Investment Model Validation

Objective

A U.S.-based insurance group engaged Graeme Group to perform an independent validation of its investment model used for internal ALM calculations and external financial reporting. The portfolio consisted of a mix of corporate bonds, government bonds, equities, ABS/CLOs, mortgage loans, real estate-backed instruments, and private credit exposures. The insurer required assurance over the soundness, accuracy, and governance of its asset modeling to comply with regulation and internal risk management standards. Specifically, the validation was essential to demonstrate the credibility of their asset projections and to support their asset liability modeling needs (e.g. CFT and internal economic bases).

Scope of Work

• Soundness of model inputs: Assessment of the appropriateness of asset inputs used in Intex and supporting asset modeling platforms, with a specific focus on prepayment assumptions, default rates, credit spreads, and product features.
• Independent re-calculations: First principles recalculation of projected asset cash flows, especially for illiquid private credit exposures.
• Actuarial soundness review: Validation of the asset model’s appropriateness, integrity, and regulatory alignment.
• Governance review: Verification of internal governance, documentation, and control structures.
• Modeling consistency review: Assessment of modeling consistency across asset classes and inputs.
• Validation documentation: Delivery of audit-ready documentation and mitigation plans for key findings.

Services Provided

Asset Cash Flow Model Challenger Model: We performed a first-principles validation of the asset model, developing separate re-calculation spreadsheets for all major asset classes. Specific attention was paid to private credit assets, as these required specific judgment for irregular amortization schedules, borrower specific prepayment behavior, and the use of expense/net/gross margins to project anticipated ratios. Independent validation was conducted at the CUSIP level for all assets above the materiality threshold defined by the client. Outlier positions received heightened scrutiny and were separately reviewed by senior specialists.

Process and Control Validation: We reviewed and validated the process controls contained throughout the investment modeling process, controls governing those process controls, whether controls covered all areas of potential errors or omissions, and the alignment of controls with internal model risk policies and regulatory expectations (e.g. NAIC Model Validation guidance, ASOP 56). A two-day site visit was conducted to interview portfolio managers and investment risk personnel, as well as to observe live demonstrations of how the investment models were run.

Validation Report: We prepared a validation report addressing the model’s intended purpose, structural design, key assumptions, and risk classification. It included an assessment of the model’s inputs, calculations, and outputs. We also conducted a review of governance practices, including documentation standards, version control procedures, and change management protocols. All findings were documented with targeted remediation recommendations.

Deliverables

This 12-week engagement resulted in:

• A detailed model validation report with findings and proposed remediation steps (including the owners of each proposed remediation)
• Custom challenger models for each asset class segment to enable the client to perform validation without Graeme Group’s involvement
• An audit-ready documentation package suitable for internal and external audit
• A list of automation opportunities where work was being performed manually
• Executive summary and debrief presentation to the insurer’s Risk and Finance leadership

Outcome

• Model Integrity: The insurer obtained objective assurance over the accuracy and soundness of their asset cash flows, particularly for opaque private credit investments.
• Control Enhancement: We identified control gaps in numerous parts of the valuation process, which were subsequently addressed by the client using our recommendations.
• Regulatory Preparedness: The engagement positioned the client well for external audit and regulator queries, as the validation documentation met actuarial and investment risk governance standards.
• Time Freed Up for Internal Resources: Since Graeme Group performed the validation task, the client’s internal team could maintain its focus on core investment and reporting functions. The client’s in-house team was only responsible for technical clarifications and final sign-off.