A.M.

Best Company
Overview, The Ratings Process and Why
Insurance Companies Fail

Angelo Lozano, ARe

Financial Analyst, A.M. Best Company
November 4, 2015

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Agenda

Parts
1. Company Overview
2. The Rating Process
3. Why Insurance Companies Fail

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Part 1
Corporate Overview

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Company Overview

A.M. Best is the oldest and most widely recognized

rating agency dedicated to the insurance industry.
Gained major recognition in the San Francisco
Earthquake of 1906.
3,500 ratings. 80 countries.
Offices in New Jersey, Washington, London, Hong
Kong, Singapore, Dubai, Mexico City.

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Part 2
Ratings Process

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Ratings Process
Primary objective is to provide an opinion of the rated entitys ability
to meet its senior financial obligations
Insurance policy and contract obligations
Analysis includes an in-depth evaluation of a companys balance
sheet strength, operating performance and business profile
Operating plans, philosophy, management, risk appetite, support
Top-down and bottom-up analysis
Top-down: risks generated at the parent/holding company
Bottom-up: risks generated by the operations of the entity itself
Incorporate a host of quantitative and qualitative measures that
evaluate various sources of risk to an organizations financial health
Underwriting/credit/interest rate/country and market risks
Economic and regulatory factors
Analysis also includes comparisons with peers, benchmarks
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Ratings Process

Key Components of Bests Credit Rating Evaluation:

1.
2.
3.
4.

Balance sheet strength

Operating performance
Business profile
Enterprise risk management

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Ratings Process

1. Balance Sheet Strength

Bests Capital Adequacy Ratio (BCAR)
Capital structure/holding company
Quality/soundness of reinsurance
Adequacy of loss reserves
Quality/diversification of assets
Liquidity

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Ratings Process

2. Operating Performance
Profitability
Historical
Prospective
Revenue composition/quality of earnings
Sustainability of earnings
Ability to meet planned projections

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Ratings Process

3. Business Profile
Market risk
Competitive advantages
Spread of risk
Event risk
Regulatory risk
Management experience and objectives

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Ratings Process

4. Enterprise Risk Management

An ongoing process to address risks and threats
Helps to identify opportunities to improve value
Holistic versus a silo approach
Responsive to all risks and opportunities
Relevant to your organization
Identify levels of responsibility
Ongoing commitment

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Ratings Process

4. Enterprise Risk Management (contd)

Risk management is the common thread that links
Balance sheet strength
Operating performance
Business profile
Risk management fundamentals can be found in a
companys
Strategic decision making process
Financial management and control practices
Daily operating procedures

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Ratings Process

4. Enterprise Risk Management (contd)

Insurers that create a structured, integrated risk framework can:
Increase the value of the firm
Provide financial security to the organization
What is A.M. Best looking for with your ERM process?
Stated risk tolerance
Delineated risk appetite
Established risk limits acceptable
Fully understand risks undertaken
AMB remains true to our original risk management criteria:
Risk management is not a separate process
Risk management is not risk avoidance
Risk management is viewed within the broader rating context
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Balance Sheet Strength

Ratings Process

Strong Operating
Performance Builds
Balance Sheet Strength

Business Profile Drives

Strong & Sustainable
Operating Performance

BCAR Guideline

Weak Operating
Performance Erodes
Balance Sheet Strength
Date of
last
balance
sheet

Presen
t

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Time

Futur
e

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Ratings Process

Country Risk Impact

Poor asset choices
Burdensome regulation
Inefficient legal system
Poor business infrastructure

Challenges unique to the

countrys operating environment
and must be explicitly addressed

Inadequate data
High vulnerability to financial crisis
High risk to financial strength
Inadequate regulation
without extraordinary preparation
(capital)
Opacity in Legal System
Societal Instability & Violence
Potential to be completely
destabilizing for any company
Government Corruption
Weak economic structure
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(Most companies would be in the

vulnerable range.)

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Ratings Process

Country Risk Impact

Country Risk - The risk that country-specific factors

could adversely affect an insurers ability to meet its
financial obligations
Sovereign Risk - The risk that a sovereign government
does not pay back its debts on time and in their entirety

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Ratings Process

Bringing It All Together

Balance sheet strength is most important
Sustained, stable operating profitability ensures future
strength
Well-diversified, strong business profile ensures
stability and profitability
Risk Management links strategy to factors above
Management depth, experience and stability
influences profile

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Ratings Process

Bringing It All Together

Company
Company Rating
Rating Meeting
Meeting Presentation
Presentation
BCAR
BCAR
Cash
Cash Flow
Flow

