criteria review seminar 2015 stochastic-based bcar (best’s capital adequacy ratio)

Criteria Review Seminar

etc.venues St.Paul’s, London

04 November 2015

Disclaimer

Criteria Review Seminar 4 November 2015 4

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Disclaimer

Criteria Review Seminar 4 November 2015 5

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Any queries of a commercial nature should be directed to A.M. Best’s Market Development function.



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Stochastic-based BCAR(Best’s Capital Adequacy Ratio)

Mathilde Jakobsen

Associate Director, Analytics, A.M. Best


Agenda

• The role of BCAR in the rating process

• Current BCAR approach

• Proposed BCAR approach

• Overview of planned changes (US P&C BCAR)

• Application of new BCAR in the rating process

• Updated timeline

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The Role of BCAR in the Rating

Process

4 November 2015

• Best’s Capital Adequacy Ratio (BCAR) provides an overall view of risk-based capitalisation

• Separate BCAR models for different areas – including the US P&C, US Life and the Universal BCAR model

• BCAR is used as a global benchmarking tool

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The Role of BCAR in the Rating

Process

4 November 2015

Balance Sheet Strength

Operating Performance

Business Prof i le

Country Risk

Enterprise RiskManagement

Rating

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Current BCAR Approach

• Output is single BCAR score, determined as:

• ‘What-if’ BCAR scores also produced, e.g. CAT stressed BCAR

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BCAR SCORE =TOTAL ADJUSTED CAPITAL

NET REQUIRED CAPITAL

NET REQUIRED CAPITAL*

+ (B1) Fixed-Income Securities

+ (B2) Equity Securities

+ (B3) Interest Rate

+ (B4) Credit

+ (B5) Loss Reserves

+ (B6) Net Written Premium

+ (B7) Off Balance Sheet Risks

- COVARIANCE


Current BCAR Approach

4 November 2015

TOTAL ADJUSTED CAPITAL

+ Shareholders’ funds

+ Adjustments made to ensure a more economic and comparable basis for capital adequacy

+ Deduction of one net tax adjusted probable maximum loss

BCAR SCORE = TOTAL ADJUSTED CAPITAL / NET REQUIRED CAPITAL

*Net required capital = SQRT [(B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² ] + B7

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New BCAR - Caveat

4 November 2015

• US P&C is the first model developed

• The application of changes to the Universal BCAR model is a work in progress

• A.M. Best’s view of risk will be the same in all models

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2015 Insurance Market Briefing - Europe

New BCAR Approach

• Look and feel of the model will be similar – structure maintained where possible

• The risk factors will be generated using stochastic simulations from probability curves – with company specific adjustments

• BCAR scores will be shown at five confidence levels

• Underlying calculations are different

• Ratio calculation has changed

• Application does change



New BCAR Approach

• Utilising VaR risk metrics

– Ensures a consistent risk metric across different model components

– Reasonable tail issues still covered

• Consistent confidence intervals across risks

– 98% 99% 99.5% 99.8% 99.9%

• BCAR scores will be shown at these confidence levels



New BCAR Approach

4 November 2015

• Time horizon for risk factors

• Ratings reviewed at least annually

Ultimate 10 Years 1 Year

Reserve risk Bond defaults Common stocks

Premium risk Reinsurer impairments

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NET REQUIRED CAPITAL*

+ (B1) Fixed-Income Securities

+ (B2) Equity Securities

+ (B3) Interest Rate

+ (B4) Credit

+ (B5) Loss Reserves

+ (B6) Net Written Premium

+ (B7) Off Balance Sheet Risks

+ (B8) Catastrophe Exposure

- COVARIANCE


New BCAR Approach

4 November 2015

AVAILABLE CAPITAL

+ Shareholders’ funds

+ Adjustments made to ensure a more economic and comparable basis for capital adequacy

BCAR SCORE = (AVAILABLE CAPITAL – NET REQUIRED CAPITAL)

/ AVAILABLE CAPITAL

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

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New BCAR Approach

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• Current BCAR Calculation(ratio to NRC)

Potential Scores:Low of 0.0 to Max of 999.9Want BCAR > 100.0

• Planned BCAR Calculation (ratio to Available Capital)

Potential Scores:Low of -999.9 to Max of 100.0Want BCAR > 0.0


Overview of Planned Changes (US P&C)

Bonds & Equities

Use Economic Scenario Generator

Update bond default risk factors – Reflect duration of company’s bond portfolio (SRQ)– Reflect asset quality of company’s bond portfolio (SRQ)

