Upcoming Changes to AM Best s Insurance Rating Methodology

Transcription

1 Upcoming Changes to AM Best s Insurance Rating Methodology IASA Carolinas August 17 th, 2017

2 Biographies Nitin Chhabra, FCAS Senior Investment Strategist Nitin joined Prime Advisors, Inc. in 2016 as a Senior Investment Strategist. He is responsible for determining the fixed income investment portfolio positioning of Prime s insurance company clients based on modeling of company underwriting and investment financial information. In this capacity, he ensures that the company s investment portfolio is aligned with its underwriting obligations, risk tolerance, regulatory/capital requirements, tax positioning, and investment policy. Nitin spent the first 10 years of his career in traditional actuarial roles at Liberty Mutual and Towers Watson before working on Wall Street for nearly 5 years as a sell-side equity research analyst covering the P&C industry at Sterne Agee. He is a Fellow of the Casualty Actuarial Society (FCAS) and graduated from Boston University with a degree in mathematics. He has also held the following securities licenses: Series 7, 63, 86, and 87. Dennis Klimes Senior Vice President, Director of Sales and Business Development Dennis joined Prime Advisors, Inc. in His primary responsibility is managing the sales and business development initiatives of the firm. Serving as the main point of contact to address Primes capabilities, he also leads the strategic marketing mandates. Dennis has over 32 years of experience in the capital markets with an extensive background in institutional fixed income sales, portfolio management and proprietary trading. Prior to joining Prime, Dennis served 20 years with legacy Morgan Stanley companies developing and servicing middle market fixed income accounts. His tenure also includes 10 years of domestic and international money center banking trading currencies and money market instruments along with corporate advisory responsibilities. Dennis graduated from Western Michigan University and earned a BA in International Business Administration. Prime Advisors, Inc. 2

3 Table of Contents I. Objectives..Pg. 4 II. Current Rating Methodology...Pg. 5-9 III. New Rating Methodology..... Pg IV. Key Changes in the New BCAR Model...Pg V. Benefits of the New Methodology & Key Takeaways..Pg Prime Advisors, Inc. 3

4 Objectives In this session, you will obtain a better understanding of the following questions relating to upcoming changes in AM Best s P&C insurance rating methodology: What s Changing? First major methodology change in over 20 years! What is the current methodology? How does the new methodology differ? Why the Change? What are the benefits/improvements? What do you need to know about the changes? Best s Credit Rating Methodology (BCRM) Best s Capital Adequacy Ratio (BCAR) Prime Advisors, Inc. 4

5 Current Rating Methodology Prime Advisors, Inc. 5

6 Current Rating Process The goal of AM Best s rating system is to provide an opinion of an insurer s financial strength and its ability to meet ongoing obligations to policyholders Driven by projected future balance sheet strength: Start by assessing current balance sheet strength Layer on expected future operating performance and business profile to project future balance sheet strength Common criticism of the current process is that it lacks transparency Prime Advisors, Inc. 6

7 BCAR What Is It? AM Best s capital adequacy model used to assess current balance sheet strength Similar to NAIC s Risk-Based Capital (RBC) model BCAR = (Adjusted Surplus / Net Required Capital) * 100 Adjusted Surplus = Balance sheet surplus translated from an accounting basis to an economic basis Net Required Capital = The estimated capital required to support the risks inherent in a company s business profile Prime Advisors, Inc. 7

8 BCAR A Closer Look at Net Required Capital Net Required Capital includes the following risks: Investment Risk: Fixed Income (B1) & Equity Securities (B2) Interest Rate Risk (B3) Credit Risk (B4) Underwriting Risk: Loss Reserves (B5) & Net Written Premium (B6) Business Risk (B7) Net Required Capital (NRC) Formula: Covariance accounted for by square root function Means that all of the risks are not likely to happen at the same time For a typical company, roughly 2/3 rds of net required capital comes from underwriting risk Prime Advisors, Inc. 8

9 BCAR Guidelines for Ratings BCAR Rating Guidelines BCAR Implied Balance Sheet Strength Rating Category >175 A++ Superior A+ Superior A Excellent A- Excellent B++ Good B+ Good B Fair B- Fair C++ Marginal C+ Marginal C Weak C- Weak <40 D Poor Source: AM Best Prime Advisors, Inc. 9

10 New Rating Methodology Prime Advisors, Inc. 10

11 BCRM Building Block Approach Source: AM Best Prime Advisors, Inc. 11

12 Current Balance Sheet Strength Primary, but not sole, determinant of current balance sheet strength is BCAR assessment BCAR is the starting point in the assessment of current balance sheet strength Source: AM Best Prime Advisors, Inc. 12

13 Current Balance Sheet Strength Current balance sheet strength, adjusted for country risk, is the foundation for the baseline rating Assessments of operating performance, business profile, enterprise risk management, and other factors are applied to this baseline rating to arrive at a final rating Source: AM Best Prime Advisors, Inc. 13

