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Effect of Reinsurance on Effect of Reinsurance on BCAR BCAR
Case StudyCase StudyCARe Seminar on ReinsuranceCARe Seminar on ReinsuranceMay 20, 2008May 20, 2008
Thomas M. Mount, ACAS, MAAAThomas M. Mount, ACAS, MAAAA. M. Best CompanyA. M. Best Company
OutlineOutline
Quick review of BCARQuick review of BCAR Baseline scenarioBaseline scenario Reinsurance “Solution”Reinsurance “Solution” What can possibly go wrong???What can possibly go wrong??? SummarySummary
Economic SurplusEconomic SurplusReported Surplus (PHS)Reported Surplus (PHS)Equity Adjustments:Equity Adjustments:
Unearned PremiumsUnearned PremiumsLoss ReservesLoss ReservesAssetsAssets
Debt Adjustments:Debt Adjustments:Surplus NotesSurplus NotesDebt Service Debt Service
RequirementsRequirementsStress Test Adjustments:Stress Test Adjustments:
Future Operating LossesFuture Operating LossesPotential Catastrophe Potential Catastrophe
Exp.Exp. OtherOther
Economic Surplus (APHS)Economic Surplus (APHS)
Net Required CapitalNet Required CapitalGross Required Capital (GRC):Gross Required Capital (GRC):
(B1) Fixed Income Securities(B1) Fixed Income Securities(B2) Equity Securities(B2) Equity Securities(B3) Interest Rate(B3) Interest Rate(B4) Credit(B4) Credit(B5) Loss and LAE Reserves(B5) Loss and LAE Reserves(B6) Net Premiums Written(B6) Net Premiums Written(B7) Off-Balance Sheet(B7) Off-Balance Sheet
Covariance AdjustmentCovariance Adjustment
Net Required Capital (NRC)*Net Required Capital (NRC)*
BCAR Ratio = Economic Surplus / Net Required Capital
*NRC= (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² +B7
BCAR - BCAR - Structural Structural
OverviewOverview
Minimum Minimum Capital Capital
RequirementsRequirementsRating LevelRating Level
Minimum BCARMinimum BCARA++A++ 175175A+A+ 160160AA 145145A-A- 130130B++B++ 115115B+B+ 100100B/B-B/B- 80 80C++/C+C++/C+ 60 60
Baseline Baseline ScenarioScenario
Monoline liability insurerMonoline liability insurer Writes in 3 statesWrites in 3 states 20+ year history20+ year history $2M per occurrence net retention $2M per occurrence net retention Softening market conditionsSoftening market conditions Current rating = A-Current rating = A- Historical BCARs 145, 140, 135 (prior Historical BCARs 145, 140, 135 (prior
yr end)yr end) Selected minimum required BCAR = Selected minimum required BCAR =
135135
Baseline Baseline ScenarioScenario
2007 YEw/o ASL
Reported Surplus 300,000Net Loss Reserves 600,000NPW 300,000
(B1) Fixed Income Risk 3,500(B2) Equities Risk 0(B3) Interest Rate Risk 6,000(B4) Credit Risk 2,700(B5) Reserve Risk 230,931(B6) Premium Risk 112,036(B7) Business Risk 0Gross Required Capital 355,167
Net Required Capital 257,986
APHS 330,042
BCAR 128
What to do?What to do?
Eliminate bad risks (re-underwrite)?Eliminate bad risks (re-underwrite)? File new (higher) rates?File new (higher) rates? Diversify into more states?Diversify into more states? Diversify into more lines?Diversify into more lines? Raise capital?Raise capital?
But I need help NOW !!!!!!
