A.M. Best s Rating Criteria Seminar

Transcription

1 A.M. Best Europe Rating Services Ltd 19 October 2012 A.M. Best s Rating Criteria Seminar Stefan Holzberger, Managing Director, Analytics Mahesh Mistry, Associate Director, Analytics Carlos Wong-Fupuy, Senior Director, Analytics Mathilde Jakobsen, Senior Financial Analyst

2 Agenda Country Risk Methodology Enterprise Risk Management Internal Capital Models versus Best s Capital Model A.M. Best s Rating Evaluation Service A.M. Best's Criteria Review Seminar 2 October 2012

3 Country Risk Methodology Mahesh Mistry Associate Director, Analytics A.M. Best's Criteria Review Seminar October

4 Defining Country Risk Country Risk: The risk that country-specific factors could adversely affect an insurer s ability to pay its financial obligations Distinct from Sovereign Default Risk: Probability that a sovereign government does not pay back its debts on time and in their entirety Transfer and Convertibility Risk: The risk that capital and exchange controls may be imposed by government authorities that would prevent or materially impede the private sector s ability to convert local currency into foreign currency and/or transfer funds to non-resident creditors A.M. Best's Criteria Review Seminar October

5 Country Risk Pyramid Sound Insurance Industry Financial System Stability Economic Prosperity Political Security and Transparency A.M. Best's Criteria Review Seminar October

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

7 A.M. Best Country Risk Analysis A.M. Best's Criteria Review Seminar October

8 Regional Distribution of CRTs Number of Countries North America Latin America Western & Northern Europe Southern Europe Eastern Europe MENA Sub-Saharan Africa Central Asia Southern Asia East Asia Southeast Asia Oceania Caribbean % of TOTAL CRT-1 CRT-2 CRT-3 CRT-4 CRT-5 A.M. Best's Criteria Review Seminar October

9 Key Components of Political Risk Political risk is the likelihood that governmental or bureaucratic inefficiencies, societal tensions, an inadequate legal system or international tensions will cause adverse developments for an insurer A.M. Best's Criteria Review Seminar October

10 Key Components of Political Risk Evaluation of Business Environment How easy/difficult is it to do business? Strength of Legal System How prevalent is corruption? Are the property rights respected? Are contracts enforceable? Government and Social Stability How likely is government disruption? Is there likely to be political/social unrest? A.M. Best's Criteria Review Seminar October

11 Doing Business in Emerging Markets Rank out of 183 Countries Caribbean Central Asia Notes: Higher rank = More difficult to do business Source: World Bank E Europe East Asia Latin America MENA N America Oceania SE Asia Sub- Saharan Africa W Europe A.M. Best's Criteria Review Seminar October

12 Corruption Adds to Uncertainty 10 9 Higher Degree of Perceived Corruption 8 Corruption Index Caribbean Central Asia Notes: Higher = Less perception of corruption Source: Transparency International E Europe East Asia Latin America MENA N America Oceania SE Asia Sub- Saharan Africa W Europe A.M. Best's Criteria Review Seminar October

13 Key Components of Economic Risk Economic risk is the likelihood that fundamental weaknesses in a country s economy will cause adverse developments for an insurer A.M. Best's Criteria Review Seminar October

14 Key Components of Economic Risk Economic and political size of the country Wealth of a country Length and depth of business cycles Inflation volatility A.M. Best's Criteria Review Seminar October

15 Economic Growth is More Volatile 10 8 Advanced Real GDP % Growth Emerging Real GDP % Growth 6 % Growth Source: IMF A.M. Best's Criteria Review Seminar October

16 Increased Inflation Volatility Egypt (CRT-5) Jamaica (CRT-5) Nigeria (CRT-5) United States (CRT-1) Forecasts underestimate volatility A.M. Best's Criteria Review Seminar October

17 Key Components of Financial System Risk Financial system risk (non-insurance) is the risk that financial volatility may erupt due to inadequate reporting standards, weak banking systems or asset markets or poor regulatory structure A.M. Best's Criteria Review Seminar October

