Feld.RtAgs

Question 1

Briefly explain the legislative response to criticism of rating agencies

Answer 1

Law now requires extensive DISCLOSURE of rating agencies' methods to help users understand ratings

Question 2

Briefly explain the importance of Financial Strength ratings to buyers of insurance

Answer 2

• helps buyers assess insurer's ability to pay claims
• some buyers MUST place business with highly rated insurers or reinsurers

Question 3

Identify 3 measures taken by rating agencies to ensure consistency across insurers?

Answer 3

1. Relate ratings to economic capital measures
2. Issue ratings by committees independent from the ratings analyst
3. Review ratings periodically
4. Collect consistent information from companies and follow consistent guidelines in assessing the information

Question 4

Identify 2 shortcomings of Rating Agencies

Answer 4

• CONFLICT of INTEREST: Rating Agencies are paid by the companies they rate
• RELIABILITY: Rating Agencies gave high ratings to companies that went bankrupt (Ex: Enron)
• Slow Response to Market Changes: Ratings lag behind market signals (e.g., stock prices reflect risks faster)

Question 5

Define ‘interactive rating’

Answer 5

An independent assessment of an insurer’s ability to pay claims BASED ON a comprehensive qualitative & quantitative analysis

Question 6

Identify 2 advantages of interactive rating.

Answer 6

1. Fewer chances of error
2. Insurer can provide proprietary data, which allows for a more accurate rating
3. Insurer has some control over information reviewed

Question 7

Identify 3 disadvantages of interactive ratings. (Hint = TIE)

Answer 7

1. Time-consuming:
   - requires extensive meetings with senior management
2. Intrusive:
   - insurer must provide detailed operational info
3. Expensive:
   - insurer must pay for rating agencies to do the interactive rating

Question 8

Identify 3 examples where a high financial rating is particularly important

Answer 8

1. Reinsurance:
   - if downgraded, a reinsurer may not be able to renew treaties
2. Low-frequency / high-severity lines:
   - harder to assess risk and a high rating proves insurer can pay claims
   (Ex: surety insurance)
3. Mortgage insurance:
   - lenders may require mortgage insurance from a highly-rated company

Question 9

Why do insurers maintain credit ratings with rating agencies (3)

Answer 9

UNRATED INSURERS: agents are wary of unrated insurers
SOLVENCY ASSESSMENT: 3rd parties rely on ratings
EFFICIENCY: agents, underwriters, & regulators don’t have expertise to do their own rating

Question 10

Identify Best, Moody and S&P rating model /capital standard model

Answer 10

A.M. BEST:
- EPD (Expected Policy holder Deficit)
MOODY’S:
- use stochastic cash flows to model economic capital
STANDARD & POOR’S:
- PB (principles-based) models & ERM practices (Enterprise Risk Management)

Question 11

Describe A.M Bests’ rating model: expected policy holder deficit

Answer 11

Method:
EPD = $P / $V
$P = pure premium of treaty
$V = market value of reserves
SELECTION:
==> choose required capital so that EPD = 1%

Question 12

Describe Moody’s rating model: stochastic CF

Answer 12

Method:
Model is based on repeated simulations of loss distributions of separate risks

Time Horizon:
Project cash flows until liabilities are settled

Question 13

Describe S&P’s rating model: PB (principles-based)

Answer 13

Method:
Evaluate insurer’s ERM (Enterprise Risk Management) & internal capital model

Rating:
Weighted average of S&P & insurer capital assessment