Exam 6 Bottom 15% Flashcards
identify exhibits/notes/interrogatories/Schedules in the Ann. Stmt. that support an actuary’s assertion that reserve increase is NOT due to prior inadequacy
Schedule P - Part 2 (ultimate losses)
supports actuary if it shows minimal reserve development
Schedule F - Part 1 (assumed reinsurance)
supports actuary it is shows MORE assumed reinsurance
Schedule F - Part 3 (ceded reinsurance)
supports actuary it is shows LESS ceded reinsurance (since reserves are shown net of reinsurance)
5-Year Historical Data:
supports actuary if it shows a mix shift from short-tail → long-tail lines (which tends to increase reserves)
General Interrogatories:
supports actuary if there was a merger
Notes to the Financial Statements:
supports actuary if there was a commutation of reserves
supports actuary if there was an increase in pooling percentage for company
why do we bother with financial strength ratings at all
for policyholders:
financial strength ratings help buyers assess an insurer’s ability to pay claims
some buyers MUST place business with highly rated insurers or reinsurers
if the potential policyholder is an insurer seeking reinsurance, the insurer may require the reinsurer have a high rating
for P&C insurers:
a high rating can help insurers get business
a financial strength rating by a rating agency can uncover potential solvency issues without involving a regulator
identify the importance of financial strength ratings to reinsurers
same as for insurers:
a high rating can help reinsurers get business
a financial strength rating by a rating agency can uncover potential solvency issues without involving a regulator
plus:
some insurers must place business with highly rated reinsurers
if downgraded to below investment grade, a reinsurer may not be able to renew its treaties and thus lose business
who does financial strength ratings
A.M. Best:
has the most experience with financial strength ratings of insurers
Moody’s:
focuses more on debt ratings (versus overall financial strength ratings)
S&P (Standard & Poor’s):
focuses more on debt ratings (versus overall financial strength ratings)
how are financial strength ratings done
All 3 agencies use something called interactive rating as an overall methodology but they differ in their specific rating or capital model
how do rating agencies ensure consistency across insurers
- standard information-gathering & assessment guidelines
- ratings are related to economic capital
- analysis & final rating should be issued by separate bodies.
describe shortcomings of rating agencies
conflict of interest
rating agencies are paid by the companies they rate
history of unreliability
rating agencies have given high ratings to companies that then went bankrupt.
E.g. Enron
identify the legislative response to criticism of rating agencies
law now requires extensive DISCLOSURE of rating agencies’ methods to help users understand ratings
why might rating agencies prefer stability over responsiveness in their rating methodology
-stability increases trust in ratings
-being too responsive might mean responding to statistical noise (versus signal)
what is the broad description of ‘interactive rating’
a comprehensive qualitative & quantitative evaluation of an insurer’s ability to pay claims (financial strength)
describe the 5 steps of the interactive rating process
RM-PDP
Research: by ratings analysts (insurer submits proprietary info)
Meeting: between rating analysts & insurer’s senior management for presentations
Proposal: the rating analyst leader proposes a rating (insurer may submit further info)
Decision: by ratings committee
Publication: to public & fee-paying subscribers
(these 5 steps should provide a comprehensive evaluation of the company)
What are drawbacks to the interactive rating methodology?
