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transcript
Risk. Reinsurance. Human Resources.
Aon Benfield
Evolving CriteriaRating agency, regulatory, and financial trends
September 2015
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1
Industry Outlooks & Rating Activity . . . . . . . . . . . . . . . . . . . . . . . .2
Rating Criteria Updates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4A.M. Best . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Standard & Poor’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Moody’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Fitch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Demotech . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Regulatory Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Europe, the Middle East, and Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Caribbean . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Accounting Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21International accounting standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Development of global Insurance Capital Standard . . . . . . . . . . . . . . . . . 21
Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22
Financial Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24Operating performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Capital adequacy continues to grow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
Public company benchmarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Enterprise Risk Management Trends . . . . . . . . . . . . . . . . . . . . . .26Risk tolerance statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Catastrophe Risk Tolerance Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Stress scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Looking Forward: Key Topics for 2015 and 2016 . . . . . . . . . . . .28
Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
Contents
Aon Benfield 1
Introduction
Evolving Criteria provides a summary of key global rating agency criteria and regulatory developments over the last year. The report also explores accounting developments, mergers and acquisitions activity in the insurance sector, financial and capital adequacy trends, enterprise risk management, as well rating agency and regulatory themes for 2016.
Key topics addressed include:
All four rating agencies have a negative
outlook on the reinsurance sector
Rating movements by A.M. Best and Standard
& Poor’s have decreased significantly in 2014
and 2015 compared to the years prior where
severe weather volatility and the financial
crisis played roles in many downgrades
Rating agencies issued new or updated criteria
— A.M. Best released details of some components
of their stochastic-based BCAR model at their
conference in March 2015, followed by a series
of webinars, and we expect a draft model will be
released in the fourth quarter of 2015
— Cyber security is an important area of focus;
A.M. Best released a set of questions that all
companies should plan to answer
— Standard & Poor’s and Moody’s released criteria
for mortgage insurance companies
— Fitch expanded their use of their Prism model to
Asia Pacific companies and finalized changes to
their notching criteria
— Demotech released an update regarding credit for
catastrophe bonds
Global regulatory updates:
— Increasing regulatory standards is a theme globally
— Solvency II will be effective on January 1, 2016 for
insurers and reinsurers in the European Union
— Risk-based capital models are continually growing
in importance and evolving
— Own Risk Solvency Assessment reporting is a
common framework
Capital adequacy, as measured by rating
agency models, continues to grow
Companies are working to define
enterprise risk management stress scenarios
and risk tolerance statements
The industry is rapidly changing with increased
technology, altered distribution channels, large scale
merger and acquisition deals, and alternative capital
moving into the sector. Both rating agencies and
regulators continue to evolve as well. The impact of
rating agencies is well understood in the industry
and changes in their criteria are of key interest to the
companies they rate.
2 Evolving Criteria
The rating environment for US property casualty insurers continued its stable trend as all industry outlooks have remained unchanged during the past year. The reinsurance sector is viewed with a negative outlook by the four major rating agencies.
A.M. Best noted the reinsurance sector experienced
significant declines in pricing in 2014, and pressure will
remain throughout 2015. Intense competition is leading
to thinner underwriting margins while the sector remains
overcapitalized. As reinsurers need increased scale and
diversification in order to remain competitive and profitable,
A.M. Best believes the merger and acquisition trends in 2014
will continue and global companies will only get larger.
Standard & Poor’s echoes a similar negative outlook rationale
and believes earnings will suffer as a result of material price
reductions. In addition, Standard & Poor’s indicated that
the negative pricing trends could lead to a reassessment of
reinsurers’ competitive position on capital and earnings.
With the exception of the negative outlook by A.M. Best
on commercial lines, the rating agencies maintain a stable
view of the US property casualty sector. This is driven by
a combination of insurers’ commitment to underwriting
discipline and profitability, very strong capitalization, and
conservative investment portfolios despite the low interest
rate environment. Industry outlooks for US personal and
commercial lines have remained unchanged since last year.
A.M. Best continues to remain the sole rating agency with a
negative outlook on the commercial sector, despite noting
improved market conditions and pricing. They believe
underwriting results will be insufficient to overcome the
headwinds that the industry faces. A.M. Best indicated
that while they expect the majority of commercial carriers
to have their ratings affirmed, they expect more negative
rating actions than positive in 2015. Reserve adequacy,
low returns on fixed-income investments, and emerging
issues like terrorism and cyber risk are the main concerns.
The personal lines outlook remains stable for all four rating
agencies. Although the segment was profitable in the last
year, results for 2014 declined slightly relative to prior years
due to slightly higher loss ratios. The segment continues to
be well capitalized and has increased surplus for the sixth
consecutive year, driven by underwriting profitability and
consistent net investment income. Favorable performance is
attributed to stable auto results and low catastrophe losses.
Exhibit 1: Current industry outlooks
Sector A.M. Best Fitch Moody’s S&P
Commercial Negative Stable Stable Stable
Personal Stable Stable Stable Stable
Reinsurance Negative Negative Negative Negative
Source: Respective rating agency reports
In 2015, the number of A.M. Best rating changes has increased
slightly from the same time period last year. Downgrades are
outpacing upgrades for the year, contrasting last year’s trend.
For both A.M. Best and Standard & Poor’s, 2014 ended with
upgrades outpacing downgrades for the first time since 2010,
although the total number of rating actions has declined
significantly. From a personal lines perspective, favorable
operating metrics resulted in the majority of ratings being
affirmed with stable outlook. Some rating volatility occurred
for companies that write non-standard auto, which is consistent
with previous year trends. Excessive growth and deteriorating
operating performance were the primary reasons for downward
rating movement. In the commercial lines segment, the
majority of companies also had their ratings affirmed. Drivers
of positive rating actions include improved earnings and
strong capital position, while drivers of negative rating action
include adverse development and decline in capitalization.
Industry Outlooks & Rating Activity
Aon Benfield 3
Exhibit 2: Rating activity: upgrades vs. downgrades
*Note: YTD 2015 as of July 1, 2015 Source: A.M. Best and Standard & Poor’s
Aon Benfield completes an annual study of A.M. Best “A-” rating
activity for US companies in order to analyze financial rating
drivers and identify key benchmarks. For many companies, an
“A-” rating is a key rating threshold, and given A.M. Best’s market
presence and the availability of US statutory financials, there is
credible data available to analyze the underwriting trends.
From 2010 to June 2015, 46 companies were downgraded from
“A-” to “B++”. The median five-year combined ratio based upon
the year of downgrade was 113 percent, and the median BCAR
was 180 percent. Poor underwriting results and subsequent
deterioration of capitalization drove the negative rating action.
Conversely, for companies upgraded from “B++” to “A-” based
on their own merit (i.e., no parental support), the median five-
year combined ratio was 94 percent, or 5 percentage points
better than the overall “A-” population.
In addition to producing favorable underwriting results,
increased emphasis is placed on management’s ability to
execute their business plan and meet projections. Companies
whose ratings were downgraded often consistently missed
projections provided to A.M. Best, which undermines the
credibility of future initiatives.
Exhibit 3: A.M. Best “A-” upgrade and downgrade characteristics
Key metrics—median
“A-” to “B++” downgrades
(year of downgrade)
All “A-” ratings
(as of July 2015)
“B++” to “A-”
own merit upgrades
5yr Combined ratio (%) 113 99 94
5yr Pre-Tax ROR (%) -5 7 15
NPW / PHS (x) 1.2 0.6 0.7
BCAR (percent) 180 295 280
Source: Aon Benfield Analytics, A.M. Best Bestlink Database
0
10
20
30
40
50
60
70
80
90
100
YTD 2015*
20142013201220112010200920082007
Upgrades Downgrades
0
2
4
6
8
10
12
14
16
18
20
YTD 2015*
20142013201220112010200920082007
Upgrades Downgrades
A.M. Best Standard & Poor’s
4 Evolving Criteria
A.M. BestA.M. Best is expected to issue draft criteria for the new,
stochastic BCAR model in October with a lengthy comment
period and potential implementation by the third quarter of
2016. The first model released will be the US property casualty
statutory model. A.M. Best will also release criteria for the
US life and health, Title, Universal, and two Canadian BCAR
models in the months following. All six BCAR models will be
adopted concurrently.
The overall structure of the model is not intended to
change materially, but the goal is to generate risk factors
using stochastic simulations from probability curves at
various confidence internals—98%, 99%, 99.5%, 99.8%,
and 99.9%. Exhibit 4 shows the layout of the new Stochastic
BCAR model. The model was last updated more than 18
years ago. The availability and application of new and more
sophisticated technology coupled with evaluating capital
adequacy across consistent confidence intervals provides a
more robust perspective of insurer balance sheet strength.