– Reflect volatility in bond default assumptions (stochastic portion – tied to ESG)

– Only defaults occurring in first 10 years are considered– Offset default with recovery on defaults (varies by rating)

– Net defaulted amounts are present valued

Update common stock risk factors– Reflect type of stocks held by company (SRQ – Beta)

– Reflect volatility (stochastic portion – tied to ESG)




Interest Rate Risk

Use Economic Scenario Generator

Update risk charges for interest rate risk – Simulated 10,000 potential one-year changes in interest rates

– Measured at various VaR levels

– Range from 210 to 310 basis points

– Reflect duration of company’s fixed income portfolio (SRQ)

– Reflect liquidity need using greater of gross PML or 10% of assets




Reinsurance

Update reinsurance credit risk factors– Reflect type of recoverable (paid, unpaid, upr)– Reflect rating of each reinsurer (Schedule F/S and ratings data)

– Reflects concentration risk (how many reinsurers)– Reflect duration of recoverables (can go out 30 years)– Reflects partial recovery when reinsurer impaired

– Simulates 10,000 impairment scenarios for each reinsurer• Only uses impairments occurring in first 10 years

• Uncollected amounts are present valued


Criteria Review SeminarCriteria Review Seminar

Update P&C underwriting factors

– Create industry UW loss and adverse development probability curves• 21 Schedule P lines and 4 size categories (VS,S,M,L)• 84 Industry probability curves (each) for premiums and loss reserves

– Use company NPW and loss reserve size (by line) to select industry probability curve

• Use company profitability (by line) to adjust NPW curve• Use company volatility (by line) to adjust loss reserve curve

– Simulate 10,000 UW profit/loss scenarios and reserve development scenarios for each line

– Reflect diversification across lines based on total NPW and loss reserves• Use one of 4 industry correlation matrices• Based on size (VS,S,M,L)


P&C Premium & Reserves

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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

– Will stress higher VaR levels if concerned with tail risk

– Reinstatement premium and tax adjustments remain

– Terrorism and other stress tests remain


Natural Catastrophe




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 all perils combined• Reinstatement premium and tax adjustments remain

2 - Increase recoverables by 40% of ceded loss• From 1-in-100 year PML from per occurrence all perils combined• 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 all perils combined

4 - See how far BCAR scores drop at all confidence levels

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Application of BCAR in the Rating ProcessWhat are the new BCAR scores telling us?

You always need to look to the right


VaR Target 98% 99% 99.5% 99.8% 99.9%

BCAR (A) 40 25 10 (15) (20)

BCAR (B) 20 15 10 5 (5)

BCAR (C) 50 35 20 (35) (70)


Application of BCAR in the

Rating Process• Changes in BCAR approach affects the broader credit methodology,

Best’s Credit Rating Methodology (BCRM)

– New BCAR score calculation

– View of capital adequacy at different VaR confidence levels rather than a single score

• BCRM update will provide clarity on how the new BCAR output (with scores displayed at five VaR confidence levels) will be considered in the rating evaluation


Updated Timeline

• Q1 2016 – likely release for public comment of US P&C BCAR draft Criteria and draft BCRM update

– Company BCAR output will be shared with rated entities

• Later 2016 – likely release for public comment of US Life/Health and Universal draft BCAR criteria and models

– Company BCAR output will be shared with rated entities

• Comment period will include updates

• Comment period will be extended to cover the release of all BCAR models to ensure consistent application of the new BCAR approach across all ratings

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4 November 2015Criteria Review Seminar

Updated Timeline – Next Steps

• What must happen before US P&C BCAR criteria procedure is released for public comment?

– Complete the update of BCRM

– Complete the initial review of the Life and Non-US BCARs

– Complete all internal training on the US P&C model and the application of BCAR

– A.M. Best will need to be comfortable that the change in application and the implications of the new BCAR on all industries is understood (Life/Health and Non-Life; US andNon-US)


Further Information

A.M. Best webinars on the new BCAR (from April, May and October 2015) provide further information and can be found here:

www.ambest.com/conferences/webinars.asp

Criteria Review Seminar 584 November 2015

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


Q & A

4 November 2015 59

Stochastic-based BCAR(Best’s Capital Adequacy Ratio)

Mathilde Jakobsen

Associate Director, Analytics, A.M. Best

criteria review seminar 2015 stochastic-based bcar (best’s capital adequacy ratio)

Economy & Finance