18 Key Components of Financial System Risk Sovereign Credit Risk Banking System Stability Selection of Assets A.M. Best's Criteria Review Seminar October

19 Equity Market Returns have Fat Tails Number of Months Emerging Market Monthly Returns to MSCI Index Developed Market Monthly Returns to MSCI Index 10 0 Source: MSCI More Return (%) A.M. Best's Criteria Review Seminar October

20 Less Developed Bond Markets Developed Average Lebanon Malaysia Thailand Brazil South Africa Poland Philippines Mexico China Emerging Average India Venezuela Colombia Turkey Pakistan Peru Argentina Indonesia Total Bonds Outstanding as % of GDP A.M. Best's Criteria Review Seminar October

21 Country Risk & Market Development 14% 12% Penetration (%) 10% 8% 6% 4% 2% 0% Country Risk Score (from lower to higher risk) Source: AXCO and A.M. Best A.M. Best's Criteria Review Seminar October

22 Country Risk and the Rating Process A.M. Best's Criteria Review Seminar October

23 Integration of Country Risk Balance Sheet Strength Operating Performance Business Profile Management Team Peer Analysis / Industry Composite Company Rating Proposal Enterprise Risk Management Industry Trends & Analysis Country Risk A.M. Best's Criteria Review Seminar October

24 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 Company Rating Proposal Country Risk Country risk is not a ceiling or cap on insurer ratings; it is one of many rating factors A.M. Best's Criteria Review Seminar October

25 Some Countries are More Challenging Ease of Doing Business Rank (Out of 183 Countries) Source: World Bank CRT-1 CRT-2 CRT-3 CRT-4 CRT-5 A.M. Best's Criteria Review Seminar October

26 Degree of Corruption Varies 10 9 Corruption Index (Higher = Less Perception of Corruption) Higher Degree of Perceived Corruption 0 CRT-1 CRT-2 CRT-3 CRT-4 CRT-5 Source: Transparency International A.M. Best's Criteria Review Seminar October October

27 Heat Chart Illustrates Relationship Relationship between ratings and CRTs A.M. Best's Criteria Review Seminar October

28 Relationship between FSR and CRT Best's Financial Strength Rating Country Risk Tier A++ 6% 1% 2% A+ 20% 15% A 55% 35% 16% 4% A- 16% 35% 59% 26% 5% B++ 2% 10% 18% 48% 32% B+ 1% 3% 2% 17% 42% B 1% 4% 16% B- 2% 5% C- 2% Sample (total / each tier): Excludes United States, Canada and Bermuda. A.M. Best data as at October 2011 Note: percentage figures may not add due to rounding A.M. Best's Criteria Review Seminar October

29 Enterprise Risk Management & Internal Capital Models Carlos Wong-Fupuy Senior Director, Analytics Mathilde Jakobsen Senior Financial Analyst A.M. Best's Criteria Review Seminar October

30 Best s Approach to Risk Management A.M. Best's Criteria Review Seminar October

31 Risk Management in the Rating Evaluation Process Business Profile Operating Performance Balance Sheet Strength Risk Management is the common thread that links balance sheet strength, operating performance, and business profile Risk Management = (Identify + Understand + Measure + Manage) Risk A.M. Best's Criteria Review Seminar October

32 Enterprise Risk Management Enterprise Risk Management (ERM) is the process through which insurers identify, quantify and manage risk on an enterprise-wide, holistic basis ERM takes into consideration the individual risks at hand, as well as any correlations and inter-dependencies of risk across the entire organisation Insurers that create a more structured, integrated risk framework and apply it prudently can: Increase the value of the company; and Provide financial security to the organisation A.M. Best's Criteria Review Seminar October

33 Enterprise Risk Management Balance sheet strength, operating performance and business profile are the key drivers of our evaluation Risk management must be viewed within the broader rating context Risk management is not one size fits all A.M. Best's Criteria Review Seminar October

34 A.M. Best s Evolving Approach How has our process evolved? Best s Supplemental Rating Questionnaire (SRQ) questions on ERM added in 2011 More focused rating committee discussions on risk management and the impact on ratings Currently rolling out a new Risk Management section in our company reports Risk management Stress tests performed Cat exposure and management Investment risk management A.M. Best's Criteria Review Seminar October