Rating Criteria Updates
The most significant criteria update is the pending release of A.M. Best’s long-awaited stochastic BCAR model. A.M. Best released details of some components of the model at their conference in March of 2015, followed by a series of webinars. The draft model has not been released and is expected in the fourth quarter of 2015. Standard & Poor’s and Moody’s released criteria for mortgage insurance companies. Fitch expanded their Prism model for Asia Pacific companies and finalized changes to their notching criteria. Demotech released an update regarding credit for catastrophe bonds.
Analyzing and testing model output
Issue Request for Comment on property casualty model
Release criteria
Industry webinars on
progress
Finalize and test other BCAR models
(life and health, Canadian, Title,
and Universal)
Receive and evaluate industry feedback
Review historical
trends under new
model
Transition to new model
Share draft model output with companies
Issue Request for Comment on other BCAR models
Timeline is subject to change based upon model testing results and level of industry feedback
Q4 2015
Q3 2016Q1 2016Q2 and Q3 2015
Q2 2016
Aon Benfield 5
Exhibit 4: Stochastic BCAR layout
Confidence intervals = 98%, 99%, 99.5%, 99.8%, and 99.9%
B1: Fixed income Risk factors to increase and will vary more by credit quality and duration
B2: Equity securities Common stock risk factor more than doubles (34 to 48%)
B3: Interest rate risk Based on gross PML; May incorporate varying levels of change in interest rates
B4: Credit risk Risk factor on recoverables to reflect tail (e.g., property versus work compensation)
B5: Reserve risk Risk factors vary by confidence interval; Diversification from correlation matrices
B6: Premium risk Risk factors vary by confidence interval; Diversification from correlation matrices
B7: Business risk
B8: Catastrophe risk All Perils Occurrence net PML after-tax; To vary by confidence interval
Gross required capital Sum of B1 to B8
Covariance adjustment Remain the same for now; B8 to be outside the covariance formula
Net required capital Denominator = Gross required capital minus Covariance
Reported surplus Equity
Stress event Occurrence net PML, after-tax; For stress BCAR analysis only
Other adjustments Loss reserve equity, fixed income equity, etc.
Adjusted surplus Numerator: Equity plus adjustments
BCAR score Score = Adjusted surplus / Net required capital Source: A.M. Best
A.M. Best indicated they intend to publish the BCAR scores
across all five confidence intervals and have determined the
financial strength rating mapping in relation to each interval,
see exhibit 5. A.M. Best expects to update the model in phases.
Phase 1 will include updated stochastic factors for bonds,
common stock, reinsurance recoverables, premium and reserve
risk, as well as the new measurement of catastrophe risk. Phase 2
will update the remaining asset classes like preferred stock, real
estate, and mortgage loans, as well as the life and annuity risks.
The catastrophe charge is expected to have the biggest
impact for many companies. The return period will
vary by confidence interval and higher rated companies
(A- or above) are expected to have more tail coverage.
Exhibit 5: Mapping by rating level
Confidence Interval 98% 99% 99.5% 99.8% 99.9%
Rating level B B+ / B++ A- / A A+ A++
Catastrophe charge 50yr 100yr 200yr 500yr 1,000yr
Source: A.M. Best
Currently, A.M. Best includes the net retention of the greater
of a 1 in 100 wind event or a 1 in 250 earthquake event,
both on an occurrence basis. In March 2015, A.M. Best was
considering using an aggregate, all-perils TVaR metric and
the rest of the model would have been on a TVaR basis. A.M.
Best changed the plan in May and announced they will use
an occurrence, all-perils VaR view of catastrophe risk and for
consistency, will switch to VaR for the other model components.
The catastrophe risk measure will be moved to the
denominator of the BCAR calculation as opposed to the
current practice of subtracting it from surplus, so the capital
position or the numerator is the same for all confidence
levels. A.M. Best commented that there will continue to
be a catastrophe stress test. Exhibit 6 summarizes the
evolution of the catastrophe risk charge over the last year.
6 Evolving Criteria
Exhibit 6: Catastrophe risk charge evolution
Category Current Approach Initial Proposed March 2015 Current Proposed May 2015
Peril Peak Peril All Perils All Perils
Return Period 100yr HU/Wind or 250yr EQ Vary by confidence interval (20yr, 40yr, 100yr, etc.)
Vary by confidence interval (50yr, 100yr, 200yr, etc.)
VaR or TVaR VaR (loss at a specific return period) TVaR (avg of losses beyond a return period) VaR
Agg or Occ Occurrence Aggregate Occurrence
BCAR Impact Reduction to surplus Addition to net required capital Addition to net required capital Source: Aon Benfield Analytics
Bond default risk factors will be based on an economic
scenario generator with inputs reflecting a company’s
duration and asset quality as provided in the supplemental
rating questionnaire (SRQ). Common stock default risk
factors will be based on an economic scenario generator
with inputs reflecting the type of stocks held by a
company based on the beta provided in the SRQ.
A.M. Best saw significant increases in these asset risk factors,
particularly in equities. They noted that the investment charge
increases have been tested on property casualty companies and
there is no material impact for most, however companies with
high equity concentrations may be impacted adversely.
Exhibit 7 by A.M. Best shows the average risk factors for a
sample of property casualty companies compared to the
current model. The public common stock baseline factor
increases from the current 15 percent to 43.8 percent at
the 99.5% (A/A-) confidence interval and 48.3 percent at
the 99.9% confidence interval (A++). Schedule BA assets or
alternative investments will receive a starting charge of
60 percent at all confidence intervals (increased from the
current 20 percent) unless further reviewed by an analyst.
Exhibit 7: Stochastic model investment charges
Asset Risk Factor Current VaR 98 VaR 99 VaR 99.5 VaR 99.8 VaR 99.9
US Gov’t 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
NAIC Class 1 Bonds 1.0% 1.2% 1.5% 1.7% 2.0% 2.4%
NAIC Class 2 Bonds 2.0% 5.4% 6.2% 6.8% 7.5% 8.4%
NAIC Class 3 Bonds 4.0% 10.0% 11.0% 11.8% 12.8% 13.7%
NAIC Class 4 Bonds 4.5% 23.3% 24.7% 25.8% 27.0% 27.8%
NAIC Class 5 Bonds 10.0% 37.6% 38.3% 38.9% 39.5% 39.9%
NAIC Class 6 Bonds 30.0% 45.5% 46.6% 47.5% 48.3% 49.2%
Public Common Stocks 15.0% 33.9% 39.1% 43.8% 47.3% 48.3% Source: A.M. Best
Aon Benfield 7
Risk charges for reinsurance recoverables will reflect the
type of recoverable, the duration of recoverables up to 30
years, and the rating of each reinsurer. The model simulates
10,000 impairment scenarios for each reinsurer and only uses
impairments occurring during the first 10 years. The amounts
will also be measured at present value. As an example,
recoverables on workers’ compensation, long tail, losses will
be subject to a higher risk charge than property, short tail,
losses. A.M. Best commented that the charges are slightly
higher than the current model, depending on the reinsurer
and the duration of the liabilities. However, the combination
of discounting and assuming no impairments beyond 10 years
has reduced the initial charges slightly. A.M. Best noted they
will incorporate a risk charge for concentration of recoverables
from a reinsurer. Credit will continue to be provided for
collateral on reinsurance recoverables.
Property casualty premium and reserve risk factors will begin
with 84 industry probability curves (21 Schedule P lines and
four size categories for each—very small, small, medium,
and large). The size categories are based on a company’s
net premium written or net reserves in each line of business.
The curves will be made company specific based on their
profitability for premium, or volatility for reserves. Ten thousand
underwriting profit and loss scenarios will be simulated for each
line of business. Diversification for premium and reserve risk
will be based upon correlation matrices. A.M. Best noted that
the auto risk factors are lower than the current BCAR, which
is not surprising due to changes in the auto line of business in
the last 20 years. They also stated that workers compensation,
general liability, and medical professional liability are slightly
higher under the new stochastic model than the current model.
A.M. Best will continue to incorporate a catastrophe stress test.
The goal is to see what a company looks like after a catastrophe
event occurs. A.M. Best intends to incorporate this by using the
same event and return period for each confidence interval and
subtracting the retention (plus any reinstatement costs, net of
tax) from surplus. Therefore, surplus would continue to remain
the same for the catastrophe stress test by confidence interval.
This is done in conjunction with the B8 charge described above.
A.M. Best reinforced that BCAR will remain only one component
of the overall rating assessment; although as their key metric
for balance sheet strength, it is a very important measure
companies use to set capital management strategies.
In addition, given the overhaul of the BCAR model, scores
from the new BCAR model are not directly comparable
to the current model. For example, if a company’s current
BCAR score is 300 percent and the new BCAR ratio at the
99% confidence interval is 200 percent, it will not be viewed
as a 100 point drop in BCAR as the model results are not
comparable. In fact, it will indicate the company’s capital
adequacy is very strong at the 99% confidence interval (double
the required capital), but the key and new perspective will
be capital adequacy at the higher confidence intervals.
