BCAR 2018 Flashcards

1
Q

What is the purpose of A.M. Best’s financial strength ratings?

A

To provide an opinion on the financial strength of the insurer (and its ability to meet ongoing obligations to policyholders).

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2
Q

What is the BCAR formula?

A

BCAR = (AC - NRC) / AC x 100

where
AC = Available Capital
NRC = Net Capital Required

Note that these are calculated at 4 different VaR levels (95th, 99th, 99.5th and 99.6th percentiles).

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3
Q

How is Available Capital (AC) calculated in the BCAR formula?

A
  • Start with the B/S Reported Capital (surplus)

- then, make appropriate adjustments

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4
Q

Identify the adjustments to B/S capital to obtain the BCAR AC (Available Capital).

A

EDO - > lura, sd, fig

Equity Adjustments:
- loss reserves
- unearned premium
- reinsurance
- assets
Debt Adjustments:
- surplus notes
- Debt servicing costs
Other Adjustments
- future operating costs
- intangibles
- goodwill
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5
Q

Why isn’t the unadjusted reported capital used as the AC (Available Capital) value in the BCAR calculation?

A

Because, incorporating these adjustments provides for a more economic and consistent view of capital available.

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6
Q

Identify the risk categories for BCAR. (8)

A
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
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7
Q

What is the purpose of the covariance adjustment in the NRC formula?

A
  • Reflects the statistical independence of 7 of the 8 risks components (B1-B6, B8).
  • this independence reduces Gross Required Capital (GRC) because it’s unlikely that these 7 components will be near maximum levels simultaneously
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8
Q

Why is B7 (Business Risk) not included in the covariance adjustment?

A

A.M. Best expects an insurer to maintain capital for business risk without the benefit of diversification.

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9
Q

In the BCAR model, what is Gross Required Capital (GRC)?

A

The sum of the required capital for all 8 risk components (B1 - B8).

Represents the total capital required if all risks developed simultaneously.

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10
Q

What is the key idea in calculating the required capital for each risk category?

A

Multiply the liability from each risk category by a specific capital factor (similar to MCT).

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11
Q

Briefly describe how BCAR’s capital factors are derived.

A
  • based on industry risk factors

- then, adjusted for the company volatility in case loss development

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12
Q

Identify considerations other than BCAR score that impact Best’s balance sheet strength assessment. (8)

A

Q^2, SALAMI

  • Quality of Capital
  • Quality of Reinsurance
  • Stress Testing
  • Adequacy of Reserves
  • Liquidity of Capital
  • Actions of Affiliates (could be positive or negative)
  • Matching of Assets and Liabilities
  • Internal Capital Models (does the company have a good procedure for assessing its own capital needs?)
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13
Q

Identify the 6 steps in A.M. Best’s rating process (leading to the final issuer credit rating).

A

BOB-ECL

  • Balance Sheet Strength (based on BCAR score, but affected by Q^2, SALAMI)
  • Operating performance
  • Business profile
  • Enterprise risk management
  • Comprehensive adjustment
  • Lift and/or Drag
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14
Q

Identify characteristics that may tend to lower a company’s BCAR score.

A
  • aggressive investment portfolio (increases NRC for investment risk categories (B1 - B3))
  • loans to poor creditors or reinsurance with low rated reinsurers (increases NRC for credit risk category B4)
  • reserve deficiency (increases NRC for reserve risk category B5)
  • Rapid growth or high UW leverage (increases NRC for premium risk category B6)
  • concentration of properties in an area prone to floods or EQs (increases NRC for catastrophe risk category B8)
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15
Q

Why does A.M. Best calculate NRC and BCAR at more than one level of VaR?

A
  • to gain more insight into the company balance sheet strength
  • to assess its ability to withstand tail events
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16
Q

Why does A.M. Best use a sensitivity analysis to supplement its BCAR calculation?

A

to assess:

  • the capital required to support future business
  • the impact of pro-forma transaction (acquisition of a subsidiary)
  • the projected year-end capital position
17
Q

Identify an aspect of the BCAR model that may make it more robust than MCT.

A

The BCAR model permits qualitative adjustments to the final assessment to account for economic considerations:

  • interest rate changes
  • stage of UW cycle
  • changes in reinsurance arrangements
18
Q

Describe 3 SIMILARITIES between the BCAR model and MCT.

A
  • Purpose: asses a company’s financial strength and its ability to meet policyholder obligations
  • Key Idea: apply capital risk factors to amounts of liability for different risk categories
  • Covariance Adjustment: to account for the statistical independence between risk categories
19
Q

Describe 3 DIFFERENCES between the BCAR model and MCT.

A

Formula:
- BCAR: max is 100%, no minimum
- MCT: min is 0%, no maximum
Robustness:
- BCAR model is more robust because the final assessment includes qualitative economic considerations (such as the stage of the UW cycle)
Time Horizon:
- BCAR: capital must support current AND future premium risk
- MCT: focuses more on current year’s risk