35 Enterprise Risk Management SRQ Questions Serves as a consistent starting point for analyst s discussion about the rating unit s risk management Cover main areas Risk culture Risk identification/measurement/monitoring EC models/use test What If...? scenarios A.M. Best's Criteria Review Seminar October

36 Enterprise Risk Management SRQ Questions Risk Culture Do you have a CRO/ERM committee? Are your strategies driven by risk/return measures? How often does the board review risk tolerances? How often does the CRO/senior officer report risk metrics and risk management activities to the board? How often does the CRO/senior officer report risk metrics and risk management activities to the business units? A.M. Best's Criteria Review Seminar October

37 Enterprise Risk Management SRQ Questions Risk Identification/Measurement/Monitoring Who is most responsible for identifying material risks? What has management identified to be its largest threat? At what level do you define risk tolerance? What is management's overall tolerance for risk? Who is most responsible for monitoring risk tolerances? How often are the material risks measured? Who receives exception reports when risk tolerances are exceeded? Are there procedures if tolerances are exceeded? What are the largest accumulations of risk at a location or an account? What lines are the most correlated that could threaten strength? A.M. Best's Criteria Review Seminar October

38 Characteristics of Strong Risk Management A.M. Best's Criteria Review Seminar October

39 Strong Risk Management Demonstrated ability to identify, understand, measure, and manage the risks inherent in your business operations (includes risk correlation) Incorporates a recognition and evaluation of the potential impact of external factors (competitive, legal, regulatory, economic) and emerging risks CRO s, risk committees, corporate dashboards, stochastic internal capital models, etc. These can all be valid elements of a robust ERM programme, but strong fundamental risk and capital management practices and a stable, sustainable business model come in many different shapes and sizes A.M. Best's Criteria Review Seminar October

40 Risk Management A Wide Spectrum Wide spectrum of tools, techniques, approaches to risk management Differences in geographic and product complexity/diversity, as well as management team skill sets and mind sets, must be considered Approaches range from a traditional silo mentality to an integrated ERM platform with ICM, with many hybrids in between Companies may migrate from one approach to another over time as their profile, skill set and the business environment changes Bottom line: a company s process should fit its profile and provide a stable, sustainable operating platform in good times and in bad A.M. Best's Criteria Review Seminar October

41 Capital Allocation and Risk- Adjusted Performance Measures Capital allocation by BUs / LoBs Risk-adjustment performance measures Incentive system aligned with risk-adjusted KPIs A.M. Best's Criteria Review Seminar October

42 Risk Management and the Rating Evaluation Process (Assessing Risk Management) A.M. Best's Criteria Review Seminar October

43 Risk Management and the Rating Process: A Practical Approach Risk management capability viewed in light of a company s risk profile A.M. Best wants companies to show me how their risk and capital management process provides a stable, sustainable operating platform that can weather the storm year after year A.M. Best's Criteria Review Seminar October

44 ERM and the Rating Process Top 5 exposures and critical success factors to mitigating/managing these risks Lessons learned through your ERM development process ERM questions addressed at rating meetings Next steps in ERM development A.M. Best recognises ERM is an on-going process. Demonstrating commitment and progress toward a goal is the key A.M. Best's Criteria Review Seminar October

45 ERM Questions Addressed at Rating Meetings What is the board s and senior management s role in your risk management framework? Has your organisation established and communicated any risk management objectives to your employees, and other stakeholders? What is your risk appetite? How is it measured? How does your organisation encourage good risk-based decision making? What is your organisation s process for identifying and cataloguing key risks across your organisation? A.M. Best's Criteria Review Seminar October

46 ERM Questions Addressed at Rating Meetings What tools does your organisation use to determine required capital? Is it a static, dynamic, or hybrid approach? How do you factor in correlation/dependency of individual risks? How are liquidity, cash flows, and financial flexibility incorporated into your risk management framework? How do you incorporate operational risk and strategic risk in your evaluation of required capital? How are emerging risks identified and evaluated? A.M. Best's Criteria Review Seminar October

