BEST S BRIEFING Our Insight, Your Advantage. October 13, 2017 A.M. Best anticipates that fewer than 5% of its current credit ratings will change owing to the adoption of the updated BCRM Q&A on A.M. Best s Updated Credit Rating Methodology A.M. Best released an update to its core methodology Best s Credit Rating Methodology (BCRM) on October 13, 2017. The update represents the culmination of an 18-month process that included extensive dialogue with insurance companies and other industry participants. The updated BCRM also includes revisions to A.M. Best s proprietary capital model, Best s Capital Adequacy Ratio (BCAR). This briefing in the form of a Q&A seeks to answer questions about the impact of the updated BCRM and BCAR. Question: Why is A.M. Best revising its core methodology? Answer: A.M. Best s updated methodology and capital model will provide the market with greater transparency around the drivers (Exhibit 1) of A.M. Best s rating decisions, while incorporating more robust analytics. Q: How will this affect capital requirements? A: A.M. Best s opinion is that the insurance industry is well capitalized overall. Capitalization will vary by company, however, and ratings on a small number of companies may experience negative pressure owing to low levels of risk-adjusted capitalization relative to their current ratings. Q: What changes or modifications resulted specifically from industry feedback? A: One of the more significant changes made following the first comment period was the removal of hard-coding at the 99.8 and 99.9 VaR (value at risk) levels in the BCAR in the balance sheet strength assessment. A.M. Best removed these levels because of concerns raised regarding uncertainty about estimates of loss that far out on the tail. That said, A.M. Best considers tail risk important to its estimate of capital adequacy and now generally expects companies to hold a capital buffer at the 99.6 VaR to cover tail risk. Potential for Movement in Credit Ratings Q: Overall, are there any segments facing rating pressure as a result of the updated methodology? A: Because the updated BCRM is a reorganization of A.M. Best s credit analysis, there is no concern for any one segment. The updated BCAR and its enhanced focus on tail risk may shine a brighter light on companies with outsized catastrophe exposures. A.M. Best believes the new focus on tail risk and the more integrated view of enterprise risk management will bring to light the excellent risk techniques that some companies have already implemented. Analytical Contact: Stefan Holzberger, Oldwick +1 (908) 439-2200, ext. 5380 stefan.holzberger@ambest.com Steve Irwin, Oldwick +1 (908) 439-2200, ext. 5454 stephen.irwin@ambest.com SR-2017-B-956 Q: Does A.M. Best expect ratings to change? A: A.M. Best estimates a shift in less than 5% of its ratings, some up and some down. The BCRM is not a means to change ratings, although applying a different lens and using enhanced tools may result in some rating movement. Q; How long will ratings be under review? A: All ratings placed under review because of the updated BCRM will be resolved within a sixmonth period. Copyright 2017 A.M. Best Company, Inc. and/or its affiliates. ALL RIGHTS RESERVED. No part of this report or document may be distributed in any electronic form or by any means, or stored in a database or retrieval system, without the prior written permission of A.M. Best. For additional details, refer to our Terms of Use available at A.M. Best website: www.ambest.com/terms.
