Sessional Event: Calibration of VaR models with Overlapping Data

Under the European Union’s Solvency II regulations, insurance firms are required to use a one-year VaR (Value at Risk) approach. This involves a one-year projection of the balance sheet and requires sufficient capital to be solvent in 99.5% of outcomes. The Solvency II Internal Model risk calibrations require annual changes in market indices / term structure for the estimation of the risk distribution for each of the Internal Model risk drivers. This presents a significant challenge for calibrators in terms of:

Robustness of the calibration that is relevant to the current market regimes and at the same time able to represent the historically observed worst crisis;

Stability of the calibration model year on year with arrival of new information;

The above points need careful consideration to avoid credibility issues with the SCR calculation, in that the results are subject to high levels of uncertainty.