47 What Should Insurers Share With A.M. Best? Insurers should provide whatever materials they feel will help us understand how their organisation defines and strives for strong risk management Demonstrate how you identify, understand, measure and manage risk Sample reports used by the board, senior management, etc. De-briefing on how risk tools were used to make a strategic or tactical decision the USE TEST! Internal or external assessments of your overall process, or components of your process ORSA evaluation documents A.M. Best's Criteria Review Seminar October

48 Risk Management Risk Profile HIGH RISK MODERATE RISK LOW RISK MINIMAL RISK Characteristics for Low Risk Profile Low volatility in earnings and capital Favorable regulatory/judicial environment Low severity claims/low limit policies Limited competition/stable pricing Standardised/unchanging coverages Low leverage measures Strong reinsurance protection Strong financial flexibility High liquid/stable investments Stable economic environment Strong data capture/quality A.M. Best's Criteria Review Seminar October

49 Risk Management Risk Profile HIGH RISK MODERATE RISK LOW RISK MINIMAL RISK Characteristics for High Risk Profile High volatility in earnings and capital Unfavourable regulatory/judicial environments High severity/low frequency claims High policy limits/excess layers Strong competition/inadequate pricing New/changing/complex coverages and products High leverage measures Weak/no reinsurance protection Weak/no financial flexibility Illiquid/volatile/complex investments Unstable/multiple economic environments Weak data capture/quality A.M. Best's Criteria Review Seminar October

50 Risk Management Characteristics of Good RM Capability Good traditional risk management (silos): Market risk Credit risk UW risk Operational risk Strategic risk Good capital management: Earnings Debt market Equity market Good knowledge of BCAR Good management and management info: Good decision making Traditional metrics Reliable projections Risk aware culture Limited ERM Capabilities Risk Management Capability Superior Strong Good Weak A.M. Best's Criteria Review Seminar October

51 Risk Management Characteristics of Superior RM Capability Superior traditional risk management Superior capital management Superior management and management info Superior ERM capabilities: Corporate wide risk aware culture Experienced CRO/ERM committee Well quantified risk appetite/risk tolerance Superior risk identification/ quantification/mitigation/monitoring/ controls Superior knowledge of correlations Across lines of business Across risk categories Superior economic capital model Decisions based on risk metrics Compensation based on risk metrics Frequent what if? scenario testing Risk Management Capability Superior Strong Good Weak A.M. Best's Criteria Review Seminar October

52 Role of Internal Capital Models Versus Best s Capital Model (BCAR) Mathilde Jakobsen Senior Financial Analyst A.M. Best's Criteria Review Seminar October

53 ICMs Can Be a Valuable Tool Wide spectrum of tools, techniques, accounting regimes Static models Partial models Stochastic capital models Differences in data availability and integrity also influence model design A.M. Best's Criteria Review Seminar October

54 ICM Approach Integrated Within Risk Management Discussions A.M. Best dialogue on capital management includes a review of key underlying elements of ICM process and results, or whatever tools or metrics the company uses to determine required capital Incorporated within the credit rating evaluation process, either at annual rating meeting or as a supplement to annual meeting A.M. Best's Criteria Review Seminar October

55 Enterprise Risk Management Questions Economic Capital (EC) Models Do you use an EC model to quantify your aggregate risk? If an EC model is not used, how do you determine capital adequacy and allocation of capital to business units? Do you use the EC model to make key business decisions? Do you use the EC model to determine any portion of management compensation? What are the three key drivers (or parameters) of the EC model that have the greatest impact? How often are these drivers of the EC model updated? How often is the EC model run? A.M. Best's Criteria Review Seminar October

56 ICM Questions Main purpose/goal of ICM/structure Who uses output and how How frequently run Time horizon for risk (1 year, 5 year, ultimate, etc.) Risk metric (VaR, TVaR, etc.) Major risk categories modelled (market, credit, pricing, reserving, operational, strategic, liquidity, regulatory, etc.) Correlations/diversification across risk categories Stress tests/scenarios modelled and outcomes Material risks not captured by model In developing this model, what were some of the important things learned Next steps/future developments/changes to model A.M. Best's Criteria Review Seminar October