Companies we believe that are most at risk from a change to the
BCAR model are those with lower current BCAR scores relative
to their rating level as there is less room to absorb the impact
of more conservative factors, especially at higher confidence
intervals. In addition, higher rated companies (A- or above)
whose current catastrophe reinsurance program exhausts
near the 100-year return period will likely see a material drop
in capital adequacy at higher confidence intervals, which will
influence A.M. Best’s view of their balance sheet strength.
Cyber security
A.M. Best has increased its focus on the emerging trends
surrounding cyber security and views it as an essential element
of enterprise risk management. Companies are now asked
to complete a new section of the SRQ reflecting what each
company is offering and the amount of protection purchased.
A.M. Best stated that it will seek answers to additional questions
regarding susceptibility to cyber attacks and measures in
place if an incident occurs, see Exhibit 8. Companies that
offer cyber security insurance are also requested to disclose
specifics about their policies, including policy limits, expected
losses, and policy type as separate versus bundled.
Other updates
From September 2014 through August 2015, A.M. Best
released nine criteria updates and currently has three draft
criteria in a request for comment period. Most updates are
minor changes to existing criteria and are not considered
material. While these updates offer minimal impact to the
overall industry, there are three significant updates applicable
to specialty insurers and insurance-linked securities.
8 Evolving Criteria
Exhibit 8: Sample A.M. Best inquiries on company’s cyber risk management
1 Has your company been a target of data breach or cyber attack?
8 During the past five years, how much have you invested in upgrading hardware and software systems?
2 If yes, how many times and how quickly were they identified? 9 How much of such investment was specifically dedicated to preventive measures on cyber attacks and data breaches?
3 What remedial measures were taken? 10 How much are you planning to invest during the next two years?
4 Where does the responsibility to manage cyber security reside? 11 If you use TPA’s, cloud, shared devices, storage or otherwise, how are you managing their risks?
5 What internal and external controls, and policies and procedures do you have in place to manage a data breach or cyber attack?
12 Briefly describe your efforts to ensure up to date “best practices” and latest preventive methods are used.
6 How often do you conduct penetration testing? 13 Do you buy cyber security insurance for your company?
7 How often do the company’s cyber security professionals receive training?
14 If yes, what are the policy limits and what is covered and excluded under such policy?
Source: A.M. Best
In March 2015, A.M. Best released draft criteria titled Rating
Residual Value Insurance. The report introduces factors specific
to the residual value insurance book of business, particularly
the calculations of loss reserve risk and premium risk, which
are dependent upon asset quality. While risks of most insurers
are mainly independent, physical assets underwritten by
insurers tend to be correlated in nature. For example, aviation
and shipping industries are highly correlated because they are
dependent upon global GDP. This results in a positively skewed
loss distribution with significant tail risk. A.M. Best assesses
the loss distribution based on the specific risks being insured.
The criteria also highlights the use of Monte-Carlo simulations
for claims and a modification to the covariance formula to
consider the correlation between investment and reserve risk.
In September 2014, A.M. Best finalized criteria titled Rating
Reinsurance/Insurance Transformer Vehicles that focuses on the
unique characteristics of transformer vehicles. A key aspect
to the rating process is conducting a risk analysis based on
the type of vehicle, as well as the instrument and mechanism
being employed. A.M. Best requires a detailed report
outlining loss sensitivity analysis, projected premium and
loss ratios, and attachment and exhaustion probabilities.
For insurance-linked securities, A.M. Best published Insurance-
Linked Fund Ratings (ILFR) in December 2014. These differ
from issuer ratings since insurance-linked funds have little
to no risk of default.
The ratings reflect A.M. Best’s judgment on an insurance-
linked fund’s vulnerability to losses and credit quality. Funds
may include surplus notes, catastrophe bonds, loss warranties,
and various other securities. The three main determinants of a
fund’s ILFR are the attachment probability, fair value of assets
and liabilities, and term to maturity.
Standard & Poor’sStandard & Poor’s has released seven criteria reports since
September 2014, many of which provide minor changes
and refined discussions. These include updates to the
treatment of operational leverage, capital charges for
residential and commercial mortgage-backed securities,
and special considerations given to title insurance
companies. Standard & Poor’s also addressed its view of
life insurance reserves in the US, more specifically, how
they treat affiliated reinsurers. In general, Standard &
Poor’s analyzes reserves on a consolidated basis unless an
affiliated reinsurer is considered sufficiently isolated.
The most impactful update applies specifically to mortgage
insurance companies and insurers that write a significant
amount of mortgage business. In March 2015, Standard
& Poor’s issued criteria on an updated model to analyze
capital adequacy for mortgage insurers. The capital model is
applied within Standard & Poor’s broader insurance criteria
framework. Specific considerations are now given to the
Insurance Industry and Country Risk Assessment (IICRA),
competitive position, capital and earnings, and liquidity.
Standard & Poor’s assesses capital and earnings based on a
specific mortgage insurance (MI) capital adequacy model.
The model output remains the same as the general model
Aon Benfield 9
where adjusted capital is compared to required capital, and
is determined to be either redundant or deficient at various
target rating levels. The following are key considerations
Standard & Poor’s uses to determine MI capital adequacy.
Standard & Poor’s uses a 10 year profit and
loss statement projection period as the basis
for the mortgage insurance model
Capital charges reflect individual loan characteristics such
as: vintage, loan-to-value, credit score, employment,
product type, loan type, property type, and occupancy
Capital charges also consider the following regional
attributes: market structure characteristics, regulatory
environment, borrower recourse, and funding sources
Moody’sIn October 2014, Moody’s published revised rating
methodologies for global reinsurers, title insurers, trade
credit insurers, and US health insurance companies. In April
2015, they released an update relating to mortgage insurers.
The updates offer more clarity concerning rating action due
to sovereign credit quality and parental/affiliate support.
Specifically, an insurer’s relation to sovereign risk is analyzed
based on geographic diversification, government debt, and
lines of business. Companies that Moody’s views favorably
in these categories could have an insurer financial strength
(IFS) rating of up to two notches above the sovereign. Factors
regarding parental support include level of commitment, brand
name distribution, operating company size compared to the
group, geographic vicinity, type of ownership, and integration
with group level operations. Moody’s generally elevates a
company’s IFS rating one or two notches, with the potential
of three or more notches if there is strong explicit support.
FitchFollowing the release of Prism Factor-Based Model for
Europe, the Middle East, and Africa insurers in September
2014, Fitch launched the model for Asia Pacific companies
in May 2015. The model will be used as the primary tool
to assess an insurer’s capital strength and will enable the
agency to use a single framework to compare companies
in different regions using distinct accounting methods.
While part of Asia Pacific, companies in Indonesia and
Sri Lanka will not be subject to the model until later in
2015 due to specific risk characteristics. There is currently
no time frame for implementation in Latin America.
In July 2015, Fitch finalized changes to notching criteria
due to regulatory changes in Europe and other markets
subject to the Solvency II framework. Areas with little
regulatory changes, such as the US, will not be meaningfully
impacted. Many rating changes are anticipated outside the
US, with most limited to one notch. Fitch projects that the
majority of European holding companies will experience
a one notch upgrade in the issuer default rating.
The new criteria define regulation as group solvency, ring
fencing, or other, with the latter two demonstrating strong
regulation. This results in more geographically defined ratings.
Group solvency—operating level and
group level capital requirements
Ring fencing—operating company only
Other—limited capital and solvency requirements
At the holding company level, a one notch reduction to the
issuer default rating will only take place under group solvency at
non-investment grade levels, while a one or two notch drop will
occur if the regulatory environment is ring fencing. No notching
will take place if the regulatory framework is determined to be
other. For operating companies, Fitch will base the IFS ratings
one notch above the issuer default rating if regulation is strong.
DemotechIn December 2014, Demotech released an update regarding
credit for catastrophe bonds. Demotech noted that catastrophe
bonds have become more prevelant in reinsurance programs
and outlined information they require for their review. If a
Demotech rated company utilizes a catastrophe bond in its
reinsurance program, Demotech requires the following:
A management narrative on factors considered
in issuing a catastrophe bond
A fully executed copy of the Reinsurance Agreement
A fully executed copy of the Reinsurance Trust Agreement
A management narrative on the replacement
of the catastrophe bond should an early season
storm exhaust the catastrophe bond
Structure chart of the reinsurance program
displaying and describing the catastrophe bond
Additionally, Demotech requires that the event trigger be
indemnity based (no basis risk). Investment guidelines must
include restrictions for holding highly liquid, investment grade
only securities as stipulated in the Reinsurance Trust Agreement.
10 Evolving Criteria
Regulatory developments remain an important topic for companies globally. Regulators continue to increase capital requirements by raising minimum capital standards, creating or refining capital models, and expanding their reviews to assess companies’ risk management practices. This section reviews key regulatory developments by region.