How About a How About a Reinsurance Reinsurance
Solution?Solution? Prospective Aggregate Stop LossProspective Aggregate Stop Loss
Coverage begins 1/1/08Coverage begins 1/1/08 Reduces NPW riskReduces NPW risk
$50M of limit in risk layer = 17% of $50M of limit in risk layer = 17% of NPWNPW
Attaches 10 points over the ELR of 80%Attaches 10 points over the ELR of 80% Low costLow cost
Increases BCAR Increases BCAR nownow
Benefit of ASLBenefit of ASL2007 YE 2007 YEw/o ASL w/ ASL
Reported Surplus 300,000 300,000Net Loss Reserves 600,000 600,000NPW 300,000 300,000
(B1) Fixed Income Risk 3,500 3,500(B2) Equities Risk 0 0(B3) Interest Rate Risk 6,000 6,000(B4) Credit Risk 2,700 2,700(B5) Reserve Risk 230,931 230,931(B6) Premium Risk 112,036 61,036(B7) Business Risk 0 0Gross Required Capital 355,167 304,167
Net Required Capital 257,986 240,271
APHS 330,042 330,042
BCAR 128 137
NPW RiskNPW RiskBEFORE ASL Adjustment
Capital RequiredLine NPW Factor Capital
Other Liability 300,000 0.373 112,036 1.00 Diversification Factor1.00 Growth Factor
112,036 Adjusted Required Capital
AFTER ASL AdjustmentCapital Required
Line NPW Factor Capital
Other Liability 300,000 0.203 61,036 1.00 Diversification Factor1.00 Growth Factor
61,036 Adjusted Required Capital
Origin of NWP Origin of NWP Risk Risk
Capital FactorsCapital FactorsLognorm(1.9607, 0.11756) Shift=-2.0183
0
1
2
3
4
5
6
-0.5 -0.4 -0.3 -0.2 -0.1 0 0.1 0.2 0.3 0.4
(Profit)/Loss % (All years)
1% in tail
breakeven
99%industry mean
Capital factor
NPW RiskNPW Risk
80% 80%
10%
17%
10%
37%
0%
20%
40%
60%
80%
100%
120%
140%
Before ASL After ASL
as of 12/31/07
Lo
ss &
LA
E R
atio
Retained Risk
Ceded Risk Layer
Retained Expected Losses
3 More Yrs Status 3 More Yrs Status QuoQuo
2007 YE 2008 YE 2009 YE 2010 YEw/ ASL w/ ASL w/ ASL w/ ASL
Reported Surplus 300,000 300,000 300,000 300,000Net Loss Reserves 600,000 600,000 600,000 600,000NPW 300,000 300,000 300,000 300,000
(B1) Fixed Income Risk 3,500 3,500 3,500 3,500(B2) Equities Risk 0 0 0 0(B3) Interest Rate Risk 6,000 6,000 6,000 6,000(B4) Credit Risk 2,700 2,700 2,700 2,700(B5) Reserve Risk 230,931 230,931 230,931 230,931(B6) Premium Risk 61,036 61,036 61,036 61,036(B7) Business Risk 0 0 0 0Gross Required Capital 304,167 304,167 304,167 304,167
Net Required Capital 240,271 240,271 240,271 240,271
APHS 330,042 330,042 330,042 330,042
BCAR 137 137 137 137
What could possibly go What could possibly go wrong???wrong???
Adverse Reserve Adverse Reserve Development Development
ScenarioScenario Limit used up on prior AY’s in CY 2010Limit used up on prior AY’s in CY 2010
$50M each for 2008, 2009, 2010$50M each for 2008, 2009, 2010 Recoverables increase $150M Recoverables increase $150M
Compounded by reinsurance dependence Compounded by reinsurance dependence factorfactor
Reserve risk analyzed pre ASLReserve risk analyzed pre ASL Revised assessment of Expected Loss for Revised assessment of Expected Loss for
NPWNPW Reduces credit to capital factorReduces credit to capital factor
Adverse Adverse Development Development
ScenarioScenarioStatus Quo Adverse2010 YE 2010 YEw/ ASL w/ ASL Change
Reported Surplus 300,000 300,000 0Net Loss Reserves 600,000 600,000 0NPW 300,000 300,000 0
(B1) Fixed Income Risk 3,500 3,500 0(B2) Equities Risk 0 0 0(B3) Interest Rate Risk 6,000 6,000 0(B4) Credit Risk 2,700 9,046 6,346(B5) Reserve Risk 230,931 288,508 57,577(B6) Premium Risk 61,036 112,036 51,000(B7) Business Risk 0 0 0Gross Required Capital 304,167 419,090 114,923
Net Required Capital 240,271 313,828 73,557
APHS 330,042 330,042 0
BCAR 137 105 (32)
Credit RiskCredit Risk
Asset AdjustedCredit Risk Statement Adjusted Risk Required
Value Adjustment Amount Factor (%) CapitalAgents' Balances
In Course of Collection 30,000 0 30,000 5.0 1,500
