Model Risk (Modellrisiko)
Model risk is the risk of flawed business decisions resulting from incorrect assumptions, errors, or improper application of quantitative models used in investment, reserving, or risk management.
Concept
Model risk refers to the risk that an insurer arrives at incorrect assessments due to incorrect assumptions, methodological errors, insufficient data, or the flawed application of a quantitative model, which can affect investment, reserving, or underwriting decisions as well as the calculation of regulatory capital requirements.
Causes and Manifestations
Model risk can arise at various levels: through an incorrect theoretical specification of the model itself, through the use of outdated or insufficient calibration data, through implementation errors in the technical build, or through improper application of the model to situations for which it was not originally designed.
Relevance for Internal Models under Solvency II
Insurers using an internal model to calculate their Solvency Capital Requirement are subject to particularly intensive supervisory scrutiny of the associated model risk; a central component of the governance framework for internal models is therefore a structured validation process that independently and regularly reviews the appropriateness of model assumptions, data quality, and the stability of model outputs.