North AmericaFirst required filings of Own Risk Solvency Assessment (ORSA) summary reports are due before the end of this year for non-exempt
companies domiciled in states that already have legislation passed. As of the publication release date, 35 states, up from 19 a
year ago, adopted the model act and three states have actions pending. In the August national meeting, the National Association
of Insurance Commissioners (NAIC) placed ORSA on the agenda for it to be voted for adoption into the NAIC’s Accreditation
Standards—Part A. (Accreditation is a certification process utilized by the NAIC to enforce uniform regulatory standards for its
member states.) Adoption of ORSA as one of the required model laws in the NAIC’s accreditation standards will ultimately result in
most, if not all, states passing ORSA legislations. The NAIC’s next task will focus on finalizing review and evaluation procedures for
regulators that are receiving the reports.
Regulatory Developments
Exhibit 9: Current ORSA enactment status
Source: NAIC and AMERICAN FRATERNAL ALLIANCE
ORSA Enacted StatesStates with Actions Pending
CA
NVUT
GAALMI
AR
LA
AK
WY
MTWA
OR
ND
NE
KS
OK
TX
MO
MN
IA
WI
IL IN
KY
OHPA
NY
TN
VA
ME
NH
CTRI
DE
VT
NJ
MA
Aon Benfield 11
Based on our experience assisting clients with preparing their
ORSA reports, common obstacles companies face include:
Reorganizing sections of a well-established enterprise
risk management program, (which mostly are Sarbanes-
Oxley 404 compliance and financial reporting
controls orientated) into a more risk-focused and
process-driven risk management documentation
Linking and consolidating the relatively fragmented risk
assessment, controls, and reporting processes already in
place into a more coherent risk management system
Regardless of the obstacles noted above, we believe that
this process is a good exercise for companies to realign
and reassess their strategic goals and operational risk
management processes. The process of completing ORSA
appears to be fulfilling NAIC’s initial intention, which was
to gain insights in insurers’ own assessment of current
and future risks and insurers’ own judgment about risk
management and the adequacy of their capital position.
Some examples of best practices we have seen in ORSA
reports include:
Executive summary highlights key risk management
functions, strategies, and explains why they work best for
the organization
Concisely articulate the group’s strategic vision, business
plan, and strategic priorities that tie to overall risk
management goals
Provide a thorough overview of the organization’s
risk governance structure with specific functions and
responsibilities of each risk management level
Include descriptions of ongoing risk monitoring, reporting
and assessment process, and describe process and frequency
of risk identification
Provide detailed risk assessment and controls for key risks
In July, the NAIC made available the results from its latest
ORSA pilot project to help the industry prepare their
ORSA reports. Feedback on areas for improvement in the
reports included:
Provide additional explanation of risk management strategy in
the context of the key business strategy objectives
Highlight the maturity of the enterprise risk management
processes and status of development
Maintain consistency between the key risks identified
in all sections
Provide additional support for the methodologies and
assumptions on assessing risk, stress testing, and quantifying
risk capital
Offer additional evidence regarding how the management
team utilizes the information in the ORSA Summary Report
to pursue its business strategy objectives
Corporate Governance Annual Disclosure Model Act
The NAIC is also actively pushing into state regulations another
corporate governance related model regulation—the Corporate
Governance Annual Disclosure (CGAD) Model Act. The main
purpose of this act is to provide a means for insurance regulators
to receive additional information on the corporate governance
practices of US insurers on an annual basis. The model act
was adopted on August 18, 2014 and set to commence in
2016 in states that adopted this act. Currently there are
three states—Indiana, Iowa, and Vermont—that have passed
legislation adopting CGAD. Three additional states—California,
Lousiana, and Rhode Island—have pending state legislation and
the remaining states with no action. However, the NAIC has
adopted this act into the accreditation standards beginning in
2020 that will require all states to pass this act in order to be
certified by the NAIC. The CGAD contains four main sections:
Organization’s corporate governance framework
Board of directors and committee policies and practices
Management policies and practices
Management and oversight of critical risk areas
CGAD is applicable to all insurers without exemptions.
Companies may choose to provide information at the ultimate
controlling parent level, an intermediate holding company
level and/or the individual legal entity level—depending on
the level where decisions are made and oversight provided.
To avoid filing redundant information, insurers may provide or
reference to other existing documents (e.g., ORSA Summary
Report, Holding Company Form B or F Filings, etc.).
12 Evolving Criteria
US risk-based capital catastrophe risk charge
Discussions of key components for calculating the risk-based
capital catastrophe risk charge have been ongoing but are
nearing finalization. The NAIC still does not have a definitive
timeline for including the catastrophe charge into the actual
risk-based capital calculation, therefore it will again be filed on
an informational basis for the 2015 reporting year. Currently, the
2016 reporting year is the tentative target for implementation
of the inclusion of the catastrophe charge. The following key
decisions made in the past year may have significant impact on
a company’s risk-based capital results when the catastrophe
charge is implemented as part of the requirements.
Contingent credit risk charge was reduced
to 4.8 percent from 10 percent
Allows companies to report both occurrence exceedance
probability and aggregate exceedance probability modeled
results as opposed to aggregate exceedance probability only
Exemption criteria: If a company uses an intercompany
pooling arrangement or quota share arrangement
with affiliates covering 100 percent of its earthquake
and hurricane risks or any of the following:
— Zero percent net exposure for earthquake and
hurricane risks
— Ratio of insured value, or property to surplus,
is less than 50 percent
— Insured value—property that includes earthquake or
hurricane coverage in catastrophe prone areas is less
than 10 percent of surplus
During the NAIC national meeting in August, the catastrophe
risk subgroup placed another key discussion topic on
its agenda. The subgroup will discuss other catastrophe
risks for possible inclusion in the property casualty risk-
based capital formula including: fire following earthquake,
tsunamis, extreme convective storm including tornadoes,
winter storm, flood, wildfire, terrorism, cyber risk, and
liability catastrophes—mass torts such as asbestos and
environmental. Expanding the catastrophe risk charge in this
manner impacts both property and casualty companies.
NAIC group capital standard
In July 215, the NAIC released an updated draft on approaches for
a group capital standard for US domiciled insurers that operate
internationally. There are three approaches discussed in the draft.
Risk-based capital aggregation approach: globally
aggregates existing capital requirements for each entity and
sets a standard for any entities without a current framework
Statutory accounting principles consolidated filing for risk-based capital approach: creates a need for global
consolidated financial statements on a statutory accounting
basis for use in the risk-based capital calculation
GAAP consolidated filing for risk-based capital approach: creates a group risk-based capital formula based on GAAP
financial statements
These approaches will continue to be discussed
at the NAIC summer meeting.
Terrorism Risk Insurance Program Reauthorization Act extended after brief lapse
The Terrorism Risk Insurance Program Reauthorization Act
of 2007 (TRIPRA) lapsed on December 31, 2014 for the first
time in its 12 year history. There were no major disturbances
in the market as S. 2244, the TRIPRA of 2015, was passed
by the US House of Representatives and the US Senate on
January 7 and 8 of 2015, respectively. The bill was then
signed into law by President Obama on January 12, 2015
with a retroactive effective date of January 1, 2015.
The six year extension features the following changes:
Increase in insurer co-participation 1 percent per year
from 15 percent to 20 percent, phased in starting 2016
Increase in program trigger USD 20 million per year from
USD 100 million to USD 200 million, phased in starting 2016
Revision to government recoupment mechanism
USD 2 billion per year from USD 27.5 billion to
USD 37.5 billion, phased in starting 2015
The changes to the program raise questions on the future of
TRIPRA and the US government’s view of the private market’s
ability to absorb terrorism exposure. Rating agencies will
continue to analyze terrorism exposure without the benefit
of TRIPRA as the 2015 bill remains temporary in nature.
Aon Benfield 13
Canada
The Canadian regulator, Office of Superintendent of Financial
Institutions (OSFI), continues their journey to enhance its
risk-based approach to supervisory oversight. In 2014, OSFI
revised its capital solvency model, minimum capital test and
branch asset adequacy test to be effective January 1, 2015.
The enhanced model incorporated changes updating the risk
factors as well as becoming more in line with the Solvency II
concept. At the same time, ORSA was introduced for all federally
regulated companies to complement the revised capital model.
Key guideline and procedure updates since September 2014.
