AM Best Understanding BCAR Flashcards
List factors from which AM Best interactive rating is derived
- An in-depth evaluation of a company’s BS strength
- Operating performance and business profile as compared with
- AM Best quantitative and qualitative standards
List sources from which UW leverage is generated
- Current premium writings
- Re recoverables
- Loss reserves
List factors to assess if company UW leverage is prudent
- Type of business written
- Quality and appropriateness of its Re program
- Adequacy of loss reserves
List stress tests within BCAR
- Above-normal CAT
- Decline in equity markets
- Rise in interest rates
Best will also stress a company’s BCAR for a second CAT event (natural CAT and/or man-made events such as terrorism)
List Broad risk categories for which the Net required capital in BCAR is calculated to support
- Investment risk
- Credit risk
- UW risk
List main risk components of investment risk
- Fixed-income securities
- Equities
- Interest rate
List components on which capital charges for different asset classes for investment risk are based
For equity and fixed-income securities
• Risk of default
• Illiquidity
• Market-value declines
List components that can modify the required capital for credit risk
- Any collateral offsets for Re balances
- Quality of the Re that participate in the company’s Re program
- Company’s dependence on its Re program
List assets having additional higher capital charges and 2 reasons why
- Affiliated investment holdings
- Real estate
- Below-investment-grade bonds and nonaffiliated
- Privately traded common and preferred shares
Because
• Illiquid nature of the asset
• Volatility of the reported value
List components of the reserve equity in UW risk
Based on the risk inherent in the compagny’s loss, reserve equity is a function of:
• Estimated reserve deficiency
• Payout pattern of the reserves
• Discount rate (currently 4% in BCAR)
List adjustments made by AM Best to reported surplus and why they are made
- Provide a more economic and comparable basis for evaluating capital adequacy
- Respond to various market issues (rate changes, stage of the UW cycle, change in Re products)
- Reflect the pricing risk inherent in UEPR reserves and non-BS risks, including CAT exposures and debt-service requirements
List components largely impacting capital required to support net UW commitment
- Mix of business
- Size of surplus
- Stability of loss development
- Profitability
- Loss-reserve adequacy
- Length of claims payout
List items that would lower the BCAR value, all else being equal
- Higher UW leverage
- Greater indicated reserve deficiencies
- Unstable or unprofitable business
List additional context within what capital adequacy should be considered
Capital adequacy should be considered within the context of the operating and strategic issues surrounding a company. Important rating considerations in evaluating a company’s long-term financial strength and viability:
• Business profile
• Operating performance
• Quality of the capital that supports the BCAR results
Briefly explain the objective of A.M. Best Co.’s financial strength ratings
To provide an opinion of an insurer’s financial strength and ability to meet ongoing obligations to PHs
Briefly explain BS strength
- Most important area to evaluate, since it is the foundation for PHs security
- Measures the exposure of a company’s surplus to its operating and financial practices
- Performance determines how it will be enhanced, maintained or eroded over time
Briefly explain Financial Leverage (in the BCAR)
Financial leverage is created through debt or debt-like instruments and is reviewed in conjunction with a company’s UE leverage
Briefly explain Asset Leverage (in the BCAR)
Measures the exposure of a company’s surplus to investment, interest rate and credit risks. Potential impact on the company’s BS strength is determined by:
• Volatility of the investment portfolio
• Credit quality of the investment portfolio
• Recoverables and agent’s balances
What does BCAR calculates?
Net required capital to support the financial risks of the company associated with the exposure of assets and UW to adverse economic and market conditions, and compares it with economic capital
Briefly contrast BCAR vs MCT
A significant proportion of capital is required to support future premium risk, reflecting AM Best’s view that BS strength must support the risks associated with a company’s current book of business as well as those it plans to insure in the upcoming year
Briefly explain how BCAR deals with foreign investment risk
Risk charge for that asset category may be increased to reflect the increase in volatility and/or decrease in liquidity associated with those foreign markets, financial systems and economie
Discuss Credit Risk Component in the BCAR
Capital charges to reflect 3rd party default risk
- Credit risk factors depending on the type of Re
- Charges for premium receivables from agents/brokers, PHs and installment premium balances
- Funds held by residual market entities (FA and PRR)
On what does the net premium writing component requires capital?
Based on the pricing risk inherent in a company’s MOB
On what does the required capital required for reserve and premium may be increased?
To reflect an additional surcharge for “excessive” growth in exposure
Which reason could provide a credit to UW risk component?
For a well-diversified book of business, but this credit is limited for those cies that maintain small books of many LOB and might not necessarily have expertise in all of these lines
Explain how long duration contracts affects risk and how to capture the difference
They create larger UEPR reserves that leads to a larger pricing risk than anticipated for regular contracts. In order to capture this increased risk, the long duration UEPR will be included on the loss reserve page instead of the pricing risk page in an effort to reflect diversification from business being written in the future versus business written in the past
What is the BCAR formula?
BCAR = Adjusted Surplus / Net Required Capital
