Society of Financial Examiners – Maryland Chapter

2008 Career Development Seminar

Hunt Valley, MD

A.M. Best Company

Process

Jennifer Marshall, CPCU, ARM

Senior Financial Analyst
Property/Casualty Division
October 1, 2008
 Discussion Topics
• Overview of A.M. Best
• A.M. Best Rating Process
• A.M. Best Rating Criteria
• Key Rating Issues
• Drivers of Rating Changes
• Industry Issues and Expectations
 A.M. Best Overview
• Established in 1899, A.M. Best has provided
the public with comprehensive and
unbiased financial information on insurance
companies for more than 100 years.
• Began rating:
• Property insurers in 1906
• Life insurers in 1928
• In 2005, recognized as a Nationally
Recognized Statistical Rating Organization
by the U.S. Securities and Exchange
Commission.
 FSR Distribution
Non-
Rating Level U.S. P/C U.S. L/H U.S. Total
A++ 75 56 12 143
A+ 425 152 90 667
A 687 224 126 1,037
A- 551 279 154 984
B++ 210 144 34 388
B+ 118 125 19 262
Secure Total 2,066 980 435 3,481
Vulnerable: B to F 116 180 37 333
Total Interactive 2,182 1,160 472 3,814
Public Data Ratings 52 151 44 247
Grand Total *2,234 *1,311 **516 4,061
*As of July 2007
**As of Dec. 2007
Comparison of Ratings Coverage
Global Insurer Interactive FSR Coverage

4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0

Moody's S&P Fitch A.M. Best

Source: NRSRO Web sites and A.M. Best.

 Global Recognition
• Best’s Ratings reach:
• More than 150,000 insurance industry professionals via
A.M. Best publications
• Over 1,400,000 professionals who have registered to
access Best’s Ratings on the Web
• Thousands of professionals via third-party news services
• Over the past 12 months:
• More than 400,000 visitors reached Best’s Ratings &
Analysis Web home page
• More than 148,000 new users registered to access Best’s
Ratings
• Best’s methodology Web pages were viewed more than
300,000 times
Rating Process
 Objective of A.M. Best’s
Financial Strength Ratings

To perform a constructive and

objective role in the insurance
industry toward the prevention
and detection of insurer insolvency
 A.M. Best Rating Process
• Rating Process
• Not driven solely by ratio analysis

• Comprehensive Review
• Quantitative
• Qualitative

• Evaluate organization as a whole

• Review all accounting standard

perspectives used by the company
 Best’s Rating Process
Information captured using SRQ, QAR, BCAR, CAR,
A.M. Best’s proprietary Galleys
rating forms/systems

Research & develop comprehensive

company database

A.M. Best meets senior

Explore company’s
company executives
strategy and future
direction

Develop rating Committee determines

recommendations rating
Rating Process Review Includes:
• Public
• Financial Statements (Regulatory--SAP, IAS, GAAP, etc.)
• Stockholder/Policyholder Reports
• CPA Audit Reports
• Insurance Exam Reports
• MD&A Reports
• Private
• Management Meetings- CEO, COO, CFO, CUO, CIO
• Business Plan
• Best’s Supplemental Rating Questionnaire (SRQ)
• Actuarial Reserve Reports
• Catastrophe/PML Reports
• Cash Flow Testing
• Regulatory Filings
• Investment and Credit Guidelines
• Reinsurance Guidelines
 Best's Financial Strength
Rating Categories
Secure Ratings
A++, A+ Superior
A, A- Excellent
B++, B+ Very Good

Vulnerable Ratings
B, B- Adequate
C++, C+ Fair
C, C- Marginal
D Very Vulnerable
E Under Regulatory Supervision
F In Liquidation
Ratings Criteria
 A.M. Best’s Rating Criteria

Balance Sheet Operating Business

Strength Performance Profile

A.M. Best Rating

 Best’s Rating Perspective

• Capital strength is most important

• Sustained, stable operating
profitability ensures future strength
• Well-diversified, strong business
profile ensures stability
A.M. Best’s Rating Evaluation
Balance Sheet Strength
• Leverage
• Capital structure / holding company
• Quality & appropriateness of
reinsurance
• Adequacy of loss reserves
• Quality and diversification of assets
• Liquidity
• Growth
• Risk Adjusted Capitalization (BCAR)
 Best Capital Adequacy Ratio
BCAR
• Comprehensive Tool to Evaluate Risk
Components Simultaneously
• Generates Overall Estimate of Required
Level of Capital to Support Risks
• Frequent Adjustments: Reserve Adequacy,
Reinsurance Recoverable Credit Risk
Charges, Growth Factor, Projected
Capitalization
• Require Minimum Capital for Specific
Ratings
Minimum Capital Requirements
Rating Level Minimum BCAR
A++ 175
A+ 160
A 145
A- 130
B++ 115
B+ 100
B/B- 80
C++/C+ 60
 BCAR - Structural Overview
BCAR Ratio = Economic Surplus (APHS) / Net Required Capital