Asset
Asset Quality
Quality
Asset
Asset Liquidity
Liquidity

Balance Sheet Strength

Financial
Financial Lev/Flex
Lev/Flex

ALM
ALM

Loss
Loss Reserve
Reserve Model
Model // LRD
LRD
Actuarial
Actuarial Reports
Reports

STAT/GAAP
STAT/GAAP Statements
Statements
QAR
QAR

SRQ
SRQ

Company
Company Forecasts
Forecasts

Operating Performance

MD&A
MD&A

Enterprise Risk
Management

Business Profile
Geographic
Geographic Spread
Spread

Distribution
Distribution Channel(s)
Channel(s)
Event
Event Risk
Risk

Country Risk

Management
Management Team
Team

Lines
Lines of
of Business
Business

Growth
Growth

Rating
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Competitive
Competitive Analysis
Analysis Report
Report

Reins
Reins Program
Program

Risk
Risk Appetite,
Appetite, Tolerance,
Tolerance, etc.
etc.
Risk
Risk Impact
Impact Worksheet
Worksheet

ICM
ICM

Lift/Drag
Lift/Drag from
from Affiliates
Affiliates

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Ratings Process

Rating Types
Financial Strength Rating (FSR)
Opinion of an insurers financial strength and ability to
meet its ongoing insurance policy and contract
obligations.
Issuer Credit Rating (ICR)
Opinion of an insurers financial strength and ability to
meet its ongoing financial obligations.

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Ratings Process

Relationship of ICR to FSR

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Ratings Process

Relationship of ICR to FSR (contd)

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Cayman Islands Monetary Authority

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Ratings Process

A.M. Best Rating Indicators

Rating outlooks
Assigned with every rating
Indication of potential direction over an intermediate term, generally defined
as 12 to 36 months

Positive

Stable

Negative

Under review
Typically associated with a pending transaction or other
significant event that causes A.M. Best to re-evaluate rating
Short-term in nature typically, a rating is under review
no longer than 6 months

Positive
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Developing

Negative
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Ratings Process

Example of a Rating Outlook: Reinsurance

These
market
pressures
have led to
mergers
and
acquisitions

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Ratings Process

Example of a Rating Outlook: Reinsurance

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Ratings Process

The Analytical Process

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Ratings Process

The Analysts Role: Extensive and Exhaustive

Before Company Meeting
AMB point of contact
Set up annual review meeting
Thorough study of public data
Review of internal A.M. Best data
Review prior RC package and notes
Review all financial information including QAR and SRQ
Initial assessment of strengths and weaknesses
Agenda and guidance
Discuss thoughts with team leader
Meeting package reviewed if received in advance

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Ratings Process

The Analysts Role: Extensive and Exhaustive (contd)

At The Meeting
Assimilate and clarify information
Discussion and Q & A
Wrap up
Additional information requests
Pressure points
Advance notice of possible rating action, outlook change, or
affirmation
Initial timeline for rating conclusion
Feedback on presentation materials

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Ratings Process

What Information Do A.M. Best Analysts Review?

Public
Financial Statements
Stockholder/Policyholder Reports
Public Filings & Offerings
Audit Reports
Insurance Exam & Market Conduct
Reports
Regulatory Filings
MD&A

Private
Management Meetings- CEO, COO,
CFO, CUO, CIO
Business Plans/Projections
Bests Supplemental Rating
Questionnaire (SRQ)
Actuarial Memorandums
Cash Flow Testing
Capital Structure and Plans
Investment and Credit Guidelines
Reinsurance Guidelines
Catastrophe Exposures
Enterprise Risk Management Metrics
Internal Capital Models

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Ratings Process

Prepare for Rating Meeting: Agenda

CEO Strategic Overview
Corporate Governance
Organizational Structure
Capital Structure
Underwriting
Marketing & Business Production
Reserving/Product Overview
Reinsurance Programs
Investments
Financial Review & Planning
Enterprise Risk Management

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Ratings Process

Prepare for Rating Meeting: Company Presentation

What should you expect of A.M. Best?
Industry perspective and feedback
Regulation, peers, emerging issues, etc..
Summary of issues and impact on ratings
Q/Q observations, financial trends, etc
Feedback on presentation materials
Acceptable or needs improvement/deficiency
May need follow-up call to resolve any open items
Six weeks to conclude on ratings

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Ratings Process

Prepare for Rating Meeting: Company Presentation

What A.M. Best expects of the company?
Prepare for an interactive dialogue
Balanced discussion of key strategies and their impact on the
companys financial
Highlight any concerns and challenges:
Balance sheet/operating performance/business profile
Discussion of any significant transactions, other material
events

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Ratings Process

Key Rating Tools Used in Review

Supplemental Rating Questionnaire (SRQ)
Quantitative Analysis Ratios (QAR)
Statutory/GAAP financial reports
Actuarial reports including CFT and ALM
Investment allocation and performance analysis
Best Capital Adequacy Ratio (BCAR)
MD&A
Meeting notes and company presentation
Reviews peer standings and competitive market position
ERM analysis

