March 17, 2013

Rating Captives:

A.M. Best’s Perspective

Andrew F. ColanninoVice President

June 3, 2014

A.M. Best Company Overview

A.M. Best Ratings

How Captives are Rated Differently

Captive Analysis

Contents

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

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

Ratings are composed of three key areas:

Balance Sheet Strength

Operating Performance

Business Profile

A.M. Best Rating Scales

FSR = Financial Strength RatingICR = Issuer Credit Rating

FSR ICR

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ure

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stm

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A- a-

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Rating Process

Rating Services Agreement

Obtain and review financial data (historical and projected)

Meeting with management

In-depth analysis including A.M. Best Quantitative Analysis Report and calculation of BCAR score

Recommendation developed by analyst

Presentation to rating committee and vote

Outcome conveyed to company

Rating release and publication of company report

A.M. Best Ratings

Ratings Methodology

Rating

Balance Sheet Strength

Operating Performance

Business Profile

INSURANCE COMPANY FINANCIAL STRENGTH

Country Risk

Enterprise RiskManagement

Balance Sheet Strength

• Best’s capital adequacy ratio (BCAR)

• Capital structure/holding company

• Quality/soundness of reinsurance

• Adequacy of loss reserves

• Quality/diversification of assets

• Liquidity

Operating Performance

• Profitability– Historical – Prospective

• Revenue composition/quality of earnings

• Sustainability of earnings

• Ability to meet plan

Business Profile

• Market risk

• Competitive advantages

• Spread of risk

• Event risk

• Regulatory risk

• Management experience and objectives

Why Business Profile & Operating Performance are Important

Leading Indicators of the Future Balance Sheet

Fin

anci

al S

tren

gth

Strong Business Profile and Operating Performance

Weak Business Profile and Operating Performance

Date of last Balance Sheet

Today Time

Country Risk Impact

Poor asset choices

Challenges unique to the country’s operating environment and must be explicitly addressed

“Burdensome” regulation

Inefficient legal system

Poor business infrastructure

Inadequate data

High vulnerability to financial crisis High risk to financial strength without extraordinary preparation

(capital)Inadequate regulation

Opacity in Legal System

Societal Instability & Violence Potential to be completely destabilizing for any company

(Most companies would be in the vulnerable range.)

Government Corruption

Weak economic structure

What is Risk Management?

• Let’s keep it simple…every company does some form of risk management

• AMB defines risk management as the risk and capital management process(es) and practice(s) employed by a company

Risk Management = (Identify + Understand + Measure + Manage) Risk

• No two companies are exactly alike• AMB’s assessment of risk management respects the

unique nature of every company we rate

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 organization

• Insurers that create a more structured, integrated risk framework and apply it prudently can– Increase the value of the firm and – Provide financial security to the organization

Enterprise Risk Management

Business Profile

Operating Performanc

e

Balance Sheet

Strength

Enterprise Risk Management is the common thread that links balance sheet strength, operating performance, and business profile.

Risk Management = (Identify + Understand + Measure + Manage) Risk

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 must fit its profile and provide a stable, sustainable operating platform in good times and bad

Enterprise Risk Management

HIGH RISK

MODERATE RISK

LOW RISK

MINIMAL RISK

Risk ProfileRisk ManagementCapability

A company’s risk management capability needs to meet its risk profile

Superior

Strong

Good

Weak

Bringing it all Together

18

• Balance sheet strength is most important• Sustained, stable operating profitability

ensures future strength• Well-diversified, strong business profile

ensures stability and profitability– Management depth, experience and stability

influences profile• Risk Management links strategy to factors

above

• Dedicated team of 5 financial analysts that only cover captives

• Captives and ART (Alternative Risk Transfer) have a separate rating methodology

• Market profile assessment has the greatest divergence

• Operating performance stresses preservation of capital and reduction of insurance cost to insured’s of profitability and return measures

How Captives Are Rated Differently Than Commercial Insurers

How Captives Are Rated Differently Than Commercial Insurers

• Criteria for obtaining a captive rating are similar for all insurance entities, however the rating process does recognize and incorporate the unique characteristics of captives.