[Hint: it TIEs up company resources]
Time-consuming: requires extensive meetings with senior management
Intrusive: insurer must provide detailed operational info
Expensive: insurer must pay for rating agencies to do the interactive ratings
if interactive ratings are such a royal pain, why do insurers bother with them
USE
Unrated insurers: agents are wary of unrated insurers
Solvency assessment: 3rd parties such as regulators or investors may rely on a rating agency’s assessment
Efficiency: agents, underwriters, regulators don’t have the expertise to evaluate the financial strength of an insurer
if rating agency concludes that an insurer’s financial strength has changed in a material way, what reporting options are available
- downgrade or upgrade insurer’s rating
- change the outlook (do not upgrade or downgrade)
→ rating agencies hesitate to change ratings too quickly to avoid angering paying clients (if their rating is downgraded) and to maintain consistency & reputation among users of financial ratings
which responds faster to shocks: rating agencies or bond/stock market (why)
- bond/stock market is faster
responds almost immediately - rating agencies may take months
interactive ratings are time-consuming
but can properly verify info and that the shock was real, not just noise
in the ‘meeting’ phase of an interactive rating, is the focus on gathering qualitative or quantative info
Qualitative
identify (Best, Moody, S&P) rating models (capital standard models)
A.M. BEST:
- EPD (Expected Policyholder Deficit)
MOODY’S:
- use stochastic cash flows to model economic capital
STANDARD & POOR’S:
- PB (principles-based) models & ERM practices (Enterprise Risk Management)
fully describe A.M. Bests’ rating model
Method:
- EPD = $P / $V
- $P = pure premium of treaty
- $V = market value of reserves
SELECTION:
- choose required capital so that EPD = 1%
fully describe Moody’s rating model
Method:
- model is based on repeated simulations of loss distributions of separate risks
Time Horizon:
- project cash flows until liabilities are settled
fully describe Standard & Poor’s rating model
Method:
- evaluate insurer’s ERM (Enterprise Risk Management) & internal capital model
Rating:
- weighted average of S&P & insurer capital assessment
identify incentives for rating agencies to create more accurate capital models
- increase public confidence in rating agencies
- increase competitive advantage against other rating agencies
identify an incentive for a rating agency to have high (or low) capital standards
high standards:
- ensures highly rated insurers are truly able to withstand stress events
low standards:
- rating agency may gain market share because weak insurers may still receive a good rating
compare the capital models used by rating agencies vs RBC
Method:
- rating agencies may use stochastic model & qualitative considerations
- RBC uses a fixed formula, quantitative only
regulatory action:
- rating agencies have no regulatory authority
- RBC results can initiate regulatory action
Data:
- rating agencies use confidential company data
- RBC uses public data
All risks:
- rating agencies can include any relevant risks
- RBC is constrained by the given formulas
identify an advantage of the capital model used by A.M. Best
- models individual risks then combines risks using a covariance adjustment (similar to RBC)
- sets capital level so that EPD (Expected Policyholder Deficit) = 1%
- GOOD because tail risks are modeled better than RBC’s ‘worst-case’ approach
identify an advantage of the capital model used by Moody’s
- uses a stochastic cash flow model
- GOOD for complex multivariate risks
identify an advantage of the capital model used by Standard & Poor’s
- uses a weighted average of its own model & a company model
- GOOD because it incorporates company knowledge of risks to the final rating
describe how state regulators & A.M. Best differ in their evaluation of capital adequacy
Note: Current RBC model DOES consider catastrophe risk and interest rate risk
quantitative vs qualitative data:
- state regulators mainly use RBC, which uses quantitative data only
- A.M. Best incorporates qualitative data
capital requirements:
- state regulator (RBC) uses RBC formula
- A.M. Best uses a 1% EPD (Expected Policyholder Deficit)
identify A.M. Best’s broad categories of financial strength ratings for insurers
- Secure: likely to meet their obligations (divided further into 3 sub-levels)
- Vulnerable: may not meet their obligations in adverse scenarios (divided further into 7 sub-levels)
identify A.M. Best’s 2 broad categories of credit quality ratings for bonds
- investment grade: 4 levels (+ sublevels)
- non-investment grade: 4 levels (+ sublevels)
identify differences between RBC requirements and rating agency capital requirements
quantitative / qualitative
- RBC is a quantitative formula
- rating agencies include qualitative information (interactive ratings)
types of risk
- RBC is constrained by the given formulas
- rating agencies can include all relevant risks
Intervention
- RBC can trigger regulatory intervention
- rating agencies don’t trigger regulatory intervention
Data
- RBC uses public annual statements
- rating agencies have access to proprietary data (interactive ratings)
identify a reason for a company to disclose damaging information to a rating agency
- non-disclosure may have worse consequences if the rating agency discovers the data later anyway
- integrity is important in a rating agency’s qualitative assessment
argue for & against: ‘A.M. Best is effectively a regulator of the insurance industry’
For:
- reputation is critical for an insurer to attract business
- a good rating from A.M. Best improves an insurer’s reputation
- therefore A.M. Best can pressure insurers to take corrective action (even without the force of law)
- ALSO, regulators often reference ratings from rating agencies
Against:
- if A.M. Best gives a low rating, insurer can just seek out another rating agency
- insurers don’t NEED a financial rating from a rating agency
- A.M. Best cannot accept/reject filings or take control of a potentially insolvent insurer
identify similarities & differences between ‘interactive ratings’ & ‘public ratings’
Similarities:
- both use public financial statement info
- both disclose rating to public
Differences:
- interactive ratings are more costly & time-consuming than public ratings
- interactive ratings use confidential company information (public ratings using publicly available info)
identify a reason for a company NOT to disclose damaging information to a rating agency
- insurer doesn’t want a lowered rating
- adverse development may be less than expected
describe procedures for monitoring solvency recommended by the NAIC
RBC formula:
- calculate capital requirements with possible regulatory action
IRIS ratios:
- allocate state regulatory resources based on IRIS results
Financial Statements:
- use annual/quarterly statements for consistent comparisons across companies & time
what is the purpose of NRRA? And how does the NRRA accomplish its purpose?
