D.2 AM Best Article Flashcards
Purpose and limitation of BCR
Purpose: independent objective opinion of an insurers credit worthiness
do not use BCR to:
- predict impairment or default of a specific insurer
- decide if a policy is suitable for a specific purpose
- make investment decisions without considering other information
Credit rating process
- Dialog between a rating analyst and the insurer for general information and analysis
- compile information
- Perform analysis on risks the insurer might be subject to
- determine rating
Opinion Outlooks
- Positive - insurer is experiencing favorable financial and market trends relative to its current BCR
- Negative outlook
- stable outlook
BCAR formula
-capital adequacy ratio
BCAR = (Available capital - net RC) / Available Cap * 100
Components of net required capital
Net RC = sqrt[(C1 non eq + C3 int)^2 + (C1 eq + C3 Mkt)^2 + C2^2] + C4
process for arriving at available capital
available capital = reported Stat surplus +/- adj
adj:
- equity adj: AVR, unearned Prem, dividends
- debt adj: surplus notes
other: future operating loss, IMR amortization, OBS derivatives, goodwill
Considerations for evaluating the equity content of surplus notes
- permanency - whether note is available to pay losses when needed and whether held to maturity
- servicing - whether IR payments are deferrable when a company is in distress
- structure and subordination - loss protection provided to PH and other creditors
Equity like when:
- longer term (remaining maturity > 10 yr)
- subordinate to PH, claimants, beneficiary claims, creditors
- interest and principal repayments are subject to regulatory approval
how surplus notes affect BCAR
- surplus notes are initially subtracted from BCAR and added back in based on how equity-like they are determined to be
- since surplus notes are generally subordinate to PH and creditors, regulators view this as more equity-like which increases BCAR
- the note will lose equity status the closer it gets to maturity. when <5 years; note reduces equity by 20% per year
- note is given more equity credit if it is from an affiliated company
Measures used to assess liquidity
- current liquidity = proportion of liab covered by cash and unaffiliated holdings
- quick liquidity = proportion of liab covered by cash and investments that can be liquidated quickly
- non investment grade bonds and capital = sum of NAIC class 3-6 bonds as a % pf total capital and surplus
- delinquent and foreclosed mortgages to capital = sum(mortgages where interest is >3mo overdue + foreclosures) / total capital and surplus
- affiliated investments as % of total capital and surplus
- mortgages as % of total capital and surplus
AM Bests stress liquidity ratio SLR
-SLR measures an insurers cash needs over short term (30 d) and long term periods (6-12 mo) under stress scenarios relative to GA reserves
3 major cash sources:
- portfolio cash and short term investments
- amount of readily saleable securities that can be quickly liquidated
- PH obligations expected to be liquidated under stress scenarios
Funding agreements
- annuity like contract sold by an insurer to an investor
- FAs issued to SPVs which are then sold to investors
- can be separated into tranches of the note
Financial leverage vs operating leverage
financial leverage = debt used for working capital
operating leverage = debt used to facilitate normal business operations
characteristics that are used to determine baseline equity credit for an instrument
- Permanence
- Higher credit based on time to maturity, call features - Servicing - determined by ability to defer payments
- more credit if payment requirement restrictions fall - structure and subordination to PH and creditors
Typical financial and coverage ratios
financial leverage = debt to capital before equity credit for hybrid securities
financial leverage = debt to capital after equity credit for hybrid securities
Debt to tangible capital = debt to capital excluding intangible assets
coverage ratios:
Interest coverage = EBIT / (interest expense + non equity preferred stock)
fixed charge coverage = EBIT / Adj fixed charges
operating leverage
operating leverage = debt used to fund specific pool of matched assets, finance non-insurance operations, or fund non economic reserves
operating leverage may be given credit as equity if:
- matched assets be sufficient to fund interest and principal payments
- insurers should have sound ALM adn risk management
- Duration mismatch should be low
- repayment and liquidity risk should be low
examples of operating leverage:
- XXX reserve financing: LOCs, debt
- embedded value securitizations
- securities lending programs
- repos
- GICs, funding arrangements, FABs
- Federal home loan bank FHLB
How off balance sheet items can impact BCAR
- credit can be given for contingent capital facilities which allow companies to preset terms and conditions of future capital raising initiatives
- fully funded facilities where the SPV has highly rated liquid securities the sponsor can access on short notice
- LOCs from strong financial counterparties