Reinsurance Recoverables (A)All Other Insurers 30,000 0 30,000 4.0 1,200Less: Funds Held By Company 0 0 0 4.0 0
Net Reinsurance Recoverables 30,000 0 30,000 4.0 1,200
Multiply: Reinsurance Dependence Factor (B) 1.00Adjusted Net Reinsurance Recoverables 30,000 0 30,000 4.0 1,200
Company Total 60,000 0 60,000 4.5 2,700
Notes:(A) - Includes ceded paid, case, IBNR, and unearned premium recoverables.(B) - Excessive Reinsurance Dependence:
Non-Affiliated Reinsurance Recoverables / PHSCompany 0.1Industry Expected 0.4
Excess 0.0
BEFORE Ceding Adverse Development to ASL
Credit RiskCredit RiskAsset Adjusted
Credit Risk Statement Adjusted Risk RequiredValue Adjustment Amount Factor (%) Capital
Agents' BalancesIn Course of Collection 30,000 0 30,000 5.0 1,500
Reinsurance Recoverables (A)All Other Insurers 30,000 150,000 180,000 4.0 7,200Less: Schedule F Provision 0 0 0 10.0 0
Net Reinsurance Recoverables 30,000 150,000 180,000 4.0 7,200
Multiply: Reinsurance Dependence Factor (B) 1.05Adjusted Net Reinsurance Recoverables 30,000 150,000 180,000 4.2 7,546
Company Total 60,000 150,000 210,000 4.3 9,046
Notes:(A) - Includes ceded paid, unpaid, IBNR, and unearned premium recoverables.(B) - Excessive Reinsurance Dependence:
Non-Affiliated Reinsurance Recoverables / PHSCompany 0.60Industry Expected 0.40
Excess 0.20
AFTER Ceding Adverse Development to ASL
Reserve RiskReserve Risk
600,000 600,000
90,000
112,500230,931
288,508
150,000
Before ASL Adjustment After ASL Adjustment
as of 12/31/2010
Do
llars
(0
00
s) Capital Charge
Deficiency
Ceded Layer
Booked Reserves
Reserve RiskReserve Risk Baseline Industry Reserve Capital Factor Calc.
0
0.5
1
1.5
2
2.5
-60% -40% -20% 0% 30% 60% 90% 120% (Favorable)/Adverse Reserve Development % of Original Reserves
1% in tail
zerodefic.
99%capital factor
Revised NPW Revised NPW RiskRisk
80%90%
37%
10%
17%17%
10%
0%
20%
40%
60%
80%
100%
120%
140%
160%
Prior View of ASL Credit Revised View of ASL Credit
Lo
ss &
LA
E R
ati
o
Retained Risk
Ceded RiskLayer
RetainedExpectedLosses
ELR=80%
ELR=107%
Prospective Stop LossProspective Stop LossRating/Capitalization Rating/Capitalization
IssuesIssues BCAR score initially improves due to the BCAR score initially improves due to the
transfer of risk to the reinsurertransfer of risk to the reinsurer Distorts true picture of risk when utilizedDistorts true picture of risk when utilized
Exposure bases understated (NWP & Reserves)Exposure bases understated (NWP & Reserves) BCAR distorted/understatedBCAR distorted/understated
Adds reinsurance recoverable credit riskAdds reinsurance recoverable credit risk Protects volatility but increases reins Protects volatility but increases reins
dependencedependence Short term solution to a long term problemShort term solution to a long term problem
SummarySummary
Understand what the contract is trying to doUnderstand what the contract is trying to do Understand the accounting of the contractUnderstand the accounting of the contract Understand the impact of that acctg on Understand the impact of that acctg on
BCARBCAR Make the appropriate BCAR adjustmentsMake the appropriate BCAR adjustments Need to update adjustments each yearNeed to update adjustments each year Any adjustments to assuming company?Any adjustments to assuming company? Commutation of these contracts also Commutation of these contracts also
requires adjustments to BCARrequires adjustments to BCAR Never allow rating to be more than 1 rating Never allow rating to be more than 1 rating
level above true picture before credit for risk level above true picture before credit for risk transfer transfer
Effect of Effect of Reinsurance on Reinsurance on
BCARBCAR
Questions/Questions/Comments?Comments?
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