C - AM Best Understanding BCAR Flashcards
AM BEST UNDERSTANDING BCAR
What does BCAR calculates?
BCAR = SURPLUS / NET CAPITAL REQUIRED (for investment, credit, and uw risks) compared to economic capital
It is one component to evaluate BALANCE SHEET STRENGTH, which, along with OPERATING PERFORMANCE and BUSINESS PROFILE, is used to calculate Best’s FSR (financial strength rating)
AM BEST UNDERSTANDING BCAR
Purpose of Best’s FINANCIAL STRENGTH RATING (FSR)
3 components of the Best’s FSR
–purpose–
to give an opinion on :
1) financial strength
2) ability to meet obligations to policyholders
1) Balance Sheet Strength
2) Operating Performance
3) Business profile
AM BEST UNDERSTANDING BCAR
Define
balance sheet strength
3 kinds of LEVERAGE to assess balance sheet strength
measure the exposure of surplus to its operating and financial practices
--UW Leverage-- from types of business written quality of reinsurance adequacy of loss reserves
–Financial Leverage–
from debt instruments
--Asset Leverage-- from investments interest rate risk credit risk
AM BEST UNDERSTANDING BCAR
3 stress tests within BCAR
1) above-normal catastrophes
2) a decline in stock markets
3) a rise in interest rates
AM BEST UNDERSTANDING BCAR
3 risks categories used in the calculation of AM Best’s net required capital
1) UW RISK- 2/3 of required capital
from premium written, loss reserves and reinsurance
2) INVESTMENT RISKS
from
fixed-income securities, equities, interest rates
3) CREDIT RISK
3rd party default risk
AM BEST UNDERSTANDING BCAR
How statistical independence of the individual components of BCAR are reflected in the formula
Individual components are subject to the “square root rule” covariance calculation to account for statistical independence
this covariance adjustment says it is unlikely all the individual risk components will develop at the same time, so it reduces overall required capital between 35% to 45%.
AM BEST UNDERSTANDING BCAR
Contrast BCAR vs MCT
in BCAR, a important proportion of capital is required to support FUTURE PREMIUM RISK, reflecting AM BEST view that balance sheet strength must support the current and future risks.
AM BEST UNDERSTANDING BCAR
2 categories encompassed by UW risk and
how much capital is required for UW risk
1) loss and loss adjustment expense reserves
2) net premium written
UW risk account for 2/3 of gross required capital
AM BEST UNDERSTANDING BCAR
how long term duration contracts affect risk and how to capture the difference
they create larger unearned premium reserves, which leads to a larger pricing risk
to capture this increased risk, unearned premium for long duration contracts 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.
AM BEST UNDERSTANDING BCAR
On what AM BEST stresses BCAR?
incorporate natural and/or man-made events such as terrorism to monitor how sensitive balance sheet strength is to a second CAT event
AM BEST UNDERSTANDING BCAR
Purpose of SQUARE ROOT RULE
Shortcoming of square root rule
how it can be counterbalanced
- Adjusting for fact that individual risk components are not likely to develop simultaneously.
- More capital-intensive UW risk components are accentuated disproportionately, while less capital-intensive Asset risk are diminished in their relative contribution to net required capital
- By using other distinct capital measures
AM BEST UNDERSTANDING BCAR
Example of market issues that could be considered in capital
Rate changes
Stage of UW cycle
Change of reinsurance
Dependence on reinsurance
AM BEST UNDERSTANDING BCAR
Limitation of BCAR
Not the sole basis to evaluate financial strength
Must also consider operating performance and business profile
