1. Trends in Capital Adequacy
AGRiP Fall Educational Forum October 3, 2016
Kevin Wick, FCAS, MAAA

2. Weak Signals “Let’s save money by increasing our retention”
“We should be able to get better investment returns than we are getting”
“Wouldn’t it be great if we can add more members?”

3. Initial pooling business model
Risk
Insurance unaffordable or unavailable
Pooling risks offered greater cost stability versus being without coverage
Initial “capital” came from retroactive assessment ability
Surplus levels were small and not that important
Temporary structure
Surplus
Cash Call

4. Financial expectations of pools have matured
Members now expect:
Stable and low rates
Financial soundness
Customized coverages
Financial uncertainty fully supported by surplus
Long-term financial viability
Permanent Structure
Risk
Surplus
Surplus

5. Benchmarking Common measures Reserve to surplus Premium to surplus
Net retention to surplus
RBC ratio
BCAR ratio
Etc.

6. Benchmark source data is important to understand
Indicates a variety of practices and there is no “standard” or “norm for the industry”
Benchmarking can be very useful and an efficient way to gauge performance
Relevant
Relevance of Source
Not useful
Limited value
Not Relevant
Inconsistent
Consistent
Consistency of Source

7. Insurer reserve to surplus ratios
Source: Reserve to Surplus Ratios from 2015 Statutory Filings

8. Insurer risk based capital ratios
Source: ACL RBC Ratios from 2015 Statutory Filings

9. Determining capital targets
Risk Measurement
Risk Appetite
Capital Requirements

10. Risk measurement process
Step 3: In a similar manner, the total funding need is determined through a risk aggregation process.
Step 2: The individual risks are aggregated into four broad categories considering interdependencies.
Total Funding Need
Underwriting
Reserving
Asset & Credit
Operational
Counter- party
Prop
APD
Prop
APD
Int. rate
People
System
Equity
Hazards GL AL GL AL WC WC
Step 1: The uncertainty associated with each of these risk elements is measured.

11. Overall results

12. Trend 1: Pools generate significant financial uncertainty
Underlying Reasons
Smaller
Risk concentration
Risk taking “independence” culture
Implication for using “insurance industry” measures

13. Trend 2: Investment risk often overlooked
Risk/Reward Analysis
Focus on the reward – easier to measure & understand. Plug into budget to see benefit.
Risk harder to measure. Does not go into budget. Where does it go?
Better returns  more risk More risk  more capital needs
Pitfalls
Extreme risk not considered
Misunderstanding the use of surplus

14. Trend 3: Sources of financial uncertainty varies significantly
Source of risk varies significantly
Tort caps reduce underwriting risk
Catastrophe risk dominates property focused pools
Asset/credit risk varies from 8% to 68% of total risk
Health trusts have more operational risk

15. Context for risk appetite
What is the insurance industry context where a cash call is not an option?
Secure rating (B+) - roughly between 1-in-100 and 1-in-250, though not specified by agencies
Rating Agencies
European and other developed countries set the “target” capital level at 1-in-200
Global Insurance Regulation

16. Trend 4: Pools recognize their capital needs differ from the “insurance industry”
Ability to “manage” book?
Restrictions on rate actions?
Ability to replenish capital?
Members rely on other services

17. Some pools are looking at a longer time horizon
Fund balance in target range – all is good
Target moved up but so did fund balance – board feels great

18. Pools tend to under estimate their capital requirement
Pools tend to generate more risk than insurers
Size, risk concentration, independence
Impact: Under estimate capital needs
Reliance on “insurance industry” metrics
Investments can lose value
Reinsurers and excess carriers may fail
Not all risks are considered
Being prepared to withstand a 1-in-100 year event not extreme for a permanent structure
Simply using “insurance industry” data points may not be sufficient
Risk appetite does not consider extreme enough events

19. So, what about the weak signals?
“Let’s save money by increasing our retention” “We should be able to get better investment returns than we are getting” “Wouldn’t it be great if we can add more members?”
Risk
Surplus
Surplus
MORE RISK = MORE CAPITAL NEEDS

20. pwc.com
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