Feld.RtAgs

Question 1

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

Answer 1

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 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

how rating agencies ensure consistency across insurers? (3)

Answer 3

• INFO-GATHERING: be consistent in (info-gathering, assessment guidelines)
• ECONOMIC CAPITAL: relate financial ratings to economic capital
• SEPARATION: the analysis & final rating should be issued by separate bodies
• Review ratings periodically

Question 4

Identify 3 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)
• Agencies hesitate to change rating too quickly
• Agencies may not be transparent with their methodologies

Question 5

Briefly explain the legislative response to criticism of rating agencies

Answer 5

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

Question 6

Define ‘interactive rating’

Answer 6

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

A costly, intrusive, but collaborative process between the insurer and the agency.

Question 7

Identify 2 advantages of interactive rating.

Answer 7

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 8

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

Answer 8

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 9

Briefly describe the 5 steps in interactive ratings by rating agencies

Answer 9

1. RESEARCH: by ratings analysts + insurer submits proprietary info
2. MEETINGS: between rating analysts & insurer’s senior management for
   presentations
3. PROPOSAL: lead ratings analyst prepares proposal + insurer may submit
   further info
4. DECISION: by ratings committee
5. PUBLICATION: to public & fee-paying subscribers

Question 10

Identify 3 examples where a high financial rating is particularly important

Answer 10

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 11

In interactive meetings, is the focus on qualitative or quantitative info?

Answer 11

Qualitative

Question 12

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

Answer 12

A.M. BEST:
- Focus: Overall financial strength ratings of insurers
- Model/Metric: EPD (Expected Policy holder Deficit) risk measure
MOODY’S:
- Focus:Debt ratings.
- Model: use stochastic cash flows, projecting cash flows forward until all liabilities are finally settled
STANDARD & POOR’S:
- Focus: Debt rating
- Model: PB (principles-based) models & evaluates ERM practices (Enterprise Risk Management)

Question 13

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

Answer 13

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

Question 14

Describe Moody’s rating model: stochastic CF

Answer 14

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

Time Horizon:
Project cash flows until liabilities are settled

They run thousands of simulations of future asset and liability cash flows. Capital is set based on Value at Risk (VaR) or Tail Value at Risk (TVaR) measures (e.g., 99th percentile)

Question 15

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

Answer 15

Method:
Uses a principles-based approach, evaluate insurer's ERM (Enterprise Risk Management) & internal capital model

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

Question 16

Why Rating Agencies are Essential (3)

Answer 16

Efficiency: Most parties (agents, policyholders, banks, courts) lack the expertise to assess an insurer's financial strength themselves.

Market Access: High ratings are often a prerequisite for writing business - ex: reinsurance, surety, homeowners insurance.

Third-Party Reliance: Banks, courts, and contractors rely on ratings to ensure the insurer can pay future claims. An unrated insurer is at a significant competitive disadvantage.