spring 2002 cas meeting modeling capital adequacy
DESCRIPTION
Spring 2002 CAS Meeting Modeling Capital Adequacy. Matthew C. Mosher, FCAS Group Vice President Property/Casualty Ratings May 21, 2002. Discussion Outline. Importance of Capital Adequacy Best’s Evaluation of Capital Future Changes. A.M. Best Mission Statement. - PowerPoint PPT PresentationTRANSCRIPT
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Spring 2002CAS Meeting
Modeling Capital Adequacy
Matthew C. Mosher, FCAS Group Vice PresidentProperty/Casualty RatingsMay 21, 2002
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Discussion Outline
Importance of Capital Adequacy
Best’s Evaluation of Capital
Future Changes
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A.M. Best Mission Statement
To perform a constructive and objective
role in the insurance industry toward the prevention and
detection of insurer insolvency
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Best’s Rating Evaluation— Rating Components
Balance SheetStrength
Operating Performance
Business Profile
Best’s FSR Rating
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Balance Sheet StrengthBalance Sheet Strength
Operating PerformanceOperating Performance
Business Business ProfileProfile
ManagementManagement
Rating ConsiderationsSuccess Factors
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Balance Sheet Strength: Rating Evaluation
Leverage Capital structure / holding company Quality & appropriateness of
reinsurance program Adequacy of loss reserves Quality and diversification of assets Liquidity Risk-adjusted capital (BCAR)
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Operating Performance: Rating Evaluation
Profitability Revenue composition Management experience & objectives
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Business Profile: Rating Evaluation
Market risk Competitive market position Spread of risk Event risk Regulatory risk
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Best’s Rating Perspective
Capital Strength is Most Important Sustained, Stable Operating
Profitability Ensures Future Strength Well-Diversified, Strong Business
Profile Ensures Stability
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Why Market Profile and Operating Performance?
Leading Indicators of the Future Balance Sheet
Fina
ncia
l Str
engt
h Strong Market Profile and Operating Performance
Weak Market Profile and Operating Performance
Date of last
balance Sheet
Today Time
~4~
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Best Rating EvaluationUpdate
In the Overall Rating Assignment Consideration of Claims Tail Consideration of Excess Capital Minimum Capital Requirements
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BCAR Considerations: Many Issues
Leverage Capital structure / holding company Quality & appropriateness of reinsurance
program Adequacy of loss reserves Quality and diversification of assets Liquidity Profitability Growth Rate
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Fundamentals of A.M. Best’s Capital Adequacy Model
Interactive Dynamic Consolidated Approach Capital Factors Calibrated to a 1% EPD Reserve and Premium Adequacy Considered One of three parts of an integrated rating approach
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Economic SurplusReported Surplus (PHS)Equity Adjustments:
Unearned PremiumsLoss ReservesAssets
Debt Adjustments:Surplus NotesDebt Service Requirements
Stress Test Adjustments:Future Operating LossesPotential Catastrophe Exp. Other
Economic Surplus (APHS)
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
Covariance Adjustment
Net Required Capital (NRC)*
BCAR Ratio = Economic Surplus / Net Required Capital
*NRC= (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² +B7
BCAR Model — Structural
Overview
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Calculation of BCAR Score
Company BCAR Score = APHS / NRC
APHS = Adjusted Policyholder Surplus NRC = Net Required Capital
BCAR > 100 ==> Secure Capitalization
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B1 & B2 Investment Risk
Fixed Charges applied to Assets 100% Charge to Non-PC Affiliates Asset Concentration Charge
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B3 “Interest Rate Risk”
Stress Tests Exposure To a Rise in a 120BP Interest Rates
Liquidity Risk During the Year Annually Mark Bonds to Market in APHS Impact of Short-Term Cash Need Considers All Assets Being Reviewed
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B4 Credit Risk
Other than Invested Assets Reinsurance Charge
Charge Based on Quality Additional Dependence Charge
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B5 Reserve Risk
Statutory Discount Treated as Deficiency Reserves Adjusted for Adequacy & Disc. Reserve Equity Included in Adj. Surplus Risk Factors
Industry By Line Company Stability Size
Growth Charge Diversification Credit
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B6 Premium Risk
Based On Net Written Premium Risk Factors
Industry By Line Company Profitability Size
Growth Charge Diversification Credit
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Frequently Made Adjustments
Reserve Adequacy (Core & A&E) Reinsurance Charges Catastrophe Exposure Affiliated Charges Stop Loss Reinsurance Loss Sensitive Business Projected Capitalization
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Why Market Profile and Operating Performance?
Leading Indicators of the Future Balance Sheet
Fina
ncia
l Str
engt
h Strong Market Profile and Operating Performance
Weak Market Profile and Operating Performance
Date of last
balance Sheet
Today Time
~4~
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Economic SurplusReported Surplus (PHS)Equity Adjustments:
Unearned PremiumsLoss ReservesAssets
Debt Adjustments:Surplus NotesDebt Service Requirements
Stress Test Adjustments:Future Operating LossesPotential Catastrophe Exp. Other
Economic Surplus (APHS)
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
Covariance Adjustment
Net Required Capital (NRC)*
BCAR Ratio = Economic Surplus / Net Required Capital
*NRC= (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² +B7
BCAR Model — Structural
Overview
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Calculation of BCAR Score
Company BCAR Score = APHS / NRC
APHS = Adjusted Policyholder Surplus NRC = Net Required Capital
BCAR > 100 ==> Secure Capitalization
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Minimum Capital Requirements
Rating Level BCAR ScoreA++ 175
A+ 160
A 145
A- 130
B++ 115
B+ 100
B/B- 80
C++/C+ 60
Exceptions Based on Overall Analysis
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Value at Risk
Currently a Separate Model in Testing
Potential Enhancements Consistency of Risk Factors Updated Investment Risk Charges Improved Interest Rate Risk Covariance Treatment Diversification Calibration
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Best Capital Adequacy Issues
BCAR Remains Best’s Standard for Measuring Capitalization Domestically
No Major Changes to BCAR in 2002 Likely to be Changes for 2003
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Spring 2002CAS Meeting
Modeling Capital Adequacy