BCAR.cdn,CAT&OSFI.EQ Flashcards
Question: 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)
BCAR formula
BCAR = (AC - NRC) / AC x 100
calculated at 4 different VaR levels: 95%, 99%, 99.5%, 99.6% (99.6% cutoff point 10, 25, 100)
6 level assessment: vw, w, a, s, vs, S
how is AC (Available Capital) calculated in the BCAR formula
balance sheet reported capital (surplus) adj for EDO: lura-sd-fig&offp
adjustments to balance sheet capital to obtain BCAR Available Capital
EDO: lura-sd-fig offp
Equity adjustments:
- loss reserves
- unearned premiums
- reinsurance
- assets
Debt adjustments:
- surplus notes
- debt service requirements
Other adjustments:
- future operating costs
- intangibles
- goodwill
OFFP
- off balance sheet loss
- fixed income equity
- future div
- protected cell surplus
why don’t we use unadjusted reported capital as the value for AC (Available Capital)
incorporating these adjustments provides for a more economic and consistent view of capital available
identify the risk categories in the BCAR model (cap required) (8)
FEI-C-PRCat-B
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 risks:
(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)
(reduces GRC 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 captial’
gross required capital = direct SUM of required capital for (B1) through (B8)
(represents total required capital if all risks developed simultaneously)
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 (similar to MCT)
briefly describe how BCAR ‘capital factors’ for reserve risk are derived
- based on industry risk factors
- then adjusted for company’s volatility in case loss development
identify considerations other than BCAR score that impact Best’s balance sheet strength assessment
Q2 - SALAMI
* Q2 → Quality of capital, Quality of reinsurance
–
* Stress testing (how well does the company perform under stress)
* Adequacy of reserves
* Liquidity of capital
* Actions of affiliates (affiliates could drag you down or pull you up)
* Matching of assets & liabilities (this is desirable for paying your bills on time)
* Internal capital models (does the company have a good procedure for assessing its own capital needs)
identify the 6 steps in A.M. Best’s rating process (leading to the final issuer credit rating)
BOB-ECL-R
[1] Balance sheet strength (based mainly on the BCAR scores, but subject also subject to Cured Salami.)
[2] Operating performance
[3] Business profile
[4] Enterprise risk management
[5] Comprehensive adjustment
[6] Lift and/or drag
identify company characteristics that may tend to lower a company’s BCAR score
- aggressive investment portfolio (increases NRC for investment risk categories B1, B2, 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 may 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 the 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
[1] formula is different and:
→ BCARmax = 100%, no minimum
→ MCTmin = 0%, no maximum
[2] robustness is different:
→ A.M. Best more robust because final assessment includes qualitative economic conditions
(like stage of U/W cycle)
[3] time horizon is different:
→ BCAR capital must support current & future premium risk
→ MCT focuses more on current year’s risk
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 (2)
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)
an insurer is then assigned 1 of 6 ratings based on it’s standard score (strongest, very strong, strong, adequate, weak, very weak)
what is a stressed BCAR score
- a score that reflects the ability of an insurer to continue operating even after a catastrophe
- based on natural catastrophe stress test
→ the standard BCAR score already has a catastrophe component so the stressed score measures the impact of a second catastrophe
Describe the purpose of A.M. Best’s natural catastrophe stress testing.
- A.M. Best stress a company’s BCAR score for a second Catastrophic event
- The purpose is test how sensitive a company’s balance sheet strength is to a second catastrophic event
- Determine the impact on surplus of multiple catastrophic events
identify considerations in adjusting an insurer’s rating based on it’s stressed BCAR score
fin-his-fre-man
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 (4)
MADM
1)catastrophe modeling: parameter selection is critical & use more than 1 model
2)data quality:
accurate property location & coding (type of buildling)
accurate property value & insurance-to-value
conduct site reviews (so that information is up-to-date)
safeguards to prevent manipulation by insured
3)aggregate loss exposure: use aggregate losses as a secondary test of model
4)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
[1] surplus
- reduce reported surplus by PML (net post-tax 1-in-100 year event)
[2] reinsurance
- increase reinsurance recoverables by at least 40% of ceded PML
[3] reserves
- increase reserves by 40% of net PML
[4] 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)
what is a broad 3-point plan for managing earthquake exposure
Measure / Monitor / Limit earthquake exposure
define PML (Probable Maximum Loss)
$-value of loss a major earthquake is unlikely to exceed ($-loss expected only once-per-X years)
describe the 5 key principles for managing earthquake exposure.
