Title: Treatment of Investments in the A.M. Best Rating Process
1Treatment of Investments in the A.M. Best Rating
Process
NYIA Educational Seminar
Jennifer Marshall Senior Financial
Analyst Property/Casualty Division February 12,
2009
2Discussion Topics
- Rating Process Overview
- Capital Model Overview
- Treatment of Investments in the Capital Model
- 2008 Review / 2009 Preview
3Rating Process Overview
4Objective of A.M. Bests Financial Strength
Ratings
- To perform a constructive and objective role in
the insurance industry toward the prevention and
detection of insurer insolvency
5A.M. Bests Rating EvaluationKey Components
Balance Sheet Strength
Operating Performance
BusinessProfile
Bests Rating
6A.M. Bests Rating Evaluation Rating
Considerations
7A.M. Bests Rating Evaluation Balance Sheet
Strength
- Leverage
- Capital structure / holding company
- Quality appropriateness of reinsurance
- Adequacy of loss reserves
- Quality and diversification of assets
- Liquidity
- Growth
- Risk Adjusted Capitalization (BCAR)
8A.M. Bests Rating Evaluation Operating
Performance
- Level of Profitability
- Historical
- Prospective
- Stability/Volatility of Earnings
- Revenue Composition/Quality of Earnings
- Ability to Meet Plan
9A.M. Bests Rating Evaluation Business Profile
- Market risk
- Spread of risk
- Event risk
- Competitive advantages
- Management
10Capital Model Overview
11Best Capital Adequacy Ratio - BCAR
- Comprehensive Tool to Evaluate Risk Components
Simultaneously - Generates Overall Estimate of Required Level of
Capital to Support Risks
12BCAR Model Overview
- Economic (Adjusted) Surplus
- Reported Surplus (PHS)
- Equity Adjustments
- Unearned Premiums
- Loss Reserves
- Assets
- Debt Adjustments
- Surplus Notes
- Debt Service Requirements
- Stress Adjustments
- Future Operating Losses
- Potential Catastrophe Exp.
- Other
- Net Required Capital
- Gross Required Capital
- (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
- Covariance Adjustment
Economic (Adjusted) Surplus
BCAR
Net Required Capital
13Capital Model TreatmentNet Required Capital
14Net Required Capital
- Investment Risk
- Bonds
- Equities
- Interest Rate Risk
- Other Issues
- Single Large Asset
- Spread of Risk
- Common Stock Leverage
15Investment Risk (B1) Bonds
- Grouped by NAIC SVO Class
- US Treasury Bonds separate from other Class 1
bonds - Risk Factor varies from 0 to 30 for
unaffiliated bonds, based on SVO class
16Bond Risk Charges
Security Type/Class
Risk Charge
US Treasury (Cl. 1) 0.0
Class 1 1.0
Class 2 2.0
Class 3 4.0
Class 4 4.5
Class 5 10
Class 6 30
17Investment Risk (B1) Other
- Cash Risk Charge 0.3
- Mortgage and Contract Loans Risk Charge 5
- Short-term investment Risk Charge 1
18Investment Risk (B2) Equities
- Publicly-traded equities have a 15 risk charge
- Private equity generally carries a 100 risk
charge due to limited liquidity - Preferred and common equities generally treated
the same
19Investment Risk (B2) Other
- Real Estate Risk Charges
- Company Occupied 10
- Investment 20
- Other Investments 20
- Title Plants 10
- EDP Other Tangibles 20
- Foreign Exchange Rate Asset 20
- Aggregate Write-Ins 20
20Additional Asset Considerations
- Single Large Asset
- Spread of Risk Adjustment
- High Common Stock Investment Leverage
21Interest Rate Risk (B3)
- Identifies potential stress for companies that
maintain a high exposure to short-term cash needs - Often greatest for companies with a high gross
catastrophe PML - Estimates impact of a 120 point increase in
interest rates on market value of bonds - Multiplies by ratio of gross PML to liquid
assets, with a minimum charge of 10 of the
decrease in market value
22Capital Model TreatmentAdjusted Policyholder
Surplus
23Fixed Income Equity Adjustment
- Reflects Difference between Market and Book Value
of Bonds - Based on General Interrogatory 28 reported
only in year-end statement - If difference is
- Positive, capped at 10 of surplus
- Negative, capped at 15 of surplus
- This adjustment has been positive (e.g., it has
increased surplus) for the industry overall and
for most companies individually
24Fall, 2008 Investment Survey
- Credit market issues had significant negative
impact on market price of bonds - Reviewed fixed income adjustment with caps in
place and without the caps (stress scenario) - Recalculated BCAR with revised FI equity
adjustment and under stress scenario
25Fall, 2008 Investment Survey
- Reviewed the recalculated BCAR in the context of
each companys - Overall liquidity and cash flows
- Operating fundamentals
- Business profile, including exposure to shock
losses - Contacted companies with potential rating concern
26Review of 2008/Preview of 2009
272008 In the Rear-View Mirror
- Capital Adequacy Remains Adequate
- Soft Market Conditions
- Underwriting Losses
- Investment Market Turmoil
- Financial Flexibility in Hibernation
282009 Market Expectations
- Modest stabilization in pricing
- Underwriting results rebound, but remain negative
- Continued uncertainty in financial markets
- Limited growth in investment earnings
29Questions?
30For More Information
- http//www.ambest.com/ratings/methodology.asp
- Financial Strength Methodology for P/C Insurers
- Understanding BCAR for P/C Insurers
- Contact your companys rating analyst
- Contact me jennifer.marshall_at_ambest.com