• Based on comprehensive analysis of balance sheet strength, operating performance and business profile

How Captives Are Rated Differently Than Commercial Insurers

• Analysis of non-insurance parent included assessment of– Publicly available credit measures (other CRA’s)– Market based credit measures (CDS)– Independently performed financial analysis

including peer analysis• Analysis can result in lift or drag to the rated

insurance entity

How Captives Are Rated Differently Than Commercial Insurers

• Treatment of Letters of Credit for ART (Alternative Risk Transfer) entities.– Generally must have all of the following

characteristics:• Stand-Alone • Irrevocable • Evergreen • Funded - In favor of the ART entity • Drawn on a highly rated bank.

How Captives Are Rated Differently Than Commercial Insurers

• Customary definition of market profile does not apply to captives.

• Capital– Loan backs– Long term commitment

• ERM in captive should be part of overall parent risk management solution

A.M. Best Single-Parent Captives Industry Diversification

Agricu

lture

Airlin

e

Auto

Mak

ers

Chem

ical

Const

ruct

ion

Ener

gy

Ente

rtain

men

t

Banki

ng

Hospi

tals

Human

Ser

vice

s

Insp

ectio

n & W

aste

Insu

ranc

e

Manuf

actu

ring

Phar

ma

Relig

ious

Retai

l

Tele

com

mun

icatio

n

Trad

ing

0%

5%

10%

15%

20%

25%

30%

4% 4%

6%

4%

8%

27%

2%

6%

4%

6%

4% 4% 4%

2% 2%

6%

4% 4%

Captive Composite Population DefinitionSAP Basis 2012

Number of Companies 203

Net Written Premium $8.3 billion

Net Income $1.6 billion

Admitted Assets $53.0 billion

Loss & LAE Reserves $18.3 billion

Year-end Surplus $24.7 billion

Captive Composite vs. Commercial CompositeLeverage Analysis

2012

Captive Commercial

Fav/(Unfav)

Net Written Premium to Surplus 0.3 to 1 0.8 to 1 0.5 to 1

Net Liabilities to Surplus 1.1 to 1 2.2 to 1 1.1 to 1

Net Leverage 1.4 to 1 3.0 to 1 1.6 to 1

Ceded Leverage 0.4 to 1 0.9 to 1 0.5 to 1

Gross Leverage 1.8 to 1 3.9 to 1 2.1 to 1

Captive Composite vs. Commercial CompositeOperating Performance Analysis

5-year Average Captive Commerci

alFav/

(Unfav)

Loss & LAE Ratio 68.1% 73.0% 4.9%

Underwriting Expense Ratio 20.1% 30.0% 9.9%

Combined Ratio Before PHD 88.2% 103.0% 14.8%

Policyholder Dividends 4.1% 0.3% (3.8%)

Combined Ratio After PHD 92.3% 103.3% 11.0%

Investment Ratio 16.3% 14.8% 1.5%

Operating Ratio 76.0% 88.5% 12.5%

Captive Composite vs. Commercial CompositeOperating Performance Analysis

10-year Average Captive Commerci

alFav/

(Unfav)

Loss & LAE Ratio 73.6% 73.1% (0.5%)

Underwriting Expense Ratio 19.9% 28.7% 8.8%

Combined Ratio Before PHD 93.5% 101.8% 8.3%

Policyholder Dividends 4.2% 0.2% (4.0%)

Combined Ratio After PHD 97.7% 102.0% 4.3%

Investment Ratio 16.2% 14.4% 1.8%

Operating Ratio 81.5% 87.6% 6.1%

Captive Composite vs. Commercial CompositeReturn Measures Analysis

5-year Average

Captive Commercial

Fav/(Unfav)

Investment Yield (Including Realized Capital Gains

3.2% 4.4% (1.2%)

Return on Revenue 20.6% 8.5% 12.1%

Return on Equity 8.4% 6.7% 1.7%

Captive Performance Analysis• Where Does Captive Surplus Growth Come From?• Captive Surplus Grew $7.5 billion over the Last 5-year Period Ended

12/31/2012.