Regulatory compliance management: updates
enterprise-wide framework appropriate for identifying
risks and the duties of the Chief Compliance Officer
Related party transaction instructions: enhances the
administrative efficiencies for related-party transactions
and improves the movement from approval on a
transaction by transaction basis to an entity level basis
Residential mortgage underwriting practices and procedures and residential mortgage insurance practices and procedures: provides
guidance on the enhancements of the underwriting
and risk management of mortgage insurance
Currently, OSFI is in the process of developing an
operational risks guideline and revising the guideline
for the role of the Chief Agent. In 2015, OSFI is focusing
their resources on certain administrative items that are
arising from the recently implemented guidelines and
new minimum capital test framework, including:
Re-approval of all of the related-party transactions
Updating and correcting the validation
rules on regulatory returns
A comprehensive review of the ORSA process work plan
Provide guidance on any new directives at the 2015
Risk Management Seminar
Lastly, both the Federal Finance Department and OSFI are
increasingly concerned with the real estate market in Canada
and the mortgage insurance sector. While steps have been taken
for lending institutions to de-risk their mortgage portfolios
and implement more stringent lending criteria for mortgage
insurance, OSFI is also in the process of developing a revised
minimum capital test framework for mortgage insurance.
Europe, the Middle East, and AfricaJanuary 1, 2016 will bring the long awaited Solvency II
regulations for insurers and reinsurers in the European Union
(EU) while Solvency Assessment and Management comes
into effect in South Africa. In the Middle East, as the insurance
industry continues its rapid growth, new regulations continue
to be introduced with existing ones strengthened to improve
market stability, transparency, and policyholder security. While
some regulators are adapting Solvency II regulations to fit their
markets, others are looking to the International Association of
Insurance Supervisors (IAIS) and its insurance core principles.
Europe
As we approach the final few months before Solvency II goes
live, the European Insurance and Occupational Pensions
Authority (EIOPA) and the European Commission have been
busy preparing final versions of guidelines, approving various
Implementing Technical Standards, and making decisions
on equivalency status of several non-EU countries.
Equivalency status is of major importance to the large
internationally active insurance groups that have operations
in the EU. There are three areas in Solvency II where
equivalence status pertains: solvency calculation, group
supervision, and reinsurance.
Under solvency calculation, if a non-EU country (e.g., Brazil)
is deemed equivalent, an EU-based group’s subsidiary in
Brazil can use Brazil’s solvency calculation rules instead of
Solvency II rules. For group supervision, if a non-EU country
(e.g., Australia) is deemed equivalent, then a group based in
Australia with operations in Europe is exempt from some of the
group supervision rules in the Union. Reinsurance equivalence
applies when a reinsurer from a non-EU country enters into a
reinsurance agreement with EU company. If the third-country
is deemed equivalent, the Union has to treat a reinsurer from
that country the same as it would a reinsurer from the EU
and thus no collateral is required to be posted as part of the
transaction. The table below shows who benefits the most
from equivalence approvals under each of the three areas.
Exhibit 10: Solvency II three areas of equivalence
Equivalence Area Beneficiary
Solvency Calculation EU-domiciled companies
Group Supervision Non-EU domiciled groups having EU operations
Reinsurance Non-EU domiciled reinsurers reinsuring EU-domiciled companies
Source: EIOPA and Aon Benfield Analytics
14 Evolving Criteria
On June 5, the European Commission announced these equivalence decisions subject to a six-month review by the European Parliament:
Exhibit 11: Equivalence status by country
Country Solvency Calculation Group Supervision Reinsurance
Switzerland Full Full Full
US Provisional Not equivalent Not equivalent
Australia Provisional Not equivalent Not equivalent
Bermuda Provisional Not equivalent Not equivalent
Brazil Provisional Not equivalent Not equivalent
Canada Provisional Not equivalent Not equivalent
Mexico Provisional Not equivalent Not equivalent
Source: European Commission
Full equivalence is for an indefinite period of time whereas
provisional equivalence lasts for ten years and would need to
be re-evaluated again prior to its expiration. What this means
for groups domiciled in US, Australia, Bermuda, Brazil, Canada,
or Mexico is that if those groups want to operate in the EU,
the entire group is subject to Solvency II group supervision
requirements. Since 2013, the US has been in discussions with
the EU on a free-trade agreement called the Transatlantic
Trade and Investment Partnership. While an agreement is not
expected to be finalized before 2016, various insurance trade
organizations in the US are pushing for full equivalence.
Meanwhile, EU-domiciled companies subject to Solvency II
continue to spend a lot of time, effort, and money to meet
the various requirements, seek approvals, and participate
in various preparatory exercises taking place in order to be
ready by January 1, 2016. Hannover Re recently became
the first company to gain approval for the use of its internal
model to calculate regulatory capital, although operational
risk will still be calculated using standard formula. The
process for developing and testing the model took over six
years. Various other large groups such as Aviva, Lloyd’s, RSA,
Swiss Re, and Munich Re have applied to use their internal
models. Documentations that need to be supplied for
these models as part of the approval process can be in the
thousands of pages and so decisions are not expected until
early December. The use of an internal model could free up
capital compared to the standard model requirements.
United Arab Emirates
Earlier this year, the Insurance Authority issued new
regulations for insurance and takaful companies. The
regulations cover accounting and investment policies,
solvency capital requirements, reserving, and reporting.
The rules should lead to better security for policyholders,
improve risk management at the companies, and bring more
stability to the sector. Some of the new rules have a one
year transition period while others will have three years.
The new regulations call for the use of IFRS to bring the U.A.E.
in line with global accounting standards. Combined with
improved data reporting standards and a data reporting
tool, data quality and consistency should improve, giving the
regulator and the companies a better understanding of the
industry. Companies in U.A.E. generally take a very aggressive
approach with investments as the asset composition tends
to be weighted towards equities and real estate. The new
rules try to address this by limiting the exposure to high-risk
assets classes. However, the limits still allow an insurer to
allocate up to 80 percent of its investment portfolio to real
estate and equity securities. Solvency capital requirements
for these assets classes might mitigate some of this
aggressiveness. There is also a requirement for an independent
board-level investment committee that has to consider
liquidity requirements, counterparty limits, and investment
portfolio stress testing as part of its investment strategy.
Aon Benfield 15
Some of the other new rules include:
Actuaries must be involved in financial reporting,
pricing, reinsurance, and risk management
Transparency of financial results
Setting of reserves using standardized actuarial
practices, an annual actuarial review of gross and net
reserves, and a requirement for adequate reserving
Better reporting and communications
between company management, the board of
directors, and the Insurance Authority
Risk based solvency calculations with a new Solvency
Capital Requirement and a Minimum Guarantee Fund in
addition to the existing Minimum Capital Requirement
A risk management framework that addresses
strategy, policy, procedures, and risk assessment
including emerging risks and a risk appetite statement
to be determined by the board of directors
The changes have been viewed positively by the rating
agencies with A.M. Best noting that “the new rules are well
placed to address these issues [significant exposure to high-
risk assets, inadequate and varied treatment of accounting
principles, unsophisticated measurement of technical reserves
and weak ERM practice].” Moody’s finds the new regulations
to be a credit positive “because they will strengthen several
credit characteristics of insurers, including capital, asset
quality (by reducing risk-taking) and reserve adequacy.”
South Africa
Solvency Assessment and Management, which is based on
Europe’s Solvency II, becomes effective on January 1, 2016.
While the implementation is going as planned, the local
regulator, Financial Services Board (FSB), released a
consultation document in April, comment period closed on
June 1, 2015, where it plans to have lower capital requirements
for risks reinsured via a local reinsurer as opposed to a
foreign reinsurer. FSB would change the international
credit ratings of reinsurers, as shown in exhibit 12.
A Lloyd’s representative office and branches of foreign
reinsurers would be required to hold reserves within
South Africa in a trust. Reinsurance placed with a foreign
reinsurer can only be accounted for if the regulatory
framework of the reinsurer’s domicile is approved by FSB,
similar to equivalency provisions under Solvency II.
FSB’s rationale is to create a level-playing field for reinsurers and
better policyholder protection. FSB considers investment in
South African sovereign bonds as risk-free, unlike international
credit ratings agencies that include the sovereign rating caps in
their methodologies. Also, locally domiciled reinsurers would
offer better protection for policyholders as they are subject
to direct oversight by the FSB, unlike the foreign reinsurers.
Feedback on the issue has not yet been publicly released but
the rating changes will impact capital requirements via the
counterparty credit risk charges, if proposals are implemented.
Ghana and Oman
In Ghana, the regulator has raised the minimum paid up
capital to GHC 15 million, from GHC 5 million, and all insurers
and reinsurers will need to comply by end of 2015. The
move is seen as a way to stabilize the sector and strengthen
insurers’ ability to write larger risks. The regulator is also in
the midst of updating the existing Insurance Act from 2006.
The changes are expected to address governance and risk
management frameworks, as well as actuarial-based reserving.
The Sultanate of Oman has also increased the minimum
capital requirements for insurers to RO 10 million, from
RO 5 million. Companies will also need to make at least
40 percent of shares listed on the Muscat Stock Market and
separate legal entities must be created for life and non-life
business as composite companies will no longer be allowed.
The mandatory listing of the shares should bring additional
financial flexibility for companies and greater transparency for
the overall market. Companies have three years to comply.
