A.M. Best s Updated Credit Rating Methodology and Capital Model. Robert Raber Senior Financial Analyst A.M. Best Company

Transcription

1 A.M. Best s Updated Credit Rating Methodology and Capital Model Robert Raber Senior Financial Analyst A.M. Best Company 1

2 Contents A.M. Best Company Overview Updated Best s Credit Rating Methodology (BCRM) Updated Best s Capital Adequacy Model (BCAR) Questions 2

3 A.M. Best Overview 3

4 A.M. Best Overview Established in 1899, pioneered the concept of insurer financial strength ratings in Provider of ratings, financial data, and news specific to the insurance industry. Multiple channels for obtaining public information from A.M. Best: daily and weekly newsletters, monthly publications, special technical reports, webinars, in-person appearances at industry events, annual publications. Coverage of approximately 3,500 companies in more than 80 countries. Only rating agency focused on the insurance industry: Methodologies are specific to the insurance environment. Analysts are industry specialists. 4

5 A.M. Best Ratings Financial Strength Rating (FSR) an independent opinion of an insurer s financial strength and ability to meet its ongoing insurance policy and contract obligations. Issuer Credit Rating (ICR) an independent opinion of an entity s ability to meet its ongoing financial obligations. All ratings are forward looking in nature as indicated by an assigned outlook Stable, Positive, Negative; or placed Under Review (with Positive, Negative, or Developing Implications). Ratings are composed of key areas covered with in the BCRM 5

6 A.M. Best Rating Scale FSR A++ A+ A ICR aaa aa+ aa aaa+ a A a B++ bbb+ bbb B+ bbb FSR = Financial Strength Rating ICR = Issuer Credit Rating 6

7 Revised Best s Credit Rating Methodology (BCRM) 7

8 Impetus for Change Transparency & clarity Reorganization of the current criteria A way to integrate new tools Application of BCAR 8

9 Tentative Timeline 03/10/16 12/31/16 Draft BCRM & PC BCAR criteria is released for comment Comment period will include public updates as specific issues raised Comment period will be extended to coincide with release of all BCAR models Comment period ends Comments incorporated as necessary into BCRM and all BCAR criteria BCRM and BCAR criteria is published and becomes effective Remainder of Q

10 An Updated BCRM The BCRM will be the key source document for deriving ratings Issuer Credit Ratings Financial Strength Ratings Issue Ratings 10

11 An Updated BCRM Not a fundamental change to rating analysis 11

12 An Updated BCRM The BCRM is being updated but the fundamental rating drivers will remain the same Balance sheet strength Operating performance Business profile Enterprise risk management 12

13 Rating Implications BCRM is NOT a means to change ratings although some ratings may change Analyst will communicate any potential rating issues as they become apparent during comment period Ratings impacted will be placed under review at end of comment period Need to be resolved within 6 months after under review 13

14 The Building Block Approach Country Risk A.M. Best s Rating Process Balance Sheet Strength Baseline (e.g., bbb+) Operating Performance (+2/ 3) Business Profile (+/ 2) Enterprise Risk Management (+1/ 4) Comprehensive Adjustment (+/ 1) Rating Enhancement Published Issuer Credit Rating 14

15 Balance Sheet Strength Balance sheet strength is now broken down into several parts Rating unit balance sheet strength assessment BCAR Other qualitative and quantitative factors Holding company impact assessment Country risk impact Country Risk Rating Unit Balance Sheet Strength Assessment Holding Company Impact Assessment Balance Sheet Strength 15

16 Balance Sheet Strength Country Risk Rating Unit Balance Sheet Strength Assessment Holding Company Impact Assessment Balance Sheet Strength Baseline BCAR Stress Tests Liquidity ALM Quality of Capital Quality of Reinsurance Reinsurance Dependence Appropriateness of Reinsurance Program Fungibility of Capital Internal Capital Models 16

17 Balance Sheet Strength 17

18 Operating Performance The BCRM is being updated but the fundamental rating drivers will remain the same Underwriting Performance Investment Performance Total Operating Earnings Prospective Financial Forecasts Other Considerations Unique to LOB, region of operation, structure 18

