September 12th, 2016

(Re)Insurers Modifying Their Behavior Ahead Of A.M. Best’s New Ratings And BCAR Criteria - GC@MC Commentary

Posted at 3:00 AM ET

eric-simpson-smallmurray_mark-smEric Simpson, Managing Director and Mark Murray, Senior Vice President


Industry Accelerates Risk Profile Analytics and Development of Their Own Risk Tolerances and Stochastic Capital Modeling

The launch of A.M. Best’s (Best) new ratings and Stochastic-based Best’s Capital Adequacy Ratio (BCAR) draft criteria became an inflection point for (re)insurers worldwide. The 2016 changes represent Best’s first major overhaul in over 20 years and are leading to a growing number of changes in market behaviors across the company size spectrum. (Re)insurers are assessing their risk and capital management positions in anticipation of the impacts of Best’s new requirements even though the changes will not result in massive differences in its published ratings nor likely become effective until later in 2017, according to Eric Simpson, Managing Director and Mark Murray, Senior Vice President of Guy Carpenter.

“Guy Carpenter is observing companies actively analyzing their risk profiles, risk tolerance statements and capital adequacy metrics at higher confidence levels,” said Mr. Simpson. “This goes beyond the traditional 1:100 threshold that was a cornerstone of Best’s BCAR model over the past two decades, in response to Stochastic-based BCAR’s multiple confidence intervals.”

“Additionally, small/mid-sized insurers are increasingly planning to develop stochastic capital modeling capabilities to stochastically measure and manage their ‘own’ risks, and position themselves for more transparent discussions and comparisons of model results with Best in future rating reviews.”

“Guy Carpenter expects the 1:250-year return time to become the upper threshold used for setting required capital levels, better aligning with prevailing global regulatory and rating agency capital standards as Best reconsiders its final array of confidence levels,” asserts Mr. Murray. “The 1:250-year is down significantly from the 1:1000-year upper level in Best’s initial draft released in March 2016 - Best’s response to concerns related to the reasonability of any model results at the extreme tail for both U.S. and international (re)insurers.”

“Under its new criteria, Best will cap BCAR’s upside contribution to a company’s overall rating,” Mr. Simpson explains. “In the future, insurers will only be able to qualify for a maximum Issuer Credit Rating (ICR) of “a+” within Best’s balance sheet strength (BSS) assessment based on a favorable result at the 250-year level. Because the maximum ICR rating of “a+” equates to a Financial Strength Rating of “A,” companies will need to outperform their peers in the three remaining evaluation areas - Operating Performance, Business Profile and Enterprise Risk Management (ERM) - in order to achieve higher Financial Strength Ratings of A+ or A++.”

The cost of rating agency capital has effectively increased for all “Secure” rated companies (>B++) - particularly those with elevated property catastrophe exposures, common stockholdings and/or long-tailed underwriting risks. Mr. Simpson asserts that “companies are considering the potential implications when measuring and managing their capital and risk positions this fall in advance of their annual planning and 2017 reinsurance renewals:

  • Guy Carpenter is assisting many property/casualty (P&C) stock insurers to project and interpret their capital positions for annual capital budgeting purposes using both Best’s U.S. P&C and Universal BCAR models;
  • Catastrophe-exposed insurers are using Guy Carpenter’s Model Suitability Analysis (MSA)® to determine an objective ‘management view’ of their probable maximum losses up to the 500- year return time. The MSA analysis combined with Guy Carpenter’s BCAR and ratings impact analysis provides important context and guidance for insurers to determine appropriate catastrophe limit protection; and
  • Companies with larger equity portfolios have begun to confirm their tolerances and risk characteristics against the backdrop of Best’s incrementally much higher industry-weighted capital charges.”

“Looking ahead,” Mr. Murray states, “Best will make more explicit and transparent notching adjustments in their evaluation of a company’s Operating Performance, Business Profile and ERM. It is clear that companies with sustained under-performance, greater earnings variability, risk concentrations and lagging development on adequate risk tolerance statements and capital modelling continue to be most at risk for downward rating pressure, although the final standards and key metrics remain uncertain.”

Mr. Simpson concludes: “Guy Carpenter assists clients with the changes borne from these new Best criteria. We recognize the potential timing implications in developing a practical, cohesive and comprehensive plan to ensure a smooth transition to the new BCAR and rating criteria methodology. With each rated company impacted differently, it is critical to understand and prepare for these implications regardless of where the organization stands on the rating scale or the influences on the rating.”

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