Exhibit 12: Proposed reinsurer credit rating adjustments
Business ceded to Impact on reinsurer’s credit rating
Foreign reinsurer (including Lloyd’s) Downgrade by three notches
Foreign reinsurer with local branch Downgrade by two notches
Local Lloyd’s representative office Downgrade by one notch
Local reinsurers Upgrade by three notches or use parent company’s rating via a parental guarantee
Source: Financial Services Board
16 Evolving Criteria
Asia PacificThe global insurance industry is undergoing significant
regulatory changes, and Asia Pacific is no exception, where
a number of markets are reviewing and undergoing changes
in their approach to insurance regulation and holistic risk
management. Regulations that protect consumer data,
strengthen insurer capital, and address mergers and
acquisitions continue to emerge at local and international
levels in Asia Pacific. The regulatory agenda varies from
financial system liberalization in China to reforms in India.
Pressures to maintain domestic control of insurance and
reinsurance markets continue to exist across the region.
Cambodia
The new Insurance Law was enacted on August 4, 2014, and
became effective on February 4, 2015, superseding the previous
law of July 25, 2000. The law updates and amends a sub-decree
regulating the insurance sector. The sub-decree had 56 articles,
while the new law has 114 and involves the following changes:
a better protection for policyholders, an increased control
for the regulatory body, dispute resolution and insurance
companies’ liquidation and dissolution process, and a clearer
regulation for insurance companies to operate in Cambodia.
China
This year has been remarkable for China’s insurance regulatory
evolution. The China Insurance Regulatory Commission
(CIRC) finalized the China Risk Oriented Solvency System also
known as China’s “Solvency II” (C-ROSS), began building a
national earthquake scheme, liberalized motor pricing, and
strengthened management of reinsurance credit risk.
In February 2015, CIRC issued the final version of C-ROSS
rules and the transition period started right after. During the
transition period, insurers report solvency under both the
expiring scheme and C-ROSS, while supervision decisions are
still based on the expiring scheme. The three-pillar C-ROSS
aims to better align solvency capital requirement with the risks
insurers face. At the same time, risk management is emphasized
and the market discipline mechanism is implemented. The first
quarter of 2015 was the first period China insurers reported their
solvency under C-ROSS. According to CIRC’s announcement,
the average solvency ratio was at 264 percent for the whole
industry and 282 percent for property casualty insurers.
CIRC commented that the solvency level for the industry was
adequate, the risk indicators properly reflected the real risks
the industry faced, and C-ROSS guided the insurers to improve
their business model, marketing strategy, and risk management.
In March 2015, CIRC formally issued the Notice on
Implementing Reinsurance Registration System. Beginning
January 1, 2016, all reinsurers, including primary insurers writing
inward business, and reinsurance brokers must register on the
platform built and maintained by CIRC. Cedents must select
reinsurance counterparties from those valid in the registration
system. Treaty reinsurers must have secure rating (“A-” or
above for leaders and “BBB” or above for followers). Certain
exemptions may apply.
In April 2015, China’s Residential Earthquake Pool was
established in Beijing. According to a media report, in
July 2015, a consultation paper called China Residential EQ
Insurance (draft) was circulated among local insurers, with
rules proposed for catastrophe insurance at the national
level. At the provincial or municipal level, on August 20, CIRC
kicked off the pilot residential earthquake scheme in Da’li
prefecture of Yun’nan province. The residential earthquake
insurance pays for direct loss and rebuilding costs of rural
residential property, as well as death, caused by earthquakes
with a magnitude at or above 5.0. Payment for direct loss of
residential property is parametric based, ranging from CNY
28 million to CNY 420 million, depending on the earthquake
magnitude. Death payment is capped at CNY 100 thousand
per person, with aggregate limit at CNY 80 million per year.
Insurers form earthquake pool and utilize reinsurance. Insurers
need to accumulate cat reserve, as a percentage of premium
income and excessive underwriting profit.
In June 2015, an experiment of motor de-tariff began in six
provinces or cities. Each insurer in these experiment zones
needs to have its pricing formula reviewed and approved
by CIRC. The insurers can adjust the price within a range to
reflect their unique underwriting and distribution profile.
Hong Kong
In September 2014, the Insurance Authority of Hong Kong
published its first consultation paper on the development of a
new risk-based capital framework. The proposed framework
adopts a 3-pillar structure. Pillar 1 consists of the quantitative
requirements, including assessment of capital adequacy
and valuation. Pillar 2 sets out the qualitative requirements,
including corporate governance, enterprise risk management
Aon Benfield 17
and ORSA. Pillar 3 focuses on disclosures and enhancing
transparency of relevant information of insurers to the public.
More specific proposals and detailed specifications for
Quantitative Impact Study are expected to be covered in later
consultation. According to the accompanying FAQ issued by
Insurance Authority, the risk-based capital regime would be
developed in four phases:
Phase I—Development of the framework and key approaches
Phase II—Development of detailed rules and conducting
of a Quantitative Impact Study that should begin in 2015
or 2016, to be followed by another consultation exercise
Phase III—Amendment of legislation; at least two to three
years will be needed to complete all the preparatory tasks
including public consultations
Phase IV—Implementation phase
India
In March 2015, the Indian Parliament passed the Insurance
Laws (Amendment) Bill raising the ceiling for foreign
investment in the insurance sector. The enactment of the bill
will raise the foreign investment cap in the pension sector
as it was linked to the ceiling in the insurance sector.
Increasing the foreign investment in insurance enhances
the industry prospects that struggle due to lack of capital.
It will increase infrastructure funding as only an insurance
entity can fund long-term public projects. The passing of the
bill will give more powers to the insurance regulator—the
Insurance Regulatory and Development Authority of India.
Key points of the bill:
The foreign direct investment cap in an Indian insurance
company will be increased from 26 percent to
49 percent but ownership and control of the insurance
company will remain with Indian residents.
The bill amends the definition of foreign company to include
a company or body established under a law of any country
outside India, and includes Lloyd’s of London, established
under the Lloyd’s Act, 1871, or any of its members.
Foreign reinsurers will be permitted to conduct reinsurance
business through setting up branch offices in India.
Insurance companies will be permitted to raise new
capital through instruments other than equity shares.
Insurance agents will be included in the definition of
insurance intermediaries and will be regulated, as will
key aspects of insurance company operations in areas like
solvency, investments, expenses, and commissions.
Indonesia
The Indonesian insurance industry is reshaping by changing
regulations and enforcing stricter capital requirements that
are aimed to introduce greater transparency and stability.
In this transformed regulatory landscape, there are more
new entrants to the market and greater opportunities for
mergers, acquisitions, and joint partnerships. Regulations
were introduced in 2008 that require insurance companies to
incrementally increase their minimum capital levels to IDR 100
billion by December 2014 and reinsurers are required to have
a minimum capitalization of IDR 200 billion by the same date.
The New Insurance Law, passed by Indonesia’s parliament
on September 23, 2014, effective a month later, sets out
a comprehensive regulatory framework for Indonesia’s
insurance sector. In broad terms, the new law updates the
1992 law in various significant areas and provides a stronger
consolidated legal foundation to the insurance sector,
covering all insurance business companies, whether they
are insurers, reinsurers, brokers, agents, or loss adjusters.
The summary below outlines the key changes introduced
by the New Insurance Law for insurance companies:
An existing joint venture insurance company whose
Indonesian shareholder is indirectly owned by foreign
parties must ensure that such Indonesian shareholder
transfers its shares to an Indonesian individual within a
period of five years from the promulgation of the New
Insurance Law. Alternatively, the joint venture company must
conduct an initial public offering within the same period.
The law is silent on foreign ownership limits, presumably
indicating that the existing 80 percent limit is still valid,
although this could be revised in future regulations.
Consideration must be given to the controlling party
concept and an assessment must be made as to whether
existing shareholders or parties may be classified as such
as a result of certain contractual or other arrangements.
18 Evolving Criteria
The New Insurance Law imposes single controlling
investment rule.
Sharia business units that form part of conventional
insurance companies must be segregated.
Additional parties or persons, the controlling party and
the internal auditor, are subject to the fit and proper test.
The Indonesian government is moving forward on an
earlier announced plan to merge state-owned reinsurers
PT Reasuransi Internasional Indonesia (Reindo) with PT Asei
Reasuransi Indonesia, to create Indonesia Re. PT Nasional
Reasuransi Indonesia also will be merged at a later date. This
will boost domestic reinsurance capacity, with plans to inject
an initial IDR 1.5 trillion in capital for the new company.
Japan
In June 2014, the Japan Financial Service Agency (JFSA)
announced the implementation of its second field tests with
the aim of introducing an economic value-based solvency
regime, and requested all insurance companies to implement
them, following the results of the first field tests which were
disclosed in 2011. The purpose of the tests is to grasp the
status of preparations of insurance companies as well as to
identify practical issues and problems that may arise in the
process by requesting all insurance companies calculate the
value of their insurance liabilities based on economic value.
