The Use of Internal Models for Determining Liabilities and Capital Requirements

Statutory capital requirements for insurers exist in several jurisdictions. They are generally formula-based and do not reflect the specific nature of a company’s asset or liability portfolio. Capital requirements for banks in the developed countries follow the Basel Capital Accord. In certain circumstances, the Accord permits the use of internal models to determine portions of a bank’s required capital. The Canadian federal regulator, OSFI, is beginning to allow life insurers to use internal models for the determination of certain components of its overall capital requirement, the MCCSR. This paper describes the risks that can be covered by these models and the conditions that must be satisfied before these models can be used.