7.5.7. Model risk

Model risk, classified by the PZU Group as significant, is defined as the risk of incurring financial losses, incorrectly estimating data reported to the regulatory authority, taking incorrect decision or losing reputation as a result of errors in the development, implementation or application of models. The formal identification and assessment process for this risk is currently being developed in PZU and PZU Życie. The process aims to ensure high quality of applied model risk management practices. The model risk management process involves:

• risk identification – taking place through regular identification of the models used in the areas covered by the process and assessment of their materiality;
• risk measurement – based on the results of independent model validations and model result monitoring;
• risk monitoring – involving ongoing analysis of deviations from the adopted points of reference regarding the model risk (among others, verification of the recommendation execution method and comparison of the risk level to the adopted tolerance level);
• risk reporting – involving communicating the process results on the appropriate management level, in particular results of risk monitoring, validation and measurement;
• management actions – aiming to mitigate the model risk level (active – e.g. recommendations resulting from completed validations – and passive – e.g. developing model and model risk management standards).

Model risk is very important for banking sector entities and therefore management of this risk was implemented in the course of adaptation to the requirements of Recommendation W issued by the KNF. Both banks have defined standards for the model risk management process, including the rules for developing models and evaluating the quality of their operation and have ensured appropriate corporate governance solutions.