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A.M. Best Rating Process With Specific Emphasis on Capitalization and an Update on the Next Generation BCAR Joel Silverthorn, Senior Financial Analyst.

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Presentation on theme: "A.M. Best Rating Process With Specific Emphasis on Capitalization and an Update on the Next Generation BCAR Joel Silverthorn, Senior Financial Analyst."— Presentation transcript:

1 A.M. Best Rating Process With Specific Emphasis on Capitalization and an Update on the Next Generation BCAR Joel Silverthorn, Senior Financial Analyst CIAA Annual Conference San Francisco, CA September 21, 2015

2 Disclaimer 2 © AM Best Company (AMB) and/or its licensors and affiliates. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY COPYRIGHT LAW AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT AMB’s PRIOR WRITTEN CONSENT. All information contained herein is obtained by AMB from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided “AS IS” without warranty of any kind. Under no circumstances shall AMB have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of AMB or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if AMB is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, financial reporting analysis, projections, and other observations, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser. Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due. Credit ratings do not address any other risk, including but not limited to, liquidity risk, market value risk or price volatility of rated securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY AMB IN ANY FORM OR MANNER WHATSOEVER. Each credit rating or other opinion must be weighed solely as one factor in any investment or purchasing decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security or other financial obligation and of each issuer and guarantor of, and each provider of credit support for, each security or other financial obligation that it may consider purchasing, holding or selling. CIAA Annual Conference, September 21, 2015

3 Agenda CIAA Annual Conference, September 21, 2015 3 o A.M Best Overview o A Ratings Primer o Review the role of BCAR in the Rating Methodology o Proposed BCAR approach o Overview of planned changes o Planned New BCAR structure o Observations o Next Steps o Proposed implementation time frame

4  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 over 3,300 companies in >70 countries  Market education through broad range of technical reports  Awarded Best Global Rating Agency at the Reactions Global Awards 2009, 2010, 2011, 2012, 2013, 2014 and 2015  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 24 October 2013 CIAA Annual Conference, September 21, 2015

5 A Ratings Primer 5 CIAA Annual Conference, September 21, 2015

6 AM Best Financial Strength Rating (FSR) 6  An independent opinion of an insurer’s financial strength and ability to meet its on-going insurance obligations based on a comprehensive quantitative and qualitative evaluation  Forward looking in nature  Value depends upon the market credibility of the rating issuer  Supported by impairment studies  Relates to a legal entity not a group  Not a warranty of a company’s financial strength CIAA Annual Conference, September 21, 2015

7  Issuer Credit Rating (ICR)  an independent opinion of an issuer’s ability to meet its ongoing senior financial obligations  Issue Rating (IR)  an independent opinion of an issuer’s ability to meet its ongoing financial obligations to security holders when due  Insurance Linked Securities (ILS) ratings  an independent opinion of an issuer’s ability to meet its ongoing financial obligations to security holders when due 7 Other types of AM Best ratings CIAA Annual Conference, September 21, 2015

8 AM Best Rating scales 8 FSRICR FSR ICR Secure Investment Grade A++ aaa aa+ A+ aa aa- A a+ a A-a- B++ bbb+ bbb B+bbb- Vulnerable Non-Investment Grade FSR = Financial Strength Rating ICR = Issuer Credit Rating E = under regulatory supervision F = in liquidation B bb+ bb B- C++ b+ b C+b- C ccc+ ccc C- bb- ccc- cc Dc CIAA Annual Conference, September 21, 2015

9  Rating outlooks  assigned with every rating  indication of potential direction over an intermediate term, generally defined as 12 to 36 months  Under review  typically associated with a pending transaction or other significant event that causes AM Best to re-evaluate rating  short-term in nature… typically, a rating is under review no longer than 6 months AM Best Rating indicators 9 Positive Stable Negative PositiveDevelopingNegative CIAA Annual Conference, September 21, 2015

10 Country Risk vs Sovereign Risk Country Risk - The risk that country-specific factors could adversely affect an insurer’s ability to meet its financial obligations Sovereign Risk - The risk that a sovereign government does not pay back its debts on time and in their entirety 10 CIAA Annual Conference, September 21, 2015