JFSA disclosed the results in June 2015 noting that although
the field tests were more extensive and included more
calculation methods than the previous tests, all companies
involved provided the results of the requested calculations.
In addition, it was recognized that insurance companies’
interests in the economic value-based solvency regime and risk
management remain strong, and that they are making progress
in developing systems for such calculation. On the other hand,
the questionnaire results from individual companies suggested
that sufficient preparation time would be necessary before
the actual introduction of the regime, and that there are many
issues which need to be solved regarding system building
and burdens on practical operations. Furthermore, some
companies requested that a scheme be developed reflecting
the differences in the risk management systems and other
factors of each company, such as the use of internal models.
JFSA summarized the direction of future examinations noting
that a variety of issues and challenges were recognized in the
field tests, as in the previous tests. Based on the results, JFSA
needs to conduct further examination toward establishing
a specific framework. There are ongoing movements in the
economic value-based solvency regime and accounting
system, such as the IAIS’s Insurance Capital Standard field tests,
Solvency II in Europe and examination of IFRS 4 “Insurance
Contracts.” Under such circumstances, it is important to
establish a regulatory framework suitable to Japan, paying
attention to the nature of the Japanese insurance market.
Introducing the economic value-based solvency regime
requires some revisions to the business management and
risk management methods used by insurance companies.
Therefore, the JFSA will make steady efforts to establish
a new framework through dialogue with relevant parties
in various situations to ensure a smooth introduction.
Malaysia
Malaysia’s non-life sector is gearing up for the expected
removal of tariffs for motor and fire insurance by 2016. The
details of the de-tariff of the motor and fire insurance premiums
are still being finalized and would incorporate premium
bands to prevent the risk of under-pricing of premiums.
Industry players expect the de-tariff to be implemented
by the middle of next year. It is believed that the de-tariff
will be a partial and gradual one and there could be slight
margin erosion, although the risk of severe erosion in the
industry due to irrational competition has been eliminated.
Pakistan
In a circular dated March 13, 2015, The Securities and
Exchange Commission of Pakistan announced a planned
increase in the minimum paid-up capital requirements
for life insurance and non-life insurance companies. The
increases, which will take place incrementally in semiannual
intervals until December 2017, are aimed at strengthening
the insurance sector. For non-life insurers, the minimum
paid-up capital has to be PKR 300 million by December 31,
2015, increasing by PKR 50 million at semiannual intervals
until it reaches PKR 500 million by December 31, 2017.
Aon Benfield 19
Philippines
The Insurance Commission, the insurance regulator in
Philippines, has made amendments to the country’s Insurance
Code to provide for increased capital requirements for existing
insurers. The minimum paid-up capital for insurers will increase
to PHP 550 million by December 31, 2016; PHP 900 million by
December 31, 2019 and PHP 1.3 billion by December 31, 2022.
New insurance companies and branches of foreign companies
are required to have an initial minimum capital of PHP 1.0
billion to be allowed registration. Reinsurance companies,
on the other hand, must have a capitalization of at least PHP
3 billion paid in cash of which at least 50 percent is paid-up
and the remaining portion thereof is contributed surplus,
which in no case shall be less than PHP 400 million or such
capitalization as may be determined by the Secretary of Finance,
upon the recommendation of the Insurance Commission.
The increase in capitalization will boost the insurance industry
to better compete globally. It will also provide more cushion
against risks for the protection of the insured. This may
lead to the merger and consolidation of small players in the
industry to meet the minimum capitalization requirements.
Pursuant to Section 194 of the Amended lnsurance Code,
the Insurance Commission is conducting a review of the
current risk-based capital framework. Hence, all life and
non-life insurance and professional reinsurance companies
are required to participate in parallel runs for the risk-
based capital 2-Quantitative Impact Study starting with
financials as of December 31, 2014. This will allow the
Insurance Commission an opportunity to engage the
industry in a meaningful dialogue and obtain feedback
prior to the full implementation date on June 30, 2016.
Singapore
The risk-based capital framework for insurers was first
introduced in Singapore in 2004. While the risk-based capital
framework has served the Singapore insurance industry well,
the Monetary Authority of Singapore (MAS) has embarked
on a review of the framework (risk-based capital 2 review)
in light of evolving market practices and global regulatory
developments. The first industry consultation was conducted
in June 2012 in which the MAS proposed a number of changes
and an risk-based capital 2 roadmap for implementation. In
March 2014, MAS issued a consultation paper on the risk-
based capital framework, updating the earlier version from
June 2012. This second paper included the detailed technical
specifications required for insurers to conduct Quantitative
Impact Study. This will gather information and help evaluate the
full impact of the risk-based capital 2 proposals. MAS is finalizing
the risk calibration and features of the risk-based capital 2
framework, with implementation expected January 1, 2017.
Tier 1 insurers in Singapore were required to submit an
ORSA report to the MAS by December 31, 2014, while
non-tier-1 insurers have until December 31, 2015.
Sri Lanka
The minimum regulatory capital of insurance companies
has been increased to LKR 500 million from LKR 100 million
per class of insurance business. However, a newly formed
insurance company that complies with the segregation
process can maintain a capital of LKR 100 million at the time
of its segregation as an insurer. It must thereafter increase
the capital to LKR 500 million on or before February 2015.
The Insurance Board of Sri Lanka issued the final risk-based
capital framework for insurers in October 2013, following
a period of consultation and testing. This framework will
become effective in 2016 and replace the current solvency
margin requirements. Since the first quarter of 2014, all insurers
have been required to submit two sets of financial returns, in
accordance with the current and new risk-based capital regimes.
Composite insurers are required to split their business into
separate non-life and life companies by February 2015.
Some insurers have created new holding companies with
separate non-life and life subsidiaries, while others have
created new subsidiaries of their existing organizations.
The split of composites will, however, increase overall
costs and put pressure on smaller insurance companies.
All insurance companies must be listed on the Colombo
Stock Exchange by February 2016. This presents a big
challenge for small entities and foreign players that desire
exemption from mandatory listing, since it provides
greater transparency and promotes better governance,
thereby improving policyholder protection.
As a consequence, it is believed that some insurers will struggle
to maintain viability once the split of composite companies and
the new risk-based capital formula take effect, leading to merger
of smaller insurers to form larger and more stable companies.
20 Evolving Criteria
CaribbeanMost Regulators in the Caribbean have been moving towards
Solvency II Framework based regimes or alternatives such as:
Canadian minimum capital test or an equivalent risk based
model. The pace of the regulatory reforms is slower due to
political and economic influences.
At the same time, improving the level of capitalization coupled
with more stable earnings and the lack of hurricane activities
in the Caribbean has resulted in the upgrade of a number
of companies by A.M. Best. The most notable changes were
from “A-” to “A” ratings, as “A” companies are less common
in this market. However, economic conditions continue to be
challenging in this area and market conditions remain extremely
competitive. Companies continue to face difficulties with
growth and diversification. Even with the improving levels of
capitalization there continues to be reliance on proportional
reinsurance to provide capital support and risk mitigation.
This strategy is likely to continue going forward. Also, there
is continued expectation of merger and acquisition activities
should opportunities arise.
Latin America
Brazil
A key regulatory change was the introduction of Regulation
CNSP 322 with the intent to reduce the percentage of the
mandatory offer of reinsurance to the local market over a
five year period. To encourage greater capital efficiencies,
there will be an increase in the percentage allowed for inter-
company transactions using a phase-in approach.
In January of 2014, the Brazilian Regulator applied to the EIOPA
(European Insurance and Occupation Pension Authority) for
Solvency II equivalency. This was granted in June of 2015
for a 10-year period. This allows Brazil to maintain its own
solvency capital model with a similar Solvency II scale.
Chile
Regulators in the Chile insurance market intend to move
toward risk-based capital requirements and Solvency II with the
purpose of recognizing companies with strong risk management
and adjusting their capital requirements accordingly. Currently,
the Chilean Securities and Insurance Supervisory Authority’s
regulations require insurance companies to establish reserves
based on their aggregate exposure in their largest CRESTA
zone. This is calculated by applying a factor of 10 percent for
personal lines and of 15 percent for commercial lines, less
reinsurance plus a 10 percent safety margin. Regulators are
considering moving to a modeled PML based approach.
Colombia
Insurance regulation is laying the foundation for more
risk based solvency framework. It is possible that they will
consider following Chile’s lead on a modeled PML approach
for catastrophe exposure. Additionally, Colombia may be
moving toward a similar approach as Chile for homeowners
purchasing catastrophe insurance in conjunction with
individuals buying a home. These exposures would be
pooled and then insurance is purchased on the entire pool
with the costs being passed back to the individuals.