Economic Surplus (APHS) Net Required Capital

Reported Surplus (PHS) Gross Required Capital (GRC):

Equity Adjustments: (B1) Fixed Income Securities
Unearned Premiums
(B2) Equity Securities
Loss Reserves
Assets (B3) Interest Rate
Debt Adjustments: (B4) Credit
Surplus Notes (B5) Loss and LAE Reserves
Debt Service Requirements (B6) Net Premiums Written
Stress Test Adjustments: (B7) Off-Balance Sheet
Future Operating Losses
Potential Catastrophe Exp. Covariance Adjustment
Other
Net Required Capital (NRC)
Economic Surplus (APHS)
Common BCAR Adjustments
• Reserve Adequacy (Core vs. A&E)
• Reinsurance Credit Risk Charges
• Changes to Reinsurance Structure (QS)
• Catastrophe Exposure (PMLs)
• Affiliated Charges
• Stop Loss Reinsurance
• Loss Sensitive Business
• Projected Capitalization
• Surplus Note/ Long Term Debt Credit
• Growth Charges
 A.M. Best’s Rating Evaluation
Operating Performance

• Level of Profitability
• Historical
• Prospective
• Stability/Volatility of Earnings
• Revenue Composition/Quality of
Earnings
• Ability to Meet Plan
A.M. Best’s Rating Evaluation
Business Profile

• Market risk
• Spread of risk
• Event risk
• Competitive advantages
• Management
A.M. Best’s Rating Evaluation
Business Profile

Market Risk
• Business segments
• Pricing cycle
• Regulatory risk
• Economic/social conditions
A.M. Best’s Rating Evaluation
Business Profile

Spread of Risk
• Distribution Channels
• Catastrophe exposure
• Geographic concentration
• Line of business
concentration
A.M. Best’s Rating Evaluation
Business Profile
Event Risk
• Potential impact of sudden and
unexpected circumstances
• Quality of Preparation
• Ability to absorb
• Potential Issues Known
• Historical Track Record
A.M. Best’s Rating Evaluation
Business Profile

Management
• Stability
• Bench Strength
• Expertise
• Motivation
• Consistent Business Strategy
Relative Importance of Rating
Components

Business Profile

Operating Performance

Balance Sheet Strength

Current balance sheet carries greater weight for short tail writers,
greater emphasis is placed on operating performance for insurers
exposed to long tail liabilities.
 A.M. Best Expectations

Secure Vulnerable
A++ B+ B D

Balance Sheet
Strength Outstanding Weak

Operating
Performance Very Stable/Strong Volatile/Poor

Business Strong Market Position Questionable Viability

Profile Sustainable Advantages Competitive Disadvantages
Well-Diversified Concentrated Risk
Key Rating Issues
 Key Rating Issues
• Underwriting Skills/Cycle
management
• Capital management
• Exposure Management
• Financial Flexibility
• Enterprise Risk Management
 Key Rating Issues

Underwriting Skills/Cycle Management

• Market Differentiators

• Underwriting culture

• Limits profile
 Key Rating Issues

Capital Management
• Basis for managing capital
• Historic track record / Financial Leverage
• Future plans
• Dividends / Stock Repurchases
 Key Rating Issues
Exposure Management
• Data quality
• Integration with is integrated into
underwriting operations?
• Use of reinsurance
 Key Rating Issues

Financial Flexibility
• Capital Structure
• Contingencies in Place
 Key Rating Issues
Enterprise Risk Management
• Not a separate component
• Impacts all areas of the rating evaluation
y Capitalization
y Operating performance
y Business profile
• Potential to weigh heavily on a rating
 ERM in the Rating Evaluation
Implementation of ERM will vary due to:
• Complexity of a company
• Type of products offered
• Number of products offered
• Investments

• Volatility of Earnings/potential
significant capital loss (Risk profile)
• Financial Flexibility
• Strength of its Traditional Risk
management
Drivers of Rating Changes
 Drivers of Upgrades
• Strengthened capitalization
• Favorable, sustainable earnings
• Conservative loss reserves
• Prudent catastrophe mitigation
• Becoming part of a larger, more highly
rated organization
 Drivers of Downgrades
• Weakened capitalization
• Earnings deterioration
• Shock loss
• Inadequate loss reserves
• Rapid growth
• Escalating or unmanaged catastrophe
exposure
• Increased operating leverage
 Rating Changes

Upgrades vs. Downgrades

200
Rating Changes

150
Upgrades
100
Downgrades
50

0
2003 2004 2005 2006 2007
Year

Source – AMB 2007 Rating Trend Review

Industry Issues &
Expectations
 Key Industry Issues
• Pricing Pressures vs. Growth
• Regulatory / Legislative
• Enterprise Risk Management
• Reserving
• Government Involvement in
Asset Valuation
 Long Term Expectations

• Soft Market Not as Severe as

Past Cycles
• Cycle Management Tested;
Underwriting Profits Diminish
• Investment Earnings Volatility
Questions?