A.M. Best Insurance Industry UpdateIASA NY/NJ Chapter

Robert RaberSenior Financial Analyst

A.M. Best Company

May 18, 2015

Re-Introduction to A.M. Best Company

Key Current Industry Observations

Expanded Topics in the Rating Process

BCAR – The New Generation

Questions

Contents

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Re-Introduction to A.M. Best Company

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Established in 1899, pioneered the concept of insurer financial strength ratings in 1906.

Provider of ratings, financial data, and news specific to the insurance industry.

Multiple channels for obtaining public information from A.M. Best: www.ambest.com, 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 70 countries.

Only rating agency focused on the insurance industry: Methodologies are specific to the insurance environment.

Analysts are industry specialists.

A.M. Best Overview

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A.M. Best Ratings Financial Strength Rating (FSR)

an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance obligations based on a comprehensive quantitative and qualitative evaluation.

Issuer Credit Rating (ICR) an independent opinion of an issuer’s ability to meet its ongoing senior 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 three key areas:

Operating Performance

Balance Sheet Strength

Business Profile

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A.M. Best Rating Scales

FSR = Financial Strength RatingICR = Issuer Credit Rating

FSR ICR

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Ratings Methodology

Rating

Balance Sheet Strength

Operating Performance Business Profile

INSURANCE COMPANY FINANCIAL STRENGTH

Country Risk

Enterprise RiskManagement

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Key Current Industry Observations

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Industry Observations Personal Lines Outlook – Stable

Strong capitalization, consistent auto results, weather volatility effectively addressed.

Commercial Lines Outlook – Negative Widening divide between strong and poor performers, uncertain loss reserve

adequacy, low investment yields, rate increases continue to moderate.

Reinsurance Outlook – Negative Excess capacity, capital convergence, benign cat losses, underwriting discipline

questionable, declining reserve redundancies, low investment yields, increased client retentions.

Market pressures leading to mergers and acquisitions.

Expected longer term time frame for this negative outlook.

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Expanded Topics in the Rating Process

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Expanded Topics Cyber risks

Coverage offered Privacy (HIPAA) violations

Credit monitoring costs

Cloud technologies and exposures

General liability exposures

Coverage obtained Business interruption exposures

D & O risks

Reconstruction costs

Reputation risks

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Expanded Topics A.M. Best Survey results show

Only 3% of companies surveyed have written over 1000 cyber risk polices.

Companies with larger surplus positions have experienced more cyber attacks, but size does not eliminate risk.

72% of companies report responsibility for cyber-security rests with IT Department.

Most significant challenges reported by management is a lack of data and consequence oriented analytics.

A.M. Best added specific questions to the Supplemental Rating Questionnaire and analysts are including cyber coverage in rating meeting discussions. A.M. Best Special Report “Cyber Security Presents Challenging Landscape for

Insurers and Insureds”, December 5, 2014.

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Expanded Topics

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Expanded Topics Cyber questions

Has your company been a target of a data breach/cyber-attack?

Where does responsibility lie in your organization to mange cyber related risks?

What controls do you have in place?

Do you offer coverage as a separate policy or bundled?

What are your premium and loss expectations?

What are your costs for Crisis Services (forensics, notifications)?

What is your legal defense cost?

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Expanded Topics Alternative Investments (Schedule BA Assets)

Seen for many years on Life/Health statements, increased frequency on Property/Casualty.

Hedge funds and private equity investments.

Concern with percent of total assets, surplus, liquidity constraints, lock-up provisions.

Real Estate Investments.

Ownership of subsidiaries.

P/C industry – BA assets are roughly 18% of PHS and 8% of assets, privately placed bonds are roughly 16% of PHS and 10% of assets, highest levels seen in many years.

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Expanded Topics Risk Appetite and Tolerance Statements

Provides additional detail on an organizations view of risk and how they choose which risks are consistent with their philosophies.

Statements can help define comfort levels and boundaries on risk-taking.

Statement should be clear and concise, with specific examples of risk categories.

Capital exposed, earnings targets, credit / reinsurance / liquidity exposures, financial impact of earnings on operational or market risks.

Request for Risk Appetite and Tolerance Statement added to the beginning of the SRQ .

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BCAR – The New Generation

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BCAR – The New Generation Reasons for proposed changes

Metrics better understood and utilized by industry: VaR (Value at Risk) vs. TVaR (Tail Value at Risk). Consistent confidence intervals (95%, 97.5%, etc.). Consistent time horizon for risk factors (ultimate exposure)

Goal is to generate risk factors using stochastic simulations from probability curves. Do not intend to change the main structure of the model. Do not intend to change underlying view of the risks.

Bond default risk, common stock volatility, reinsurance credit risk, pricing, reserves.

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BCAR – The New Generation

Adjusted Surplus (APHS)Reported Surplus (PHS)Equity Adjustments:

Unearned Premiums (DAC)Equalization/Contingency ReservesLoss ReservesAssets

Debt Adjustments:Surplus NotesDebt Service Requirements

Other Adjustments:Future Operating LossesPotential Catastrophe LossFuture DividendsGoodwillOther Intangible AssetsMinority Interests, etc.

Net Required CapitalGross 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(B7) Catastrophe Risk

Covariance Adjustment

Net Required Capital (NRC)*

BCAR Ratio = Adjusted Surplus / Net Required Capital

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*NRC= SQRT [ (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² ] + B7 + B8

BCAR – The New Generation Key Points BCAR remains a measure of risk-adjusted capital at a specific

point in time. General objective remains the same APHS/NRC.

Phase 1 built, being testing internally with 2013 year-end data.

Run parallel BCARs internally with 2014 year-end data. New PC criteria scheduled to be released later this year. Share next generation BCAR score 2014 year-end output

with companies when draft criteria is released. BCAR guidelines – do they need to change?

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BCAR – The New Generation Will be tested in phases

Phase 1 – Economic Scenario Generator, Bond Default and Common Stock Risk Factors updated (data taken from A.M. Best SRQ filings), PC Premium and Reserve Factors Updated, Natural Cat PMLs per occurrence from all perils curve (still stress tested).

Phase 2 – Remaining Asset classes risk factors updated, Life and Annuity Risks, square root formula for covariance.

Phase 3 – Simulate Natural Cat PML Curve, Operational Risks, Simulate Cash flow, Simulate asset values.

Observations to date – Investment risk appears slightly greater for PC, reinsurance charge appear higher, PC underwriting risk factors: slightly lower for personal auto, commercial auto, slightly higher for WC, GL, MPL.

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BCAR – The New Generation

Webinar “A.M. Best Panel Updates Capital Model Developments”, May 14, 2015 Available for viewing at:

http://www.ambest.com/conferences/webinars.asp

Additional Information to be released later this year.

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Questions

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