19 Operating Performance Benchmarks ensure operating performance metrics for each insurer are being evaluated in proper framework Can be created using: Industry composites/sub-composites ICR composites Other customized parameters May be appropriate to compare a rating against multiple benchmarks Rating Committee has flexibility in determining the appropriate benchmark(s) for each rating unit Various insurance organizational types will have differing benchmarking metrics 19

20 Business Profile The BCRM is being updated but the fundamental rating drivers will remain the same Product/Geographic Concentration Market Position Pricing Sophistication & Data Quality Product Risk Degree of Competition Investment Risk Management Quality Regulatory, Event & Market Risks Distribution Channels 20

21 ERM The BCRM is being updated but the fundamental rating drivers will remain the same Product & Underwriting Risk Reserving Risk Concentration Risk Reinsurance Risk Financial Flexibility Risk Investment Risk Legislative/Regulatory/Judicial/Economic Risk Management Risk Operational Risk Risk Appetite/Stress Testing 21

22 Comprehensive Adjustment Evaluation of key rating factors includes parameters which place limits on any one factor Recognizes a truly uncommon strength/weakness that is not captured through the rating process Allows for additional weighting beyond the parameters noted in Balance Sheet Strength, Operating Performance, Business Profile and ERM A vast majority of ratings will not require a comprehensive adjustment 22

23 Rating Enhancement Non-lead rating units may be eligible for partial rating enhancement based on benefits it receives from being affiliated with the lead rating unit Rating drag can also occur from negative impact of the lead rating unit on the non-lead unit Benefit from explicit support guarantees, reinsurance, and / or capital contributions Can achieve the same level as the lead unit, but does not imply rating levels of the entities will more in lock-step 23

24 The Building Block Approach Country Risk A.M. Best s Rating Process Balance Sheet Strength Baseline (e.g., bbb+) Operating Performance (+2/ 3) Business Profile (+/ 2) Enterprise Risk Management (+1/ 4) Comprehensive Adjustment (+/ 1) Rating Enhancement Published Issuer Credit Rating 24

25 Updated Best s Capital Adequacy Ratio (BCAR) 25

26 Stochastic Based BCAR Best s Capital Adequacy Ratio (BCAR) is a comprehensive quantitative tool that evaluates many of the risks to the balance sheet simultaneously and generates an overall estimate of the required level of capital to support those risks and compares it with available capital BCAR is a key tool in the assessment of balance sheet strength Not the sole determinant of Balance Sheet Strength Not the sole determinant of the rating 26

27 Summary of Changes More sophisticated and faster software available now Simulations / probability curves Correlations / diversification Company specific detail Economic scenario generators (ESGs) A computer model that randomly simulates thousands of possible values for a variety of economic and financial variables over a series of selected timeframes An ESG does not predict a path the economy will follow but instead produces a collection of possible paths including some that have not yet been observed 27

28 Summary of Changes Do not intend to change underlying view of the risks Do not intend to change the main risk categories of the models Goals are to: Generate risk factors using stochastic simulations from probability curves & ESG Incorporate company specific detailed data from SRQ & statutory financial statements 28

29 Summary of Changes 5 scores calculated and published instead of 1 95%, 99%, 99.5%, 99.8%, and 99.9% confidence levels New Calculation of BCAR Formula change Difference between Available Capital and Required Capital, as a ratio to Available Capital Better alignment with risk appetite/tolerance statements 29

30 Summary of Changes New Metric VaR (Value at Risk) 100% Probability of Potential Scenario UW (Profit)/Loss as Percent of NPW 95% of potential scenarios Break even 5% in tail VaR 99.0 VaR 99.5 VaR does not tell us about what s in the tail so we need to look at more than one VaR 0% -50% -40% -30% -20% -10% 0 10% 20% 30% 40% (Profit)/Loss as % of NPW VaR 95 UW Loss = 23% of NPW 30

31 New Structure PC BCAR BCAR Ratio = (Available Capital Net Required Capital) / Available Capital Available Capital (AC) Reported Capital (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. 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) Business Risk (B8) Potential Catastrophe Loss Covariance Adjustment Net Required Capital (NRC)* *NRC= SQRT [ (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+(B5)]²+(B6)² ] + B7 + B8 31