11 Country Risk 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 11 CIAA Annual Conference, September 21, 2015

12 The rating process 12 CIAA Annual Conference, September 21, 2015

13 Balance Sheet Strength Operating Performance Business Profile Country Risk Enterprise Risk Management General Rating Process BCAR Cash Flow Asset Quality Asset Liquidity Financial Lev/Flex Actuarial Reports ALM QAR IFRS Statements Company Forecasts MD&A Lines of Business Management Team Geographic Spread Growth Risk Impact Worksheet Event RiskReins Program Benchmarking ICM SRQ Loss Reserve Modeling Lift/Drag from Affiliates Risk Appetite, Tolerance, etc. Distribution Channel(s) Rating 13 AMB Projections ORSA DCAT CIAA Annual Conference, September 21, 2015

14 How is BCAR Used? 14 o As an analytical tool o Indication of current balance sheet strength o Proforma projections o Stress tests…Natural Cats…Terrorism o Other what if scenarios Changes to reinsurance Business acquisition or disposition Changes in asset (or liability) mix Sovereign default o Most important … it is a basis for discussion CIAA Annual Conference, September 21, 2015

15 Proposed BCAR Approach o Utilizing VaR risk metrics BCAR is a tool and a part of the overall BSS analysis Ensures a consistent risk metric Reasonable tail issues still covered Does not preclude further analysis of risk o Consistent confidence intervals across risks 98%, 99%, 99.5%, 99.8%, 99.9% Balance sheet strength relation to confidence levels Guideline/ tool – not directly tied to any rating outcome 15 CIAA Annual Conference, September 21, 2015

16 Proposed BCAR Approach o Framework – Look and feel of the Model unchanged Wanted to maintain structure, if possible Understanding of industry constituents Implementation Saw no real need for change in the structure Will show five confidence levels o Goal is to generate risk factors using stochastic simulations from probability curves o Company specific adjustments Mix and duration of bonds Volatility of common stock portfolio Diversity, Duration, strength, and dependence on reinsurers Profitability Volatility of loss reserve development 16 CIAA Annual Conference, September 21, 2015

17 Proposed BCAR Approach o Time Horizon for risk factors Ultimate basis for: Reserve Risk Pricing Risk Using a 10 year period for: Bond defaults Reinsurer impairments Common stocks One year Ratings are reviewed annually Provides a reasonable perspective, but recognizes how BCAR fits into the overall rating analysis 17 CIAA Annual Conference, September 21, 2015

18 o Bonds & Equities Use Economic Scenario Generator Update bond default risk factors Reflect duration of company’s bond portfolio (SRQ) Reflect asset quality of company’s bond portfolio (SRQ) Reflect volatility in bond default assumptions (stochastic portion - tied to ESG) Only defaults occurring in first 10 years are considered Offset default with recovery on defaults (varies by rating) Net defaulted amounts are present valued Update common stock risk factors Reflect type of stocks held by company (SRQ – Beta) Reflect volatility (stochastic portion – tied to ESG) 18 Overview of Planned Changes CIAA Annual Conference, September 21, 2015

19 o Reinsurance Update reinsurance credit risk factors Reflect type of recoverable (paid, unpaid, upr) Reflect rating of each reinsurer (Schedule F/S and ratings data) Reflects concentration risk (how many reinsurers) Reflect duration of recoverables (can go out 30 years) Reflects partial recovery when reinsurer impaired Simulates 10,000 impairment scenarios for each reinsurer Only uses impairments occurring in first 10 years Sums up entire amount of recovs associated with that impairment (i.e. if impairment in year 1, and recovs collected over 30 years, then all 30 years of recovs counted in that impairment) Amounts are present valued 19 Overview of Planned Changes CIAA Annual Conference, September 21, 2015

20 o PC Premium & Reserves Update PC underwriting factors Create Industry UW Loss & adverse development probability curves –Using lines for PC-1 and 4 size categories (VS,S,M,L) (Possibly only 3) –84 industry probability curves (each) for premiums & loss reserves »(Still heavily mirroring US method) Use company NPW & loss reserve size (by line) to select industry probability curve –use company profitability (by line) to adjust NPW curve –use company volatility (by line) to adjust loss reserve curve Simulate 10,000 UW profit/loss scenarios & reserve development scenarios for each line Reflect diversification across lines based on total NPW and loss reserves –use one of the industry correlation matrices –based on size (VS,S,M,L) 20 Overview of Planned Changes CIAA Annual Conference, September 21, 2015

