Early warning or false alarm

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By Eoin O'Byrne, Lyndsay Wrobel, Russell Ward | 14 October 2013

In May 2013, following the approval of internal models, the Prudential Regulation Authority (PRA) issued a letter to insurance firms setting out proposals for the continued monitoring of the levels of Solvency Capital Requirement (SCR) through a series of simplified metrics to be known as Early Warning Indicators (EWI). The EWI should provide the PRA with a rule that indicates when a firm’s SCR calibration has potentially slipped below the required calibration standard of 99.5% value at risk (VaR) over a one year period. This paper explores the potential performance of the EWI proposed for life insurance business. Although the desire for simplified measures to assist regulatory engagement with insurers is understandable, our analysis suggests that the current proposals may need further refinement in order to better balance simplicity with reliability.