NRRA = Nonadmitted & Reinsurance Reform Act of 2010
Purpose:
- create a better surplus lines tax payment and regulatory system
How:
- limits regulatory authority of surplus lines to the customer’s home state
- establishes federal standards for surplus lines regarding:
premium taxes
insurer eligibility
commercial purchaser exemptions
describe a surplus lines transaction
a specially licensed surplus lines broker places insurance with an unauthorized/non-admitted insurer
identify 2 types of regulatory exemptions for surplus lines and the benefits to policyholders
exemption ==> from filing rates
- Benefit
– insurer can always charge adequate premium
exemption ==> from guaranty funds
- Benefit:
– costs of fund not passed on to policyholder
identify the key provisions of NRRA discussed in the Emmanuel reading
1-state compliance (only an insured’s home state can regulate the placement of surplus lines)
- 1-state compliance refers to licensing of surplus lines brokers whereas uniform eligibility standards applies to surplus lines insurers
uniform eligibility standards (for an insurer to sell surplus lines coverage)
ECPs or Exempt Commercial Purchasers (a diligent search is not required for sophisticated commercial purchasers)
national producer database (producers must be in a database to collect licensing fees from a surplus lines insurer)
describe the key provision of NRRA: 1-state compliance
insured’s home state has exclusive authority to regulate the placement of nonadmitted insurance (which includes surplus lines)
- only home state can require a broker’s license to sell nonadmitted insurance
– (but note that WC is an exception)
- only home state can collect premium taxes
describe the key provision of NRRA: uniform eligibility standards
states are empowered to create uniform eligibility standards for surplus lines insurers but all are currently using the NRRA default standards
- U.S. domiciled insurers (also called foreign insurers because they are foreign to all but the home state)
– ==> must have ≥ 15m in capital & surplus (or the state minimum if it’s higher)
– ==> must be authorized to write in its domiciliary jurisdiction
- non-U.S. domiciled insurers (AKA alien insurers, not foreign insurers!!!)
– ==> if insurer is listed in the Quarterly Listing of Alien Insurers, states may not prohibit placing insurance with them
–(this list is also called the “IID” list because it’s maintained by the NAIC’s International Insurer’s Department)
describe the key provision of NRRA: Exempt Commercial Purchaser (ECP)
definition of ECP: any person purchasing commercial insurance that:
- employs a NRRA-qualified risk manager
- has paid aggregate commercial premiums ≥ $100,000 (in past 12 months)
- the person’s company is “large” (high net worth ≥ ~20m or high revenues or lots of employees,…)
the related NRRA provision is:
- states cannot force a broker to do a diligent search if the purchaser is an ECP and:
– ==> the broker has disclosed to the purchaser that coverage may be available in the admitted market (which is better regulated)
– ==> the purchaser has then instructed the broker to purchase insurance in the non admitted market
describe the key provision of NRRA: national producer database
this database (or another national equivalent) is for the licensure & renewal of surplus lines brokers
- Has to be national, not regional
the specific NRRA requirement is that:
- ==> if a state doesn’t participate in such a database then they cannot collect licensing fees
Surplus Lines Laws
there is very little regulation regarding forms & rates (compare that with auto insurance which is very highly regulated)
surplus lines regulation is focused mainly on brokers (not the surplus lines insurers)
brokers must perform a diligent search before exporting business from the admitted market to the nonadmitted surplus lines market
- ==> or the broker can instead use an “export list” which is a list of coverages deemed to be unavailable through the admitted market
brokers submit tax and other filings
identify 2 methods of accessing the nonadmitted market
- surplus lines (use a local licensed broker to buy coverage from a nonadmitted insurer in your home state)
- independent procurement (also called direct placement)
what is independent procurement / direct placement
- when a U.S. citizen leaves their home state (goes to an insurer outside their home state) to insure a risk located in their home state
- and the purchase is either directly from an unauthorized insurer or a broker not licensed by the home state
describe a legal precedent related to home state regulation of independent procurement
Case: State Board of Insurance v. Todd Shipyards Corporation
Facts:
the buyer purchased property coverage from an out-of-state unauthorized insurer
