What is a Partial Internal Model?

Sampo announced today that it has submitted an application for a Group Partial Internal Model (PIM) for purposes of solvency capital requirement (SCR) calculation to the Finnish Financial Supervisory Authority.

In this blog post we briefly explain what a partial internal model is and the benefits it brings.

Starting with the basics. The main objective of the Solvency II framework is to ensure that insurance companies operating within the EU have sufficient capital to cover their risks. In other words, to ensure the adequate protection of policyholders and beneficiaries. To cover risks, an insurance company’s own funds must exceed its solvency capital requirement (SCR). This translates into Solvency II ratio (own funds / SCR). The SCR is a sum of various risk factors and usually the main components are market risk and insurance risk, i.e. underwriting risk (see picture below). 

To calculate the SCR, risks can be assessed by using a standard formula provided in the law (Solvency II regulation), but insurance companies also have an option to use internal models to assess some risks, usually insurance risks, if they meet specific criteria and gain approval from the supervisory authorities. Thus, using an internal model for some risk categories and relying on the standard formula for the rest makes it a partial internal model.

Sampo’s subsidiaries If and Topdanmark already use partial internal models, but the Group level SCR has been based on the standard formula only. In the past, using a partial internal model at the Group level would not have provided much benefit because the market risk was relatively high compared to the insurance risk due to Nordea ownership. Now that market risk has clearly decreased after the Nordea exit, and will decrease further after the Mandatum demerger, the positive effect from using a partial internal model becomes more meaningful. 

The partial internal model Sampo has applied for is based on the If PIM and recognises the risk profile of Sampo’s P&C operations better than the standard formula as it recognises the size of If’s insurance operations and their geographical diversification better. It is estimated that the partial internal model would have reduced the group-level SCR by up to EUR 0.3 billion at the first quarter of 2023.

So, what does a lower SCR essentially mean? 

Lower SCR means that the company does not have to hold that much own funds to cover it. In other words, excess capital emerges. 

Sampo expects that the application process will be completed during the first half of 2024.

 

Picture: Q1/2023 Investor presentationinternal link