21 o Natural Catastrophe Update natural catastrophe approach Per Occurrence Total all perils Measured at various VaR levels Risk added to Net Required Capital Will continue stress test approach Will stress higher VaR levels if concerned with tail risk Reinstatement premium and Tax adjustments remain Terrorism and other stress tests remain 21 Overview of Planned Changes CIAA Annual Conference, September 21, 2015

22 Planned Structure – PC BCAR Adjusted Surplus (APHS) Reported Surplus (PHS) Equity Adjustments: Unearned Premiums (DAC) Equalization/Contingency Reserves Loss Reserves Assets Debt Adjustments: Surplus Notes Debt Service Requirements Other Adjustments: Future Operating Losses Potential Loss Future Dividends Goodwill Other Intangible Assets Minority Interests, etc. 22 Net Required Capital Gross Required Capital (GRC): (B1) Fixed Income Securities (B2) Equity Securities (B3) Interest Rate (B4) Credit (B5) Loss and LAE Reserves (B6) Net Premiums Written (B7) Off-Balance Sheet (B8) Catastrophe Exposure Covariance Adjustment Net Required Capital (NRC)* BCAR Ratio = Adjusted Surplus / Net Required Capital *NRC= SQRT [ (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² ] + B7 + B8 CIAA Annual Conference, September 21, 2015

23 Example of Impact to PC Model 23 CIAA Annual Conference, September 21, 2015

24 Observations o Investments Greater risk than previous considered, particularly in equities Bond charges are slightly higher on investment grade Impact on US PC companies has been tested Not material impact on most US PC BCARs 24 CIAA Annual Conference, September 21, 2015

25 Observations o Reinsurance Charges higher than current BCAR in tail –depending on reinsurer(s) and duration of liability –reflects severity of impairment Combination of discounting and no impairments beyond 10 years has reduced initial charges slightly o US PC Underwriting (Reserves and Premium) Auto risk factors lower than current BCAR – not surprised by this GL, MPL risk factors slightly higher than current BCAR 25 CIAA Annual Conference, September 21, 2015

26 Observations o Sample of “Medium” US PC Mutuals 26 CIAA Annual Conference, September 21, 2015

27 Observations o Catastrophe Exposure Model will highlight companies with limited tail coverage Because we are looking at BCAR at VaR levels above 99% Higher rated companies are expected to have more tail coverage o BCAR Guidelines Target for B+/bbb- level likely to be VaR 99 (Still TBD) 27 CIAA Annual Conference, September 21, 2015

28 Observations o Next generation BCAR as an indication of current balance sheet strength…what do scores say about relative financial strength? 28 CIAA Annual Conference, September 21, 2015 Confidence Interval BCAR

29 Next Steps o Continue to evaluate VaR based output Life, Universal, and Canada (PC & LH) models) o How should liquidity needs be considered o Are there any unintended consequences o Industry discussions We have had a few, but we have more people to talk to o Draft Methodology Criteria Procedure Re-write of Property Casualty Update to other areas (Life, Universal, Health, Canadian, Title) Release of methodology updates will be staggered Lengthy comment period 29 CIAA Annual Conference, September 21, 2015

30 Expected Timeline o Model being developed in phases Phase 1 built – testing internally with 2013 YE data Parameters completed Run BCARs (PC; LH; Universal) internally with 2014 YE data Draft criteria for US PC expected to be released late this fall for comment We do anticipate sharing 2014 YE output with US companies as draft criteria are released Time frames for final criteria release will be impacted by comments received on criteria, changes based on comments, & LH impact study Likely roll-out for Phase 1 components (US) will be 2Q 2016 for year-end 2015 financials Phase 2 – 1 year after Phase 1 finalized 30 CIAA Annual Conference, September 21, 2015

31 Questions/Comments? joel.silverthorn@ambest.com 31 Thank You! CIAA Annual Conference, September 21, 2015


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