Exhibit 1 Best's Credit Rating Methodology Building Blocks Source: Best's Credit Rating Methodology Q: How much advance notice have companies had about a potential rating change? A: A.M. Best has been proactive and transparent with the industry during the process of revising its methodology and capital models. A.M. Best first publicly released the BCRM and the U.S. property/casualty BCAR for comment in March 2016. Since then, A.M. Best has had several comment periods; released several briefings to update its progress; held numerous webinars; and given numerous presentations, all with the goal of ensuring a robust dialogue with insurance industry participants. The Role of Enterprise Risk Management Q: Has A.M. Best s view of enterprise risk management changed with this updated methodology? A: Enterprise risk management (ERM) was an important part of A.M. Best s rating process before the release of the updated BCRM and will remain an important part of the rating process under the updated BCRM. Its impact on the rating will now be more transparent. Q: Has the process by which A.M. Best evaluates a company s ERM changed? A: A.M. Best believes ERM is at its best when it is integrated into all the components of an organization and analysis. Generally, A.M. Best will not have a separate rating meeting on ERM. However, ERM will remain an important subject to be addressed during meetings with a company s management team. Q: Why is the scoring for enterprise risk management asymmetric? A company can be moved up one notch, but can go down four notches? A: A.M. Best expects the ERM assessment of a significant majority of its rated companies to be in the Marginal (-1), Appropriate (0), or Very Strong (+1) categories. However, there are instances when, either because of ERM failures or non-recognition of key ERM principles, an assessment of Weak (-2) or Very Weak (-3/4) is appropriate. Q: Why does A.M. Best limit the number of combined notches across Business Profile and ERM to two? A: Companies with highly complex and large-scale business profiles require a well developed, sophisticated, and best-in-class ERM program to manage such large arrays of risk. A.M. Best will recognize and acknowledge the strength of the ERM program but does not create additional notches of financial strength. 2
Q: How many companies do you expect will achieve an assessment of Very Strong (+1 notch) in the ERM category? A: A.M. Best expects just a small number of companies to achieve an assessment of Very Strong. To achieve an assessment of Appropriate, A.M. Best generally expects a company s ERM framework to be adequate given the size and complexity of its operations and its risk management capabilities to be very sound and well aligned with its risk profile. Therefore, to achieve an assessment of Very Strong, an insurer must clearly differentiate itself relative to what is expected for a company with its profile. Revisions to Best s Capital Adequacy Ratio Q: How much total overall capital will need to be infused into rated insurers balance sheets under the updated methodology? A: The changes to BCAR reinforce A.M. Best s opinion that the insurance industry is well capitalized overall; however, this varies by company and is difficult to address in general. Q: With respect to the previous question, have you made the same determination by segments? A: A.M. Best s testing has not uncovered an industry segment that as a whole is deficient in capital. Q: What is the timeline for the release of BCAR scores? A: Companies have received output from the 2015 BCAR model from their analytical teams. The 2016 stochastic-based BCARs are being released to companies on a rolling basis, starting this fall. A.M. Best s analysts are happy to share the 2016 BCARs with companies management teams upon request. Q: What is gained from running BCAR at so many different confidence levels? A: A.M. Best estimates required capital at different confidence levels, to drive a deeper understanding of the company s exposure to significantly adverse tail events. Q: What does it mean if a company s updated BCAR score is 100 points lower than its old one? A: The calculation of the BCAR has changed and is not comparable to the old BCAR scores. Q: Will companies BCAR scores be published? A: A.M. Best will be publishing the BCAR score for all rating units at the four confidence intervals. This is an update, as in the past BCAR scores were published for only U.S. and Canadian companies. Q: If a company has a top BCAR score under the updated BCRM, will it get a Financial Strength Rating of A (Excellent)? A: The BCAR score did not equate to a Financial Strength Rating under the former BCRM, nor does it under the updated methodology. There are many quantitative and qualitative considerations that are assessed in the rating process. A.M. Best is hopeful that the updated methodology will provide greater clarity on this issue. Q: How does this methodology update compare with NAIC s risk-based capital standard? A: The recent proposed changes in risk-based capital (RBC) such as adding catastrophe risk to the RBC move NAIC s view of risk-based capital closer to A.M. Best s view. 3
