. it must be clear to all that we are not putting monetary policy into the service of ﬁscal policy. it is essential to keep ﬁscal assistance measures targeted and temporary to reduce the likelihood of conﬂicts arising between monetary and ﬁscal policy. matters would become particularly critical if the foreseeable demographic burdens on public ﬁnan