AM Best Understanding BCAR

Question 1

List factors from which AM Best interactive rating is derived

Answer 1

• An in-depth evaluation of a company’s BS strength
• Operating performance and business profile as compared with
• AM Best quantitative and qualitative standards

Question 2

List sources from which UW leverage is generated

Answer 2

• Current premium writings
• Re recoverables
• Loss reserves

Question 3

List factors to assess if company UW leverage is prudent

Answer 3

• Type of business written
• Quality and appropriateness of its Re program
• Adequacy of loss reserves

Question 4

List stress tests within BCAR

Answer 4

• Above-normal CAT
• Decline in equity markets
• Rise in interest rates

Best will also stress a company’s BCAR for a second CAT event (natural CAT and/or man-made events such as terrorism)

Question 5

List Broad risk categories for which the Net required capital in BCAR is calculated to support

Answer 5

• Investment risk
• Credit risk
• UW risk

Question 6

List main risk components of investment risk

Answer 6

• Fixed-income securities
• Equities
• Interest rate

Question 7

List components on which capital charges for different asset classes for investment risk are based

Answer 7

For equity and fixed-income securities
• Risk of default
• Illiquidity
• Market-value declines

Question 8

List components that can modify the required capital for credit risk

Answer 8

• Any collateral offsets for Re balances
• Quality of the Re that participate in the company’s Re program
• Company’s dependence on its Re program

Question 9

List assets having additional higher capital charges and 2 reasons why

Answer 9

• Affiliated investment holdings
• Real estate
• Below-investment-grade bonds and nonaffiliated
• Privately traded common and preferred shares

Because
• Illiquid nature of the asset
• Volatility of the reported value

Question 10

List components of the reserve equity in UW risk

Answer 10

Based on the risk inherent in the compagny’s loss, reserve equity is a function of:
• Estimated reserve deficiency
• Payout pattern of the reserves
• Discount rate (currently 4% in BCAR)

Question 11

List adjustments made by AM Best to reported surplus and why they are made

Answer 11

• Provide a more economic and comparable basis for evaluating capital adequacy
• Respond to various market issues (rate changes, stage of the UW cycle, change in Re products)
• Reflect the pricing risk inherent in UEPR reserves and non-BS risks, including CAT exposures and debt-service requirements

Question 12

List components largely impacting capital required to support net UW commitment

Answer 12

• Mix of business
• Size of surplus
• Stability of loss development
• Profitability
• Loss-reserve adequacy
• Length of claims payout

Question 13

List items that would lower the BCAR value, all else being equal

Answer 13

• Higher UW leverage
• Greater indicated reserve deficiencies
• Unstable or unprofitable business

Question 14

List additional context within what capital adequacy should be considered

Answer 14

Capital adequacy should be considered within the context of the operating and strategic issues surrounding a company. Important rating considerations in evaluating a company’s long-term financial strength and viability:
• Business profile
• Operating performance
• Quality of the capital that supports the BCAR results

Question 15

Briefly explain the objective of A.M. Best Co.’s financial strength ratings

Answer 15

To provide an opinion of an insurer’s financial strength and ability to meet ongoing obligations to PHs

Question 16

Briefly explain BS strength

Answer 16

• Most important area to evaluate, since it is the foundation for PHs security
• Measures the exposure of a company’s surplus to its operating and financial practices
• Performance determines how it will be enhanced, maintained or eroded over time

Question 17

Briefly explain Financial Leverage (in the BCAR)

Answer 17

Financial leverage is created through debt or debt-like instruments and is reviewed in conjunction with a company’s UE leverage

Question 18

Briefly explain Asset Leverage (in the BCAR)

Answer 18

Measures the exposure of a company’s surplus to investment, interest rate and credit risks. Potential impact on the company’s BS strength is determined by:
• Volatility of the investment portfolio
• Credit quality of the investment portfolio
• Recoverables and agent’s balances

Question 19

What does BCAR calculates?

Answer 19

Net required capital to support the financial risks of the company associated with the exposure of assets and UW to adverse economic and market conditions, and compares it with economic capital

Question 20

Briefly contrast BCAR vs MCT

Answer 20

A significant proportion of capital is required to support future premium risk, reflecting AM Best’s view that BS strength must support the risks associated with a company’s current book of business as well as those it plans to insure in the upcoming year

Question 21

Briefly explain how BCAR deals with foreign investment risk

Answer 21

Risk charge for that asset category may be increased to reflect the increase in volatility and/or decrease in liquidity associated with those foreign markets, financial systems and economie

Question 22

Discuss Credit Risk Component in the BCAR

Answer 22

Capital charges to reflect 3rd party default risk

• Credit risk factors depending on the type of Re
• Charges for premium receivables from agents/brokers, PHs and installment premium balances
• Funds held by residual market entities (FA and PRR)

Question 23

On what does the net premium writing component requires capital?

Answer 23

Based on the pricing risk inherent in a company’s MOB

Question 24

On what does the required capital required for reserve and premium may be increased?

Answer 24

To reflect an additional surcharge for “excessive” growth in exposure

Question 25

Which reason could provide a credit to UW risk component?

Answer 25

For a well-diversified book of business, but this credit is limited for those cies that maintain small books of many LOB and might not necessarily have expertise in all of these lines

Question 26

Explain how long duration contracts affects risk and how to capture the difference

Answer 26

They create larger UEPR reserves that leads to a larger pricing risk than anticipated for regular contracts. In order to capture this increased risk, the long duration UEPR will be included on the loss reserve page instead of the pricing risk page in an effort to reflect diversification from business being written in the future versus business written in the past

Question 27

What is the BCAR formula?

Answer 27

BCAR = Adjusted Surplus / Net Required Capital