Q: Why is the catastrophe risk charge now included in the overall risk charge in the updated BCAR model? A: The catastrophe risk charge has moved from a deduction from available capital to an addition to required capital, so that it allows for a clear view of the increase in required capital as the confidence level increases, while the available capital to cover those risks remains constant. In addition, since catastrophe risk is not fully correlated to other risks borne by an insurer, A.M. Best felt it was appropriate to allow for some diversification benefit. Q: Will all companies receive assessments of their building-block scores when the updated BCRM takes effect? A: Not all companies will receive assessments of their building-block scores when the updated BCRM takes effect. A.M. Best will continue to rate companies and produce credit reports on a rolling basis. Upon request, analysts can share the building-block scores with companies whose ratings are not expected to change and will hold in-depth conversations prior to the annual management meeting. This will allow analysts the ability to prioritize discussions with companies whose ratings are likely to be placed under review because of the updated BCRM. Q: Will the building-block scores be publicly released? A: Yes. A.M. Best will publish each company s assessment of balance sheet strength, operating performance, business profile, and enterprise risk management, as well as any lift or drag applied to the rating from the parent or affiliates (Exhibit 2). Q: Isn t there going to be overlap within the building-block categories? A: A.M. Best does recognize that there may be some overlap of these components and that analytical judgment will play an important role in assigning credit, to avoid double counting. Potential Reinsurance Issues Q: What impact will this have on reinsurance demand? A: Insurance companies make reinsurance decisions based on what is most appropriate for their business. A.M. Best does not expect this to change as a result of the updated methodology. Q: Do brokers stand to gain or lose under this updated methodology? A: A.M. Best is focused on engaging with rated insurers and reinsurers in its interactive rating process. The updates to A.M. Best s methodology and capital models will not change the important role brokers and agents play as intermediaries in the (re)insurance buying process. Q: Is A.M. Best biased toward larger (re)insurers? A: There is no size bias in A.M. Best s rating process. Being a smaller (re)insurer creates challenges with regard to product and geographical concentration that can lead to increased performance volatility, which A.M. Best views as a negative rating factor. However, numerous small companies have overcome these challenges because of their specialized knowledge of the markets in which they operate, which can more than offset the challenges. Companies should understand their risks and use the tools available to them to mitigate those risks. Miscellaneous Concerns/Questions Q: Is there any change to how insurance-linked securities are rated? A: In August 2016, A.M. Best released the Best s Insurance-Linked Securities & Structures Methodology (BILSM), which outlines the process for rating insurance-linked securities and offers insight into the information to be reviewed, key rating considerations, risk modeling, and surveillance activities that are generally taken into consideration in the process. 4
Exhibit 2 Best's Credit Rating Methodology Building Block Assessments Balance Sheet Strength Operating Performance Business Profile Enterprise Risk Management Strongest Very Strong Very Favorable Very Strong Very Strong Strong Favorable Appropriate Strong Adequate Neutral Marginal Adequate Marginal Limited Weak Weak Weak Very Limited Very Weak Very Weak Source: Best's Credit Rating Methodology Very Weak Q: What role does cyber play in this updated methodology? A: A.M. Best collects a range of cyber data from rated insurers. Although these data are not incorporated into its capital model, A.M. Best considers insurers cyber exposures on both a packaged and a standalone coverage basis. Q: Does this updated methodology cap the overall rating for smaller, less financially diverse insurers? A: No. The updated BCRM is a reorganization of the same key pillars of financial strength that A.M. Best uses in its credit analysis. Insurance companies with less than USD 20 million in capital and surplus typically are not considered for the Strongest balance sheet strength assessment, as their capital base would be too small to absorb any significant shock. Q: Does this updated methodology apply equally across different company types for example, publicly traded versus a mutual insurer? A: A.M. Best s methodology is global and applies to all insurance companies. It assesses both quantitative and qualitative factors, as well as the unique strengths and weaknesses of different entities with different organizational structures and operating strategies, all of which are factored into the analysis. 5
A.M. Best WORLD HEADQUARTERS (Oldwick, NJ) +1 908 439 2200 Washington +1 202 347 3090 Mexico City +52 55 1102 2720 London +44 20 7626 6264 Dubai* +971 4375 2780 Hong Kong +852 2827 3400 Singapore +65 6589 8400 *Regulated by the DFSA as a Representative Office Important Notice: A Best s Financial Strength Rating is an independent opinion of an insurer s financial strength and ability to meet its ongoing insurance policy and contract obligations. It is based on a comprehensive quantitative and qualitative evaluation of a company s balance sheet strength, operating performance and business profile. These ratings are not a warranty of an insurer s current or future ability to meet contractual obligations. The Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance policy and contract obligations. The rating is not assigned to specific insurance policies or contracts and does not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional information, see A.M. Best s Terms of Use at www.ambest.com/terms.html. Data sourced from the BestLink system is retrieved around the time of the report creation and is subject to revision. 6