57 Balance Sheet Strength Balance sheet strength continues to be the foundation of the rating evaluation process Best s Capital Adequacy Ratio (BCAR) continues to be one of the primary tools used in the assessment of balance sheet strength One of many factors in assessment of the balance sheet Value of BCAR in rating process proven over time through our default statistics Balance sheet strength and the BCAR are not (and never have been) the sole determining factors in a rating A.M. Best's Criteria Review Seminar October

58 A.M. Best s Capital Adequacy Ratio (BCAR) Acts as a global capital adequacy benchmarking tool Best s Capital Adequacy Ratio (BCAR) is determined: BCAR SCORE = TOTAL ADJUSTED CAPITAL/NET REQUIRED CAPITAL A.M. Best's Criteria Review Seminar October

59 A.M. Best s Capital Adequacy Ratio (BCAR) NET REQUIRED CAPITAL + (B1) Fixed-Income Securities + (B2) Equity Securities + (B3) Interest Rate + (B4) Credit + (B5) Loss Reserves + (B6) Net Written Premium + (B7) Off Balance Sheet Risks - COVARIANCE TOTAL ADJUSTED CAPITAL + Shareholders funds + Positive adjustments. Typically: Discounting of reserves Difference between market and book values Value of In-Force Business (VIF) Economic Reserves e.g. RfBs Hybrid Equity - Negative adjustments: Deduction of one cat PML DAC BCAR SCORE = TOTAL ADJUSTED CAPITAL/NET REQUIRED CAPITAL 59 A.M. Best's Criteria Review Seminar October

60 Cat Risk in the BCAR Standard BCAR Two Event Cat Stress Test EVENT 1/100 Wind or 1/250 Earthquake 1 st EVENT 1/100 Wind or 1/250 Earthquake ADJUSTMENT - Subtract after-tax net PML from surplus ADJUSTMENT - Subtract after-tax net PML from surplus + Add 40% of pre-tax net PML to loss reserves + Add 40% of reinsurance recoverable to credit risk 2nd EVENT 1/100 Wind or 1/100 Earthquake ADJUSTMENT - Reduce surplus by after-tax net PML 60 A.M. Best's Criteria Review Seminar October

61 Determining Required Capital Determination of required capital based on an interactive dialogue comparing: Company s view of capital (e.g. ICM) BCAR score and historical trends Holding company issues Risk management capability Other models or metrics A.M. Best's Criteria Review Seminar October

62 Benefits to Improved ERM Benefits to improved risk management: Potentially greater outside stakeholder confidence: Including from rating agencies Potentially lower capital requirements After impacts observed in results over time A.M. Best's Criteria Review Seminar October

63 Risk Management and BCAR Weak Risk Management Strong Risk Management BCAR Guidelines Exposure to Earnings and Capital Volatility A.M. Best's Criteria Review Seminar October

64 Best s Rating Evaluation Service (RES) Nick Charteris-Black, Managing Director, Market Development - EMEA A.M. Best's Criteria Review Seminar October

65 RES Overview Provides opinion in advance as to the potential rating impact of major corporate activity Review one or more hypothetical scenarios: M&A Asset divestiture or restructuring Major shift in business profile Capital restructuring Formal rating committee feedback Non-binding but... A.M. Best's Criteria Review Seminar October

66 Q & A Country Risk Methodology Enterprise Risk Management Internal Capital Models versus Best s Capital Model A.M. Best s Rating Evaluation Service A.M. Best's Criteria Review Seminar October

67 Disclaimer 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. A.M. Best's Criteria Review Seminar October

68 A.M. Best Europe Rating Services Ltd 19 October 2012 A.M. Best s Rating Criteria Seminar Stefan Holzberger, Managing Director, Analytics Mahesh Mistry, Associate Director, Analytics Carlos Wong-Fupuy, Senior Director, Analytics Mathilde Jakobsen, Senior Financial Analyst