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Ratings Process

After the Meeting: Analysts Perspective

Follow-up information / meeting/
Discuss timelines
Complete analysis
Top down Bottom up approach
Peer analysis
Stress test projections
Rating Committee recommendation
Arrive at a rating decision
Communicate rating and key drivers
Annual report update/press release

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Ratings Process

Ongoing Dialogue with Companies

Dialogue should be on-going
No surprises on either side!
Keep your analytical team in the loop in any material decline in
capital, operating results, business profile or potential M&A
Company should be aware of potential rating outcomes
Discuss methodologies to gain insight

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Ratings Process

FAQs
What are the current guidelines A.M. Best uses to convert
BCAR to a rating?
BCAR by itself is insufficient as the sole basis for
determining the final rating
Risk-adjusted capital is one of many factors considered in
assigning an A.M. Best rating
The process also considers:
Other factors that impact Balance Sheet Strength
Operating Performance
Business Profile
Enterprise Risk Management
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Ratings Process

FAQs
Our performance in recent years has differed from the
projections we provided to our analyst. How might this impact
our rating?
Credible financial projections are important given the
forward-looking nature of the rating process
Your analyst may make changes to your projections for use
in the analytical process, particularly if there isnt a clear
understanding of how they will be achieved
General requirement is current year + 1; additional years
may be requested based on circumstances

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Ratings Process

FAQs
What are the current guidelines A.M. Best uses to convert
BCAR to a rating?
BCAR by itself is insufficient as the sole basis for
determining the final rating
Risk-adjusted capital is one of many factors considered in
assigning an A.M. Best rating.
The process also considers:
Other factors that impact Balance Sheet Strength
Operating Performance
Business Profile
Enterprise Risk Management
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Ratings Process

FAQs
What role does size or concentration (product or geographic)
play in my rating?
Business Profile, including product mix and geographic
scope, is just one of the factors considered in the rating
process
Generally speaking, companies with more diverse
operations generate more consistently favorable results
True specialization in a niche may offset concern about
concentration, where a company has a demonstrated track
record and leadership position in that niche

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Ratings Process

FAQs
Will my analytical team share their recommendation to the
rating committee with me in advance?
Analysts generally do not share individual opinions
Analyst should:
Discuss key drivers of the rating prior to committee
Allow company to respond to concerns
Provide likely range of outcomes
Goal is to eliminate any surprises in rating process

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Ratings Process

FAQs
What options does my company have if we do not agree with
the rating committee decision?
Initial ratings can be declined by the company
Companies have a right to appeal committee decisions,
including initial ratings
Appeal requires that material new or additional information
that was not available when the committee made the
decision be provided
Must be presented shortly after rating notification
Reasonably be expected to influence R/C determination
If material deemed sufficient, rating release withheld
until R/C reconvened
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Ratings Process

FAQs
Due to scheduling issues, our management team will not be
able to have our annual rating meeting in person this year.
Will this have any negative repercussions?
An annual in-person meeting is not required
Periodic in-person meetings at company location are a
standard part of the process
Otherwise, rating meetings can be held at A.M. Best or in
another location or by phone or video conference
If you would like to schedule a video conference, please let
your analyst know as soon as possible, so the facilities can
be scheduled

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Part 3
Why Insurance Companies Fail

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Why Insurance Companies Fail

1. What causes companies to fail?

2. Which companies tend to fail most?
3. Recent examples of failures?

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Why Insurance Companies Fail

1. What causes companies to fail?

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Why Insurance Companies Fail

1a. Deficient Loss Reserve/Inadequate Pricing

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Why Insurance Companies Fail

1b. Deficient Loss Reserve/Inadequate Pricing

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Why Insurance Companies Fail

1c. Deficient Loss Reserve/Inadequate Pricing

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Why Insurance Companies Fail

2. CAT Losses

Five Year Rating History

Date
FSR
2009
B
2010
B
2011
B
2012
C++
2012
E

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Why Insurance Companies Fail

2. CAT Losses

Erosion of Capital Caused by:

Frequent tornado/hail losses in Missouri and
Wisconsin
Pension plan liability

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Why Insurance Companies Fail

2. CAT Losses

P&C Catastrophe Examples:

Hurricanes
Typhoons
Tsunamis
Earthquakes
Tornados

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Why Insurance Companies Fail

2. Which companies tend to fail most?

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Why Insurance Companies Fail

3. Recent examples of failures?

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Angelo Lozano
Financial Analyst
A.M. Best Company
908-439-2200 x.5169
angelo.lozano@ambest.com

Questions?

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