BCAR 2018

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 the insurer (and its ability to meet ongoing obligations to policyholders).

Question 2

What is the BCAR formula?

Answer 2

BCAR = (AC - NRC) / AC x 100

where
AC = Available Capital
NRC = Net Capital Required

Note that these are calculated at 4 different VaR levels (95th, 99th, 99.5th and 99.6th percentiles).

Question 3

How is Available Capital (AC) calculated in the BCAR formula?

Answer 3

• Start with the B/S Reported Capital (surplus)

- then, make appropriate adjustments

Question 4

Identify the adjustments to B/S capital to obtain the BCAR AC (Available Capital).

Answer 4

EDO - > lura, sd, fig

Equity Adjustments:
- loss reserves
- unearned premium
- reinsurance
- assets
Debt Adjustments:
- surplus notes
- Debt servicing costs
Other Adjustments
- future operating costs
- intangibles
- goodwill

Question 5

Why isn’t the unadjusted reported capital used as the AC (Available Capital) value in the BCAR calculation?

Answer 5

Because, incorporating these adjustments provides for a more economic and consistent view of capital available.

Question 6

Identify the risk categories for BCAR. (8)

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 Risk:
- B7: Business risk

Question 7

What is the purpose of the covariance adjustment in the NRC formula?

Answer 7

• Reflects the statistical independence of 7 of the 8 risks components (B1-B6, B8).
• this independence reduces Gross Required Capital (GRC) because it’s unlikely that these 7 components will be near maximum levels simultaneously

Question 8

Why is B7 (Business Risk) not included in the covariance adjustment?

Answer 8

A.M. Best expects an insurer to maintain capital for business risk without the benefit of diversification.

Question 9

In the BCAR model, what is Gross Required Capital (GRC)?

Answer 9

The sum of the required capital for all 8 risk components (B1 - B8).

Represents the total capital required if all risks developed simultaneously.

Question 10

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

Answer 10

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

Question 11

Briefly describe how BCAR’s capital factors are derived.

Answer 11

• based on industry risk factors

- then, adjusted for the company volatility in case loss development

Question 12

Identify considerations other than BCAR score that impact Best’s balance sheet strength assessment. (8)

Answer 12

Q^2, SALAMI

• Quality of Capital
• Quality of Reinsurance
• Stress Testing
• Adequacy of Reserves
• Liquidity of Capital
• Actions of Affiliates (could be positive or negative)
• Matching of Assets and Liabilities
• Internal Capital Models (does the company have a good procedure for assessing its own capital needs?)

Question 13

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

Answer 13

BOB-ECL

• Balance Sheet Strength (based on BCAR score, but affected by Q^2, SALAMI)
• Operating performance
• Business profile
• Enterprise risk management
• Comprehensive adjustment
• Lift and/or Drag

Question 14

Identify characteristics that may tend to lower a company’s BCAR score.

Answer 14

• aggressive investment portfolio (increases NRC for investment risk categories (B1 - B3))
• loans to poor creditors or reinsurance with low rated reinsurers (increases NRC for credit risk category B4)
• reserve deficiency (increases NRC for reserve risk category B5)
• Rapid growth or high UW leverage (increases NRC for premium risk category B6)
• concentration of properties in an area prone to floods or EQs (increases NRC for catastrophe risk category B8)

Question 15

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

Answer 15

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

Question 16

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

Answer 16

to assess:

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

Question 17

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

Answer 17

The BCAR model permits qualitative adjustments to the final assessment to account for economic considerations:

• interest rate changes
• stage of UW cycle
• changes in reinsurance arrangements

Question 18

Describe 3 SIMILARITIES between the BCAR model and MCT.

Answer 18

• Purpose: asses a company’s financial strength and its ability to meet policyholder obligations
• Key Idea: apply capital risk factors to amounts of liability for different risk categories
• Covariance Adjustment: to account for the statistical independence between risk categories

Question 19

Describe 3 DIFFERENCES between the BCAR model and MCT.

Answer 19

Formula:
- BCAR: max is 100%, no minimum
- MCT: min is 0%, no maximum
Robustness:
- BCAR model is more robust because the final assessment includes qualitative economic considerations (such as the stage of the UW cycle)
Time Horizon:
- BCAR: capital must support current AND future premium risk
- MCT: focuses more on current year’s risk