Key Risk Issues in Emerging Markets: A Ratings Agency Perspective

Introduction to AM Best 3

 Established in 1899 in the US, pioneered the concept of insurer financial strength ratings in 1906  Provider of ratings, financial data and news relating to insurance industry  Coverage of approximately 3,500 companies in >70 countries  Market education through broad range of technical reports, e.g Special Report: The Potential of Microinsurance  Awarded Best Global Rating Agency at the Reactions Global Awards 2009, 2010 and 2011  Only international rating agency focused on the insurance industry:  methodologies are specific to the insurance industry  analysts are insurance specialists and only analyse insurance companies  ability to provide specific indications as to the main drivers of a rating grounded in industry knowledge AM Best overview 4

Global coverage (re)insurers FSRs 5 Source: NRSRO Web sites and AM Best as at 11 th July 2011 Note: Data does not include PD ratings, NR ratings, National ratings with local scales or companies who are under regulatory supervision or in liquidation. No. of ratings

AM Best and the Latin American market 6  AM Best has the strategic ambition to continue to expand its ratings franchise beyond core North American market  AM Best is already playing a significant role in other emerging markets around the world (e.g. Middle East and Asia Pacific)  Increasing interest in international ratings, particularly among Latin American companies expanding beyond their national markets  Significant regional coverage of financial data on AM Best’s information products (Statement File Global)  Recent Financial Strength Ratings issued to IRB-Brasil and other high- profile institutions represent an opportunity to expand in the region

AM Best current activities in the region 7  Country visits by management delegations to raise the awareness of AM Best and benefits of pursuing an international-scale rating  Panama – February  Brazil – April & June  Chile – April  Colombia – June  Opening of a market development office in Miami (May)  Focus on broadening our ratings coverage of the region:  Brazil 1 (IRB Brasil Resseguros, A- Stable)  Costa Rica 1 (INS Instituto Nacional de Seguros, A- Stable)  Mexico 7 (including top insurers and local reinsurer)  Panama6 (including top insurers and reinsurers)

How does AM Best look at countries? Country related issues Company specific challenges Agenda

1.Regulatory Risk 2.Investment Risk 3.Economic Volatility 4.Data Quality and the Impact 5.Modeling Limitations 6.Business Profile Issues Country Related Challenges Company Specific Challenges Talking points

The risk that country-specific factors could adversely affect an insurer’s ability to pay its financial obligations Economic Risk Macroeconomy Prospects Government Finance Political Risk Business Environment Government Stability Social Stability Legal System Financial System Risk Non-Insurance Insurance Banking System Reporting Standards & Regulation Sovereign Debt Government & Legislation Supervisory Authority Insurer Accountability CRT-1 Lowest Risk CRT-5 Highest Risk CRT-3 Moderate Risk Country Risk

A.M. Best Country Risk Analysis

17% 16% 24% 21% 22% Regional distribution of CRTs

Company Rating Proposal Peer Analysis / Industry Composite Industry Trends & Analysis Enterprise Risk Management Management Team Country Risk Integration of country risk Balance Sheet Strength Operating Performance Business Profile

Company Rating Proposal Country Risk Integration of country risk Key elements of country risk can be managed or mitigated, effectively reducing the impact on an insurer’s rating. As a result, it is possible that A.M. Best’s highest ratings can be achieved in any country. Country risk is not a ceiling or cap on insurer ratings; it is one of many rating factors

Heat chart illustrates relationship

1.Regulatory Risk 2.Investment Risk 3.Economic Volatility Country related challenges

World Bank Ease of Doing Business Rank Doing business in emerging markets Source: World Bank

World Bank Ease of Doing Business Rank Some countries are more challenging Source: World Bank

Transparency International Corruption Perception Index Corruption adds to uncertainty Source: Transparency International

Transparency International Corruption Perception Index Degree of corruption varies Source: Transparency International

World Bank Doing Business Sub-score Ranking Impacts policyholder protection Source: World Bank

1.Regulatory Risk 2.Investment Risk 3.Economic Volatility Country specific challenges

Lack of investible assets –Particularly high credit quality assets Lack of market liquidity Higher volatility in equity market returns Investment risk