- Risk Management
- Data Management (ACC I LV)
- Models (AML)
- PML (Probable Maximum Loss) (dumb)
- Financial Resources & Contingency Plan
describe the key principle of Risk Management for earthquake exposure
[1] earthquake exposure risk management policies are overseen by Senior Management
[2] Have sound Eq risk management program, subject to oversight by the board
describe the key principle of Data Management for earthquake exposure
- data required is MORE than for traditional ratemaking
- must address data INTEGRITY, VERIFICATION, LIMITATIONS
- ACC I LV: data Accuracy, Consistency, Completeness, Integrity, Limitation, Verification
describe the key principle of Modeling for earthquake exposure
understand (assumptions, methods, limitations) of earthquake models (AML)
describe the key principle of PML (Probable Maximum Loss) for earthquake exposure
PML = Total Expected Ultimate Cost
- includes considerations for data quality, non-modeled exposure, model uncertainty, multi-region exposure. (dumb)
describe the key principle of Financial Resources & Contingency Plan for earthquake exposure
Financial Resources: quantification of how financial resources cover PML
Contingency Plan: how to continue efficient business operations after disaster
items that should be documented for earthquake risk management
- risk appetite and risk tolerance of insurer
- data management framework
- model assumptions, methods, limitations
- calculation of PMLs
- nature & adequacy of financial resources
- contingency plans supporting the risk
- how concentration of exposures is measured & monitored
what are the best practices for earthquake modelling
DAQKD-UP
[1] Docs:
→ document use of model within risk management program (Ex: for measuring & monitoring of exposure)
[2] Alternatives:
→ explain why a particular model is used versus alternatives
[3] Qualified:
→ need qualified staff to run in-house models regularly
[4] Knowledge:
→ must have knowledge of assumptions, methods, limitations of earthquake model
[5] Data:
→ should provide evidence to show that granularity & quality of data is appropriate
[6] Uncertainty:
→ must understand the impact of uncertainty on capital adequacy & reinsurance requirements
[7] PMLs:
→ if PML(model 1) ≠ PML(model 2) then must explain differences & any subsequent model adjustments
identify uses of earthquake models aside from PML calculation (2)
- make U/W decisions
- monitor exposure-accumulations
what are sound practices for earthquake model VERSION
- use more than 1 model
- ensure timely updates of material changes to model (within 1 year of change)
- understand assumptions, methods, limitations of vendor software for PML calculation
- if in-house PML model is used, should compare result to alternate models
what are sound practices for earthquake model VALIDATION
- compare modelled losses with actual losses
- compare tail losses with market price for reinsurance
- use global data to supplement limited Canadian earthquake data
how might management adjust for low data quality in earthquake PML estimate
may add a margin of safety to the PML estimate (not an excuse to ignore data quality)
identify non-modeled exposures when calculating PML (4)
- exposure growth between (date of data) & (relevant exposure period)
- consider adequacy of ITV (Insurance-to-Value)
- consider GRC (Guaranteed Replacement Cost)
(may be inadequate due to inflation) - increased seismicity after large event
identify 2 examples of model uncertainty (2)
- uncertainty associated with conversion from (location-specific ground motion) to (actual damage levels)
- model assumptions are being continuously updated & refined
how might management adjust for model uncertainty in earthquake PML estimate
may add a margin of safety to the PML estimate
Regarding multi-region exposures, identify disadvantages of using the maximum of (BC, QC) exposures (2)
- understates risk for insurers with exposure in both regions
- ignores earthquake elsewhere, which could be material
how should PMLs be reported for Canadian versus foreign insurers with exposure outside Canada
BoD, senior management would report PMLs to OSFI as follows:
- Canadian insurers report PMLs based on worldwide exposure
- foreign insurers report PMLs based on Canada-wide exposure
identify financial resources for covering PML for earthquake exposure
- capital & surplus (max 10% of capital & surplus)
- reinsurance (most insurers use cat reinsurance)
- earthquake reserves (calculated as part of MCT)
- capital market financing (OSFI prior approval)
identify a restrictive condition on earthquake exposure financial resources for: reinsurance coverage
when including non-cat reinsurance must consider ‘per event’ limits and other events that may exhaust coverage
identify a restrictive condition on earthquake exposure financial resources for: capital market financing
OSFI prior approval is required before recognition as a financial resource (under MCT guidelines)
identify a restrictive condition on earthquake exposure financial resources for: capital & surplus
limited to a maximum of 10% of capital & surplus
identify a restrictive condition on earthquake exposure financial resources for: EPR
must not exceed countrywide PML500
what are OSFI’s earthquake exposure reporting requirements
- file Earthquake Exposure Data form annually
- if no material exposure then submit letter stating so
what are OSFI’s earthquake exposure supervisory requirements
if an insurer has material earthquake exposure:
* insurer must submit earthquake risk management policies
* must submit FCT report that includes earthquake exposure scenario (or provide reason for not including)
what are OSFI’s supervisory options when an insurer’s earthquake exposure risk management principles are not being followed
OSFI may adjust capital or asset requirements or TSR (Target Solvency Ratio)
what are the duties of senior management regarding earthquake exposure risk management (3)
- implement risk management plan & internal controls
- discretion to increase PML from model (due to low data quality OR model uncertainty)
- a senior manager reports to all senior management about compliance and the PML
what is included in a senior officer’s regular reports to senior management regarding earthquake exposure (2)
- state compliance with risk management policies (except where noted)
- explain calculation of PML with details of supporting financial resources
what are the duties of the Board of Directors regarding earthquake exposure risk management (2)
oversight of risk management plan & ensuring adequacy of internal controls
