BCAR Flashcards
what is the purpose of A.M.Best’s financial strength ratings
to provide an opinion on the financial strength of an insurer and it’s ability to meet ongoing obligations to policyholders
what’s the BCAR formula
BCAR = (AC - NRC) / AC x 100
how is AC(available capital) calculated in BCAR formula
- start with balance sheet reported capital(surplus)
- make appropriate adjustments
adjustments to balance sheet to obtain BCAR AC
(EDO: lura-sd-fig)
equity adjustments:
- loss reserves
- unearned premiums
- reinsurance
- assets
debt adjustments:
- surplus notes
- debt service requirements
other adjustments:
- future operating costs
- intangibles
- goodwill
why don’t we use unadjsuted reported capital as the value for AC
incorporating these adjustments provides for a more economic and consistent view of capital available
identify the risk cateogries in the BCAR model
(FEICRasPBerryCAT):
asset risk:
- B1: fixed income securities
- B2: equity securities
- B3: interest rate risk
- B4: credit risk
U/W risk:
- B5: reserve risk
- B6: premium risk
- B8: catastrophe risk
other risk:
- B7: business risk
what is the purpose of the covariance adjustment in the NRC formula
- reflects the assumed statistical independence of 7 of the 8 risk components B1-B6 and B8, because it’s unlikely that these 7 components will be near their maximum levels simultaneously
why is B7, business risk, excluded from the covariance adjustment
A.M.Best expects an insurer to maintain capital for business risks without the benefit of diversification
in the BCAR model, what is gross required capital
direct sum of B1-B8
what is the formula to calculate NRC
NRC = B7 + SQRT((B1)^2 + (B2)^2 + (B3)^2 + (0.5(B4))^2 + (0.5(B4) + (B5))^2 + (B6)^2 + (B8)^2)
what is the key idea in calculating the required capital for each risk category
multiply the liability from each risk category by a specific capital factor
how BCAR’s capital factors for reserve risk are derived
deviation of reserve capital factors is:
- based on industry risk factors
- then adjusted for company’s volatility in case loss development
formula for FAR(final adjusted reserve)
FAR = (B/S amt + adjustment) * defeciency factor * discount factor
formula for excess growth factor
the indicated excess growth = actual growth - industry threshold
selected excess growth factor = 1 + max(1-yr indicated, 3-yr indicated)
WHERE
primary insurer: use exposures
reinsurer: use gross written premiums
formula for final B5
B5 = FAR * capital factors * diversification factor * excess growth factor
identify considerations other than BCAR score that impact Best’s balance sheet strength assessment
(Q^2 - SALAMI):
- Q^2: quality of captial, quality of reinsurance
- stress testing
- adequacy of reserves
- liquidity of capital
- action of affiliates
- matching of assets & liabilities
- internal capital models
6 steps in A.M.Best’s rating process leading to the final issuer credit rating
(BOB-ECL):
- balance sheet strength
- operating performance
- business profile
- enterprise risk management
- comprehensive adjustment
- lift and/or drag
identify company characteristics that may tend to lower a company’s BCAR score
think about the risk categories in BCAR formula (AC - NRC)/AC*100
- aggressive investment portfolio (increases NRC investment risk categories B1-B3)
- loans to high-risk entities or reinsurance with low-rated reinsurers (increases NRC for credit risk category B4)
- reserve deficiency (increases NRC for reserve risk category B5)
- excessive growth or high U/W leverage (increases NRC for premium risk category B6)
- concentration of property risks in Florida (increases NRC for catastrophe risk category B8)
why does A.M.Best calculate NRC and BCAR at more than 1 level of VaR
- to gain more insight into the company’s balance sheet strength
- to assess its ability to withstand tail events
why does A.M.Best use a sensitivity analysis to supplement its BCAR calculation
- assess capital required to support future business
- assess impact of a pro-forma transaction (acquisition of a subsidiary)
- assess projected year-end capital position
identify an aspect of the BCAR model that make it more robust than MCT
BCAR model permits qualitative adjustments to final assessment for economic conditions:
- interest rate changes
- stage of U/W cycle
- changes in reinsurance arrangements
describe 3 similarities between BCAR model and MCT
- purpose (assess financial strength and ability to meet policyholder obligations)
- key idea (apply capital factors to liabilities in various risk categories)
- covariance adjustment (to account for the statistical independence between risk categories)
describe 3 differences between BCAR model and MCT
formula is different and:
- BCARmax = 100%, no minimum
- MCTmin = 0%, no maximum
robustness is different:
- A.M.Best more robust because final assessment includes qualitative economic conditions (like stage of U/W cycle)
time horizon is different:
- BCAR capital must support current & future premium risk
- MCT focuses more on current year’s risk
why is cat loss a big threat to financial health
cats are significant, unexpected, rapid
identify drivers for recent increase in frequency/severity of cats
- frequency: climate change
- severity: increase in population density & complexity of supply chains
identify Best’s expectations for insurers accepting cat risks
insurers must demonstrate ability to:
- manage cat risk
- absorb potential losses
what is a standard BCAR score
a measure of an insurer’s financial strength includes a component for catastrophes
what is a stressed BCAR score
- a score that reflects the ability of insurer to continue operating even after a catastrohpe
- based on natural catastrophe stress test
-> the standard BCAR score already has a catastrophe component so that the stressed score measures the impact of a second catastrophe
identify considerations in adjusting an insurer’s rating based on its stressed BCAR score
- financial flexibility: tolerance is higher if the company is willing & able to replace capital after an event
- historical volatility: tolerance is lower if the company has as history of volatile operating performance
- frequency of severe exposures: tolerance is lower if the company has multiple exposures to severe events in a single season
- risk management: tolerance is higher if the company has good/experienced risk management
describe the elements of strong cat risk management
catastrophe modeling:
- parameter selection is critical
- use more than 1 model
data quality:
- accurate property location & coding
- property value & insurance-to-value
- conduct site reviews so that information is up-to-date
- safeguards to prevent manipulation by agent/underwriter
aggregate loss exposure:
- use aggregate losses as a secondary test of model
monitoring MML:
- measure, monitor, limit exposure on a continuous basis
what is the purpose of the A.M.Best natural catastrophe stress test
test financial condition of insurer after 2 major catastrophe events
describe the steps in the natural catastrophe stress test
- surplus: reduce reported surplus by PML (net post-tax 1-in-100 year event)
- reinsurance: increase reinsurance recoverables by at least 40% of ceded PML
- reserves: increase reserves by 40% of net PML
- optional: adjust PMLs used in cat risk portion of standard BCAR score due to changes in reinsurance structure after 1st cat event
how do earthquakes impact BCAR surplus
reduce reported surplus by PML (net post-tax 1-in-100 year event)
