BCAR.Cdn

Question 1

What is the purpose of A.M. Best’s financial strength ratings?

Answer 1

to provide an opinion on the financial strength of an insurer
(and it’s ability to meet ongoing obligations to policyholders)

Question 2

What is the BCAR formula

Answer 2

BCAR = (AC - NRC) / AC x 100
(calculated at 4 different VaR levels)

Question 3

How is AC (Available Capital) calculated in the BCAR formula?

Answer 3

• start with balance sheet reported capital (surplus)
• make appropriate adjustments

Question 4

Identify 9 adjustments to balance sheet capital to obtain BCAR Available Capital.

(Hint: EDO: lura-sd-fig)

Answer 4

Equity adjustments:
- loss reserves
- unearned premiums
- reinsurance
- assets
Debt adjustments:
- surplus notes
- debt service requirements
** O**ther adjustments:
- future operating costs
- intangibles
- goodwill

Question 5

Why don’t we use unadjusted reported capital as the value for AC (Available Capital)?

Answer 5

incorporating these adjustments provides for a more economic and consistent view of capital available

Question 6

Identify the risk categories in the BCAR model (8 within 3 categories)

Answer 6

asset risk:
(B1) Fixed income securities
(B2) Equity securities
(B3) Interest rate risk
(B4) Credit risk
U/W/ risk:
(B5) reserve risk
(B6) premium risk
(B8) Catastrophe risk
other risks:
(B7) Business risk

Question 7

What is the purpose of the covariance adjustment in the NRC formula?

Answer 7

reflects the assumed statistical independence of 7 of the 8 risk components: (B1)-(B6) and (B8)
(reduces gross required capital because it’s unlikely that these 7 components will be near their maximum levels simultaneously)

Question 8

Why is (B7), Business risk, excluded from the covariance adjustment?

Answer 8

A.M. Best expects an insurer to maintain capital for business risks without the benefit of diversification

Question 9

In the BCAR model, what is ‘gross required capital’?

Answer 9

gross required capital = direct SUM of required capital for (B1) through (B8)
(represents total required capital if all risks developed simultaneously)

Question 10

Briefly explain how the strength assessment table work.

Answer 10

Strongest: BCAR@99.6% between 25 and 100
Very Strong: BCAR@99.6% between 10 and 25
Strong: BCAR@99.6% smaller than 10, but BCAR@99.5% positive
Adequate: BCAR@99.5% negative, but BCAR@99% positive
Weak: BCAR@99% negative, but BCAR@95% positive
Very weak: BCAR@95% negative

Question 11

NRC formula

Answer 11

NRC=  B7+SQRT [ B1^2 +B2^2 +B3^2+(0.5B4)^2 + (0.5 x B4 + B5)^2 +B6^2  +   B8^2 ]

Question 12

What is the key idea in calculating the required capital for each risk category?

Answer 12

multiply the liability from each risk category by a specific capital factor (similar to MCT)

Question 13

Briefly describe how BCAR ‘capital factors’ are derived

Answer 13

derivation of capital factors is:
- based on industry risk factors
- then adjusted for company’s volatility in case loss development

Question 14

Identify 8 considerations other than BCAR score that impact Best’s balance sheet strength assessment

Hint: Q2 - SALAMI

Answer 14

Q2 → Quality of capital, Quality of reinsurance
–
Stress testing
Adequacy of reserves
Liquidity of capital
Actions of affiliates
Matching assets & liabilities
Internal capital models

Question 15

Identify the 6 steps in A.M. Best’s rating process (leading to the final issuer credit rating)

Hint: BOB-ECL

Answer 15

BOB-ECL
Balance sheet strength
Operating performance
Business profile
–
Enterprise risk management
Comprehensive adjustment
Lift and/or drag

Question 16

Identify 5 company characteristics that may tend to lower a company’s BCAR score

Answer 16

• aggressive investment portfolio (increases NRC for investment risk categories B1, B2, B3)
• loans to poor creditors or reinsurance with low-rated reinsurers (increases NRC for credit risk category B4)
• reserve deficiency (increases NRC for reserve risk category B5)
• excessive growth or high U/W leverage (increases NRC for premium risk category B6)
• concentration of property risks in Florida (increases NRC for catastrophe risk category B8)

Question 17

Why does A.M. Best calculate NRC and BCAR at more than 1 level of VaR?

Answer 17

• to gain more insight into the company’s balance sheet strength
• to assess its ability to withstand tail events

Question 18

Why does A.M. Best use a sensitivity analysis to supplement its BCAR calculation? (3 reasons)

Answer 18

1. Assess capital required to support future business
2. Assess impact of a pro-forma transaction (acquisition of a subsidiary)
3. Assess projected year-end capital position

Question 19

Identify an aspect of the BCAR model that may make it more robust than MCT

Answer 19

BCAR model permits qualitative adjustments to final assessment for economic conditions:
- interest rate changes
- stage of U/W cycle
- changes in reinsurance arrangements

Question 20

Identify 3 similarities between the BCAR model and MCT

Answer 20

• purpose (assess financial strength and ability to meet policyholder obligations)
• key idea (apply capital factors to liabilities in various risk categories)
• covariance adjustment (to account for the statistical independence between risk categories)

Question 21

Identify 3 differences between BCAR model and MCT

Answer 21

formula is different and:
→ BCARmax = 100%, no minimum
→ MCTmin = 0%, no maximum
robustness is different:
→ A.M. Best more robust because final assessment includes qualitative economic conditions
(like stage of U/W cycle)
time horizon is different:
→ BCAR capital must support current & future premium risk
→ MCT focuses more on current year’s risk