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

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 adjustments to balance sheet capital to obtain BCAR Available Capital

Answer 4

EDO: lura-sd-fig

Equity Adjustments:
- Loss reserves
- Unearned premiums
- Reinsurance
- Assets

Debt adjustments:
- Surplus notes
- Debt service requirements

Other 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

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) and shows it’s mostly unlikely that all risks will reach their maximum values at the same time

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 to B8

(represents total required capital if all risks developed simultaneously)

Question 10

What is the formula for NRC

Answer 10

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

Question 11

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

Answer 11

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

Question 12

Briefly describe how BCAR “capital factors” for reserve risk are derived

Answer 12

Derivation of reserve capital factors is:
- Based on industry factors
- Then adjusted for company’s volatility in case loss development

Question 13

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

Answer 13

Q^2-SALAMI

• ## Q^2: Quality of Capital, Quality of Reinsurance
• Stress testing (how well does the company perform under stress)
• Adequacy of reserves
• Liquidity of capital
• Actions of affiliates (affiliates could drag you down or pull you up)
• Matching of assets & liabilities (this is desirable for paying your bills on time)
• Internal capital models (does the company have a good procedure for assessing its own capital needs)

Question 14

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

Answer 14

BOB-ECL
- Balance sheet strength (mainly based on the BCAR scores, but subject also to Q^2-SALAMI)
- Operating performance
- Business profile
-
- Entreprise risk management
- Comprehensive adjustment
- Rating lift and/or drag

Question 15

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

Answer 15

• Aggressive investment portfolio (increases NRC for investment risk categories B1, B2, B3)
• Loans to high-risk entities 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 certain CAT prone area (increases NRC for catastrophe risk category B8)

Question 16

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

Answer 16

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

Question 17

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

Answer 17

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

Can also reflect other changes, such as those expected to affect business mix and the investment portfolio.

Question 18

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

Answer 18

BCAR model permits qualitative adjustments to final assessment for economic conditions such as:
- Interest rate changes
- Stage of U/W cycle
- Changes in reinsurance arrangements

(these are essentially market adjustments within the BCAR framework)

Question 19

Describe 3 similarities between the BCAR model and MCT

Answer 19

• Purpose: assess financial strength & 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 20

Describe 3 differences between the BCAR model and MCT

Answer 20

Formula is different and:
- BCAR max = 100%, no minimum
- MCT min = 0%, no maximum

Robustness is different:
- A.M. Best is more robust because final assessment includes qualitative economic conditions

Time horizon is different:
- BCAR capital must support current & future premium risk
- MCT focuses more on current year’s risk

Question 21

BCAR Assessment Formulas (Strongest, very strong, strong, adequate, weak, very weak)

Answer 21

Strongest: 25 < BCAR at VaR(99.6) ≤ 100

Very Strong: 10 < BCAR at VaR(99.6) ≤ 25

Strong: BCAR at VaR(99.6) ≤ 10 and BCAR at VaR(99.5) > 0

Adequate: BCAR at VaR(99.5) ≤ 0 and BCAR at VaR(99) > 0

Weak: BCAR at VaR(99) ≤ 0 and BCAR at VaR(95) > 0

Very Weak: BCAR at VaR(95) ≤ 0