the only connection between the buyer and the home state was the location of the covered property in the home state
Issue:
can the home state tax or otherwise regulate the transaction
Ruling:
under McCarran-Ferguson, the home state could not tax or regulate the transaction
because federal laws applying exclusively to insurance supersede state laws
what is a wholesale broker
- an intermediary broker between a “regular” retail broker and an insurer
- (they place business brought to them by retail brokers and have no contact with the insured)
how is licensing of a wholesale broker different from that of a “regular” retail broker
- the wholesale broker must have a license in the home state of each insured they place with an insurer
- Which means the wholesale broker may have to have many separate licenses
how are the licensing requirements of wholesale brokers being addressed
- 2015 legislation established the National Association of Registered Agents and Brokers or NARAB
- it’s a 1-stop national licensing system for brokers operating outside of their home state
- requires submission of an application and adherence to strict standards
identify criteria a surplus lines insurer must generally satisfy to become a DSLI
- DSLIs = Domestic Surplus Lines Insurance Companies
- PHS ≥ 15 million (Policyholder Surplus)
- insurer is an eligible surplus lines insurer in a jurisdiction other than its state of domicile
- the insurer’s board of directors passes a resolution seeking to be a domestic surplus lines insurer in the state of domicile
- insurance commissioner approval and issuance of certificate of authority
A start-up company has proposed entering a state as a surplus lines carrier to compete with admitted carriers by offering similar coverage on a direct-to-consumer basis. Identify 4 surplus lines regulatory requirements and briefly describe why this start-up may or may not meet those requirements.
surplus/capital requirements
- there is a minimum capital requirement (can vary by state)
- → a start-up may have troubling raising enough capital
authorization/licensing requirement
- insurer must be authorized in domiciliary jurisdiction
- → we are not told if the start-up has been authorized
coverage must be declined by admitted market
- unless insured is an ECP (Exempt Commercial Purchaser) they must first perform a diligent search for an admitted insurer
- → start-up would only be able to write business with exempt commercial purchasers (market may be small)
must meet managerial requirements
- ensures surplus lines carrier can meet customer’s needs
- → start-up management may be inexperienced (may not satisfy this requirement)
Identify the 2 categories and 10 Notes to the Financial Statements that are covered in Odomirok
Category 1: notes requiring direct involvement by actuaries [Hint: noteCARD +PDR]
- Change (incurred loss & LAE)
- Asbestos & environmental reserves
- Reinsurance
- Discounting (unpaid loss & LAE)
- PDR (Premium Deficiency Reserves)
Category 2: notes that are relevant to actuaries: [Hint: SHIES]
- Summary of significant accounting principles (This is Note #1 in the reading)
- High deductibles
- Intercompany pooling
- Events subsequent (aka ‘subsequent events’.)
- Structured settlements
describe the Financial Statement NOTE: Change in incurred loss & LAE
shows prior AY changes
- affects current CY U/W income
- disclose change & reasons for change (segment, LOB,…)
describe the Financial Statement NOTE: Asbestos & environmental exposure
- significant adverse development over several decades
- must disclose detailed quantitative & qualitative information regarding reserves
- these reserves relate to exposures other than for policies specifically covering A&E
describe the Financial Statement NOTE: Reinsurance
reserves are net of reinsurance on the B/S & I/S
- reinsurance can significantly lower the B/S reserves and affect the surplus
- must understand credit risk associated with reinsurance (use Sections A,B,D of reinsurance notes)
- A: unsecured recoverables, B: disputed recoverables D: uncollectible recoverables
questions the actuary might ask about each section
- A: why wasn’t security provided? did a cat increase recoverables unexpectedly? are the unsecured amounts concentrated with 1 reinsurer?
- B: what is the nature of the dispute? is the disputed amount material? is there a legal opinion on the dispute?
- D: what was the reason for the uncollectible insurance? could other unpaid amounts become uncollectible for similar reasons?
other comments
- A: a note is required if (unsecured amounts) / surplus > 3%
- B: recoverable is considered to be in dispute once a formal written refusal to pay is received from the reinsurer
- D: uncollectible amount is treated as an expense
