What are rating agencies?
Rating agencies provide an opinion of insurance companies’ financial strength which is a measure of their ability to pay claims under their insurance policies and contracts.
Note that this does not refer to the insurance company’s ability to meet its non-policy (i.e. debt) obligations, although debt that a company issues on the capital markets is normally separately rated.
Who are the 4 main rating agencies?
Standard and Poor’s (S&P),
AM Best,
Moody’s
Fitch
Why do insurance companies prefer to have a financial strength rating?
- it demonstrates to policyholders that a third party has measured the likelihood of them meeting their financial commitments.
- it allows for financial strength comparisons between different insurers.
- it should allow an extremely strong (AAA) insurer to charge a higher premium or be offered a wider range of business than a good (BBB) insurer as the customer is buying into a stronger rated (and therefore potentially more secure) company; and
- brokers and customers can decide on their risk appetite by choosing the financial strength rating that they prefer for their insurance carriers. For example, they may decide that their insurance policies must be placed with companies that have an S&P financial strength rating of higher than A-
What is a typical analytical framework that would be used by a rating agency?
- Economic and industry risk.
- Competitive position.
- Management and corporate strategy.
- Enterprise risk management (ERM).
- Operating performance.
- Investments
- Capital adequacy.
- Liquidity
- Financial flexibility
Under the typical analytical framework, what is economic and industry risk?
The environmental framework in which insurance companies operate. Typical points would be to look at the threat of new entrants, volatility of the sector, country risk and the potential ‘tail’ to liabilities or risk of catastrophic losses.
Under the typical analytical framework, what is What is Competitive position
The profile of the business mix in terms of the competitive strengths and weaknesses. This is particularly relevant in terms of the insurance company’s strategy.
Under the typical analytical framework, what is Management and corporate strategy.
This looks at the quality and credibility of an insurer’s senior management team and the strategy it has set and is one of the most important elements in determining how successful the company will be going forward.
Under the typical analytical framework, what is Enterprise risk management (ERM).
ERM is the method by which a company manages risk (both risks that have an upside as well as a downside).
Most large insurers are expected to have an effective ERM to earn the stronger financial ratings.
Under the typical analytical framework, what is Operating performance.
This involves looking at the performance ratios – loss ratio, expense ratio, combined ratio, return on equity etc.
Under the typical analytical framework, what is Investments
Of key importance here is how the insurer’s investment strategy fits with its liability profile, and to what extent investment results contribute to total company earnings.
Under the typical analytical framework, what is Capital adequacy.
This looks at the quality and level of capital required to run the business based on the risk appetite adopted.
Under the typical analytical framework, what is Liquidity.
The ability to manage cash flows efficiently and easily borrow money if required.
Under the typical analytical framework, what is financial flexibility.
This looks at the insurer’s potential need for additional capital or liquidity in the future.
Under (GENPRU 1.2.26) what is the regulatory requirement?
‘A firm must at all times maintain overall financial resources, including capital resources and liquidity resources, which are adequate, both as to amount and quality, to ensure that there is no significant risk that its liabilities cannot be met as they fall due.’
The risk appetite statement would typically include:
- acceptable risks
- unacceptablerisks;
- the probability of failure that is deemed to be acceptable;
- the maximum loss that is acceptable from any one incident;
- the target level of financial security; and
- the quality and diversity of investments.
How is a risk appetite statement used?
The risk appetite statement would be used by the insurance company to set:
- the risk acceptance criteria;
- an investment policy;
- a reinsurance policy; and
- other financial and risk policy statements.
What is the solvency 2 directive
a set of EU-wide capital requirements, valuation techniques and risk management standards to replace the previous Solvency I requirements.
The objectives of Solvency II are to enhance policyholder protection and create a safer, more resilient insurance sector.
How many pillars are there under solvency 2?
Three
What is pillar 1 under solvency 2?
Pillar 1 – Financial requirements. This applies to all firms and considers key quantitative requirements, including own funds, technical provisions, and calculation of the Solvency II capital requirements the solvency capital requirement (SCR) and minimum capital requirement (MCR) through either an approved full or partial internal model or the standard formula approach.
What is pillar 2 under solvency 2?
- Pillar 2 – Governance and supervision. This includes an effective risk management system and prospective risk identification through the own risk and solvency assessment (ORSA).
What is pillar 3 under solvency 2?
- Pillar 3 – Reporting and disclosure. Insurers are required to publish details of the risks facing them, capital adequacy and risk management. Transparency and open information are intended to assist market forces in imposing greater discipline on the industry.
Under solvency 2 what are the three tiers of capital?
- Tier 1 capital, such as common equity and retained earnings, is the highest quality of capital
- Tier 2 capital, such as subordinated debt, is of a lower quality ofcapital
- Tier 3 capital is the lowest quality of capital permitted and has only limited loss-absorbing capacity.
What are the two capital requirements under solvency 2?
the solvency capital requirement (SCR) and
the minimum capital requirement (MCR).
What is the SCR (solvency capital requirement)
The SCR is the quantity of capital that is intended to provide protection against unexpected losses, over the following year, up to the statistical level of a ‘1 in 200-year event’.