14 Adjustment #1: Operating Performance AM Best looks at a variety a metrics in order to assess expected future operating performance Focus is on stability and volatility of earnings stream Source: AM Best Prime Advisors, Inc. 14

15 Adjustment #2: Business Profile Qualitative component of the rating process Some areas of focus include: market position, degree of competition, management quality, product/geographic concentration, and product risk Source: AM Best Prime Advisors, Inc. 15

16 Future Balance Sheet Strength So far, we ve taken estimated current balance sheet strength and applied assessments of operating performance and business profile to arrive at estimated future balance sheet strength The focus on future balance sheet strength hasn t changed it s just more quantifiable now Source: AM Best Prime Advisors, Inc. 16

17 Adjustment #3: Enterprise Risk Management Specific categories of review include: risk identification & reporting, risk appetite & tolerance, stress testing, risk management & controls, governance & risk culture Source: AM Best Prime Advisors, Inc. 17

18 Adjustment #4: Comprehensive Adjustment Accounts for situations in which, based on comparison to other companies, the creditworthiness of the rating unit exceeds (or is less than) what was captured through the rating process to this point Source: AM Best Prime Advisors, Inc. 18

19 Building Block Approach Example Source: AM Best Prime Advisors, Inc. 19

20 Key Changes in the New BCAR Model Prime Advisors, Inc. 20

21 New BCAR Change #1: Scale Caps at 100 BCAR will still be the primary metric used to assess current balance sheet strength, but the scale is changing New scale provides better alignment with risk appetite/tolerance statements Net Required Capital now includes potential catastrophe losses Source: AM Best Prime Advisors, Inc. 21

22 New BCAR Change #2: Four Scores Instead of One New approach: stochastic based New metric: Value at Risk (VaR) Source: AM Best Prime Advisors, Inc. 22

23 New BCAR Change #3: Investment Risk Charges Biggest change to the BCAR model appears to be an increase in the investment risk charges, primarily for common stocks and other invested assets Other invested assets (Schedule BA) risk charges will be equal to 110% of the risk charges for common stocks Asset Risk Factor For: Upcoming Methodology Current PC BCAR VaR 95 VaR 99 VaR 99.5 VaR 99.6 US Government 0% 0% 0% 0% 0% NAIC Class 1 Bonds 1% 0.6% 0.9% 1.0% 1.1% NAIC Class 2 Bonds 2% 3.3% 4.3% 4.6% 4.7% NAIC Class 3 Bonds 4% 10% 11% 12% 12% NAIC Class 4 Bonds 5% 21% 22% 23% 23% NAIC Class 5 Bonds 10% 42% 42% 43% 43% NAIC Class 6 Bonds 30% 54% 55% 55% 55% Non-Affiliated Public Common Stock 15% 25% 38% 43% 44% Source: "Understanding BCAR for US Property/Casualty Insurers", AM Best, 11/14/2016 Prime Advisors, Inc. 23

24 New BCAR Change #4: New BCAR Guidelines Source: AM Best Prime Advisors, Inc. 24

25 New BCAR Distribution of Indicated Assessments Source: AM Best Prime Advisors, Inc. 25

26 Benefits of the New Methodology and Key Takeaways Prime Advisors, Inc. 26

27 Benefits of the New Methodology Greater transparency into the rating process Encourages companies to develop their own internal capital models and compare the results of those models against the results of the stochastic-based BCAR model Increases focus on ERM Prime Advisors, Inc. 27

28 Key Takeaways More structured rating process should result in greater transparency and less subjective ratings Companies with high investment portfolio allocations to common stocks and other invested assets will likely see the biggest impact to their BCAR scores, as will companies with significant net property catastrophe exposure Overall, AM Best does not expect sweeping ratings changes and the assumption is that current ratings are appropriate Prime Advisors, Inc. 28

29 Disclaimer on Behalf of Prime Advisors, Inc. Prime Advisors, Inc. ( Prime ) is a federally registered investment adviser that customizes portfolios for its clients. Accordingly, while the views expressed in this presentation and are a general guide to Prime s economic and marketplace opinions, these are macro or strategy-level views and do not replace portfolio-level advice. Moreover, they do not constitute legal, tax or investment advice; and they are not intended as an offer to sell or a solicitation to buy investment products or individual securities. This presentation is current as of August 17, Some of the views expressed are expectations, and constitute forward-looking statements. They also reflect the presenter s best judgment. Actual results may differ. Neither the presenter nor Prime are under any obligation to update this presentation to reflect changed conditions. Additionally, these views are not intended to predict or guarantee the future performance of any individual security, asset class, market, or the future performance of any Prime account. Prime Advisors, Inc. 29

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