Net Underwriting Income $3.5 billion

Net Investment Income (Including Realized and Unrealized Capital Gains

$7.9 billion

Income Tax ($2.5) billion

Contributed Capital $1.5 billion

Owner Dividends ($4.2) billion

Other Surplus Gain/(Loss) $1.3 billion

Surplus Increase $7.5 billion

Captive Investment Portfolio AnalysisYear End 2012

Long-Term Bonds $29.6 billion

64%

Equities $6.0 billion 13%

Real Estate $0.1 billion Nm

Cash and Short Term $4.1 billion 9%

Other $6.3 billion 14%

Total Non-affiliated Investments $46.1 billion

100%

RRG Composite Population DefinitionSAP Basis 2012

Number 42

Net Written Premium $1.3 billion

Net Income $321 million

Admitted Assets $7.6 billion

Loss & LAE Reserves $2.7 billion

Year-end Surplus $3.4 billion

RRG Composite vs. Commercial CompositeLeverage Analysis

2012

RRG Commercial

Fav/(Unfav)

Net Written Premium to Surplus 0.4 to 1 0.8 to 1 0.4 to 1

Net Liabilities to Surplus 1.2 to 1 2.2 to 1 1.0 to 1

Net Leverage 1.6 to 1 3.0 to 1 1.4 to 1

Ceded Leverage 1.7 to 1 0.9 to 1 (0.8 to 1)

Gross Leverage 3.3 to 1 3.9 to 1 0.6 to 1

RRG Composite vs. Commercial CompositeOperating Performance Analysis

5-year Average

RRG Commercial

Fav/(Unfav)

Loss & LAE Ratio 53.7% 73.0% 19.3%

Underwriting Expense Ratio 27.5% 30.0% 2.5%

Combined Ratio Before PHD 81.2% 103.0% 21.8%

Policyholder Dividends 3.9% 0.3% (3.6%)

Combined Ratio After PHD 85.1% 103.3% 18.2%

Investment Ratio 17.5% 14.8% 2.7%

Operating Ratio 67.6% 88.5% 20.9%

RRG Composite vs. Captive CompositeOperating Performance Analysis

5-year Average RRG Captive Fav/(Unfav)

Loss & LAE Ratio 53.7% 68.1% 14.4%

Underwriting Expense Ratio 27.5% 20.1% (7.4%)

Combined Ratio Before PHD 81.2% 88.2% 7.0%

Policyholder Dividends 3.9% 4.1% 0.2%

Combined Ratio After PHD 85.1% 92.3% 7.2%

Investment Ratio 17.5% 16.3% 1.2%

Operating Ratio 67.6% 76.0% 8.4%

Single-Parent Captive Composite vs. Commercial Composite

Operating Performance Analysis5-year Average

SPC Commercial Fav/(Unfav)

Loss & LAE Ratio 61.2% 73.4% 12.2%

Underwriting Expense Ratio 6.1% 29.3% 23.2%

Combined Ratio Before PHD 67.3% 102.7% 35.4%

Policyholder Dividends 19.3% 0.8% (18.5%)

Combined Ratio After PHD 86.6% 103.5% 16.9%

Investment Ratio 14.8% 15.6% (0.8%)

Operating Ratio 71.8% 87.9% 16.1%

Single-Parent Captive Composite vs.Captive Composite

Operating Performance Analysis5-year Average

SPC Captive Fav/(Unfav)

Loss & LAE Ratio 61.2% 68.1% 6.9%

Underwriting Expense Ratio 6.1% 20.1% 14.0%

Combined Ratio Before PHD 67.3% 88.2% 20.9%

Policyholder Dividends 19.3% 4.1% (15.2%)

Combined Ratio After PHD 86.6% 92.3% 5.7%

Investment Ratio 14.8% 16.3% (1.5%)

Operating Ratio 71.8% 76.0% 4.2%

• Take Aways:• Captive and RRG composite operational leverage is

approximately half of the commercial composite leverage.• Captive composite operating performance substantially

outperforms the commercial composite (12.5 points) on a 5-year basis and significantly outperforms (6.1 points) on a 10-year basis.

• RRG composite operating performance blows away the commercial composite (20.9 points!) on a 5-year basis.

• RRG composite operating performance significantly outperforms the captive composite (8.4 points) on a 5-year basis.

• Take Aways (cont.)• Single-parent captives operating performance substantially

outperforms the commercial composite (16.1 points) on a 5-year basis.

• Single-parent captives operating performance incrementally outperforms the captive composite (4.2 points) on a 5-year basis.

• No matter how you slice it, alternative risk outperforms!

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