32 Example of Impact to PC Model Current PC BCAR Calculation (ratio to NRC) Potential Scores: Low of 0.0 to Max of Wanted BCAR > New PC BCAR Calculation (ratio to Available Capital) Potential Scores: Low of to Max of Want BCAR >

33 Example of Impact to PC Score Current PC BCAR Calculation (ratio to NRC) APHS (ex Potential Cat Losses) = $150M Potential Cat Losses = $30M NRC (ex Potential Cat Losses) = $80M BCAR = ( ) / 80 = 120/80 = Planned PC BCAR Calculation (ratio to Available Capital) Available Capital (ex Potential Cat Losses) = $150M Potential cat Losses = $30M NRC (ex Potential Cat Losses) = $80M NRC (incl Potential Cat Losses) = $110M BCAR = ( ) / 150 = 40/150 =

34 Display of BCAR Scores 50 BCAR VaR 95 VaR 99 VaR 99.5 VaR 99.8 VaR

35 Summary of Changes Bond Defaults Publicly Traded Common Stocks Other Asset Classes Interest Rate Risk Credit Risk Reinsurance Recoverable Amounts Premium Risk Reserve Risk 35

36 Investment Risk Fixed Income Securities Default Risk Bonds Mortgage Loans Preferred Stocks Equities Market Value Volatility Publicly Traded Common Stocks Real Estate Schedule BA assets Affiliated and Private investments receive 100% risk charge 36

37 Interest Rate Risk Interest Rate Risk Risk of having to sell fixed income assets when market values are lower Exposure to a rise in interest rates over next one year Liquidity risk during the upcoming year Risk is driven by sudden shock event PC - Usually natural catastrophe, or man-made, could be economic 37

38 Credit Risk Credit Risk Risk of default on: Reinsurance recoverable amounts (recov on pd & unpd, ceded UPR) Reinsurance Recoverable Charge: Credit risk charge (ability to pay) Reinsurer AMB issuer credit rating Duration of recoverables Uses stochastic simulation software and impairment table Credit Risk Charges reduced for: Recovery on default (50%) Funds Held (100%) Acceptable LOCs & Trusts (up to 90%) Discounted to present value Dispute Risk calculation remains 38

39 Reserve Risk Risk of unanticipated adverse development on net loss & loss-adjustment expense (LAE) reserves Reserve Risk Factors Uses stochastic simulation software probability distributions correlation matrix Further adjustment to required capital for Excessive Growth 39

40 Premium Risk Risk that pricing of business written next year will be inadequate Potential for Underwriting Loss on one more year s worth of business This is the one-year look forward in terms of adding additional exposure Current year s NWP used as proxy for next year Premium Risk Factors Uses stochastic simulation software probability distributions correlation matrix Further adjustment to required capital for Excessive Growth 40

41 Business Risk Risks not reflected in balance sheet that may affect surplus Contingent Liabilities Non-controlled assets Unfunded Pension & other post employment/ retirement benefits Separate Account Assets Etc. Risk factors determined by analyst Use same required capital at all VaRs 41

42 Potential Catastrophe Loss 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 Reinstatement premium and Tax adjustments remain Terrorism and other stress tests remain 42

43 Catastrophe Stress Test If a cat loss occurs, what would the BCAR scores look like? 1. Reduce Available Capital 1-in-100 year Net PML from Per occurrence, Total all perils Reinstatement premium and tax adjustments remain 2. Increase Recoverables by 40% of ceded loss From 1-in-100 year PML from Per occurrence, Total all perils Adjust credit risk factors if needed 3. Increase Net loss reserves by 40% of pretax net PML From 1-in-100 year PML from Per occurrence, Total all perils 4. See how far BCAR scores drop at all confidence levels 43

44 Catastrophe Stress Test BCAR How far did the curve shift down, is this a material drop, and how do you manage this drop? VaR 95 VaR 99 VaR 99.5 VaR 99.8 VaR Published BCAR Stressed BCAR Need to assess Financial Flexibility to determine impact. 44

45 Additional Resources Complete proposed methodology available on our website: Assigned analytical team A.M. Best staff attending industry events Webinars available for viewing at comments to: 45

46 Questions 46

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