MSCI Index Returns Source: MSCI Equity markets are more volatile

Histogram: Monthly Returns to MSCI Index (Emerging vs. Developed) Source: MSCI Equity market returns have “fat tails”

Total Bonds Outstanding as a % of GDP Source: BIS and A.M. Best Less developed bond markets

1.Regulatory Risk 2.Investment Risk 3.Economic Volatility Country specific challenges

Real GDP Growth Source: IMF Economic growth is more volatile

Average Nominal GDP (USD) Source: IMF Countries are economically smaller

Average Nominal GDP (USD) Source: IMF Thus susceptible to external shocks

Forecasts underestimate volatility Source: IMF Increased inflation volatility

1.Data Quality and the Impact 2.Modeling Limitations 3.Business Profile Issues Company specific challenges

1.Data Quality and the Impact 2.Modeling Limitations 3.Business Profile Issues Company specific challenges

34 Different conditions across emerging markets  Asia Pacific - required to disclose information on a wide range of statutory and financial metrics  Latin America - promote and enforce transparency via  consistent reporting  public-domain access to insurance-specific information  Africa - there are limited reporting requirements  Eastern Europe - regulators are beginning to address Solvency II requirements in order to stay competitive

35 Challenges ahead  IFRS helps with consistency but not with transparency  Need to increase the availability/consistency of insurance-specific financials  Regional policing of statutory filings would underpin trend towards increased transparency  No "benefit of the doubt" to companies with missing or limited data

36 Improvement in financial reporting, but…  Not all companies have to adhere to the standards  Alignment of standards towards IFRS makes insurance performance monitoring both difficult and time consuming  Variability of interpretation of accounting standards, still undermines viable comparisons between countries and regions  Accounting standards do not address the need for insurance-specific data  Resources lacking

37 Insurance specific needs  Improvement seen in financial data, but  Specific detailed information needed  Underwriting  Claims  Investment

38 Insurance specific needs  The information required goes well beyond the information in a financial statement  Without this information many key risk areas cannot be properly managed  Pricing / classification  Loss reserving  Catastrophe management  Asset/Liability matching  Spread of risk  Risk management in general

39 The lack of insurance data is a real issue  In emerging markets first time entrants to the rating process  Often surprised by information requests  Reaction  Initial preparation takes much longer  Often involve rating consultants  Alternative – typically lower ratings  Issue related to data  Systems to capture the information  Quality of the information once captured  Expertise to process the information  No regulatory requirements

1.Data Quality and the Impact 2.Modeling Limitations 3.Business Profile Issues Company Specific Challenges

41 Modelling Limitations  Data  Ability to develop quality models is hampered  Catastrophe models  Coverage of major insured perils by major firms  Reliability of data impacts models  Capital models  Risk factors are estimated with proxies  Exposure data is less refined  Most regulatory models are simplistic

42 Modelling Limitations  Rating (pricing) models  Proper pricing difficult  Granular pricing to gain advantage nearly impossible  Market fundamentals often drive pricing  Loss reserving  Incomplete claims data  Limited exposure data information  Lack of regulatory requirements  Limited actuarial expertise  Cash flow reserving in some local companies

Catastrophes play important role

1.Data Quality and the Impact 2.Modeling Limitations 3.Business Opportunities Company specific challenges

Insurance as a % of GDP for 15 Largest Economies Average of Developed Countries: Average of Developing Countries: Source: IMF, AXCO and A.M. Best Lower insurance penetration

Average GDP Per Capita (USD) Source: IMF Wealth plays an important role

Average GDP Per Capita (USD) Source: IMF Emerging markets are less wealthy

Premiums as % of GDP Source: IMF, AXCO and A.M. Best Insurance smaller part of economy

Premiums as % of GDP Source: AXCO and A.M. Best High country risk and low penetration

Relationship between penetration and GDP per Capita Source: IMF, AXCO and A.M. Best Wealth and insurance

Index of Government Intervention Source: A.M. Best Government relationships critical

Index of Government Intervention Source: A.M. Best High risk countries, more intervention

Source: AXCO and A.M. Best Country risk and market development

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