Mexico
On April 4, 2015, the Mexican regulators officially adopted
the new Insurance and Surety Institutions Law (Ley de
Instituciones de Seguros y Fianzas, or LISF). Under the new
law, regulation authority will be shifted from the Ministry
of Finance and Public Credit to the National Insurance and
Surety Commission, replacing the statutory examiner with an
audit committee. The LISF also creates opportunity for a new
surety insurance product, seguro de caución, or Insurance
Bond, to the Mexican market, enhancing it as a leader in surety
business, after the US and Italy. The LISF regulation paved the
way for the Unified Insurance and Surety Regulations (Circular
Unica de Seguros y Fianzas, or CUSF), which was adopted on
April 4, 2015 as well. The main objective of this regulation
is to incorporate the Solvency II framework throughout
the country. Both the LISF and CUSF set forth regulation
similar to Pillar 2 of Solvency II and ORSA requirements
with increased Board responsibilities and implementation
of risk management and internal control committees.
Argentina
The Argentine Superintendence of Insurance adopted
antifraud regulations that will require insurers and reinsurers
to establish anti-fraud governance policies and guidelines.
Such policies and guidelines must be approved by insurance
entities’ board of directors. In 2014, Argentina Federal
Congress passed a new unified civil and commercial
code, which includes provisions to increase protections
to consumers, and will obviously have significant impact
on the insurance activity conducted in the country.
Aon Benfield 21
International Accounting StandardsIt has been anticipated that the International Accounting
Standards Board (IASB) would issue the finalized IFRS 4
“Insurance Contracts” this year with the standard becoming
effective in 2019. Last year, the Board finalized IFRS 9 “Financial
Instruments” and set its effective date at January 1, 2018, raising
concerns from insurers. Both standards impact insurers, so the
IASB has spent a considerable time this year addressing concerns
about temporary accounting mismatches and volatility in profit
or loss due to the differing effective dates of the two standards.
Although the impact would be limited to only a select group of
companies, the IASB is considering various optional solutions.
These include amending the existing IFRS 4 or deferral of
IFRS 9 for insurers until the effective date of the new IFRS 4.
Amending the existing IFRS 4 means the IASB will need
to go through its due process, including the issuance
of an exposure draft, allow for a comment period and
then finalize changes based on the comments. This
will not impact the finalization of the new IFRS 4.
The rating agencies continue to follow the development of
the new standard as it will significantly change the way the
insurers will report their financials. Income statements will
be vastly different with short and long duration contracts
being split and shown differently. A.M. Best expects the new
IFRS 4 to impact the data they use to analyze the companies
in the non-US insurance sector. Standard & Poor’s sees a
reduction in net income volatility. Fitch thinks comparability
may be hampered due to different methodologies companies
are allowed to use, like in the discount rate a company can
pick, and so expect disclosures to be critical. All three of
the rating agencies do not expect any rating actions as a
result of the new standard but do expect discussions in
their rating meetings and some impact on their analysis.
Development of global Insurance Capital StandardWhile the banking industry is seen as the predominant source
of the 2008 financial crisis, there is a growing concern that there
are risks in the insurance industry that could lead to a crisis of
similar proportions. As in banking, there are key institutions
(referred by IAIS as Global Systemically Important Insurers or
G-SIIs) that play a significant role in the global economy.
To reduce the risk of their failure and thus trigger another
crisis, the IAIS took on the task of developing a global
capital and supervisory framework known as the Common
Framework, ComFrame, for the supervision of Internationally
Active Insurance Groups. They are defined as groups with:
Premiums written in less than three jurisdictions,
and percentage of gross premiums written outside
the home jurisdiction is at least 10 percent of the
group’s total gross written premium; and
Total assets of at least USD 50 billion, or gross
written premiums of not less than USD 10 billion
(based on a rolling three-year average)
The quantitative portion of the ComFrame is the risk-
based global Insurance Capital Standard (ICS). With
hopes of implementing ICS by 2019, the IAIS released a
consultation paper in December 2014 seeking feedback
on the use of valuation method of balance sheet
items, methodology of determining the ICS capital
requirement, and qualifying resources of capital.
The feedback was overwhelming—1,321 pages—and has
forced the IAIS to reconsider their aggressive timeline
for the ICS. As a result, the IAIS announced in June that
it would push back the first and second version of the
rules by about a year to 2017 and 2019, respectively.
The IAIS is also working on developing standards for an
additional buffer of capital called Higher Loss Absorbency
which will impact only the G-SIIs, currently nine insurance
groups. A consultation paper issued by the IAIS suggests
that capital requirements could be 20 percent higher for
a G-SII. Fitch commented that the average 20 percent
increase in minimum capital proposed by the IAIS is unlikely
to result in any G-SIIs needing to raise additional capital.
Accounting Developments
22 Evolving Criteria
M&A activity in the industry remains in the spotlight as there has been several deals involving large market players that are changing the industry landscape. As companies have record capital levels and are looking for ways to grow, acquisitions are offering opportunities for companies to achieve geographic expansion, product diversification, cost efficiencies from scale, and profitable growth.
Below is a summary of recent large acquisitions and the primary
rationale for the acquiring entity. Several of the deals are
focused on expansion of the acquirer’s Lloyd’s platform that
provides access to the global market with a relatively efficient
capital structure. Both the Fosun and Ironshore, and EXOR and
Partner Re deals stem from multi-industry companies looking
to enter or grow their insurance platforms in the hopes of
modeling the Berkshire Hathaway structure.
The reinsurance market has gone through a period of
unprecedented change over the past three years. The
pressure on rates, terms, and conditions due to alternative
market capital and low catastrophe losses in recent years
has squeezed margins. These challenges do not appear to
be short-term but rather will be issues for the foreseeable
future. There are very few “pure” reinsurance companies
left as most are now part of larger insurance and reinsurance
organizations. Monoline writers, or companies focused only
on reinsurance or property catastrophe insurers only, are
likely a thing of the past and face the most pressure. Some of
the third party capital may elect to enter the market through
the acquisition of insurance and reinsurance groups.
Exhibit 13: Notable M&A in the industry
Acquirer Target Company Primary Rationale
ACE Group Fireman’s Fund
Chubb
Acquiring Fireman’s Fund’s personal lines insurance
Global scale and distribution / market clout
EXOR Partner Re Diversify holdings / enter insurance sector
Endurance Montpelier Access to Lloyd’s and third party capital management
Fairfax Brit
American Safety
Various QBE European operations
Secure a top five position in the Lloyd’s market
Growth in environmental casualty, E&S, and property lines
Expansion in Czech Republic, Hungary, and Slovakia
Fosun Ironshore Growing insurance platform outside the Asian region
Hamilton Re Sportscover U/W Ltd (manages Syndicate 3334)
Valiant
Entry into the Lloyd’s market
Entry into US specialty insurance on admitted and E&S basis
Enstar Torus Expansion into active underwriting (prior focus was run-off)
Renaissance Re Platinum Underwriters Accelerate US casualty platform
Sompo Canopius Geographic expansion in specialty lines via this Top 10 Lloyd’s insurer
Tokio Marine Houston Casualty Further penetration into the US property casualty market
Validus Western World Entry into US commercial insurance on an E&S basis
XL Catlin Global expansion via Catlin’s significant Lloyd’s presence
Source: Aon Benfield Analytics
Mergers & Acquisitions
Aon Benfield 23
All these changes will likely mean that there is significant
pressure on the smaller reinsurers as:
They will not have the economies of scale of larger
organizations
They may have a more limited product offering and
less expertise in local markets and emerging risks
They may not be able to make the same investments
in technology
Potential increased regulations may raise operating
costs and contribute to their inability to compete
More limited ability to adapt to changing market conditions
Some of these smaller reinsurers may become acquisition targets.
Primary companies are also well capitalized and are retaining
more risk now than in recent years. As interest rates remain
low and provide cheap financing for deals, companies are
looking for targets that will offer growth, entrance into new
markets, cost savings and diversified product lines, and
distribution channels. The illustration highlights key reasons that
companies are interested in merger and acquisition activity.
The implications of the insurance entity’s and the group’s
ratings are an important factor as well. When an acquisition
is announced, the target is generally placed ‘under review’
with positive, negative, or developing (neutral) implications
based on the rating agency’s view of the likely outcome at
the conclusion of the deal. It is critical to understand the
lift or drag implications of each rating agencies’ notching
criteria relative to the holding company’s ratings and the
impact to the insurance entity’s business profile. Rating
agencies recognize the possible benefits of cost savings and
enhanced competitive position but also note the challenges
surrounding execution risk, legacy reserve exposures, impact
to capital position and financial flexibility, and enterprise risk
management. From an ERM standpoint, acquirer’s should
be prepared to discuss how the new parent is prepared for
taking on the risks of the target, commitment level to support
insurance entity, and how their interests are aligned.
As we continue to see the industry consolidate, it will mean fewer
choices for buyers, but more solid balance sheets.
Earnings Drivers
M&A Influences
Scale
Diversification
Changing Buying Habits
Underwriting margins are being eroded by increased competition
Investment returns continue to decline
Benign catastrophe activity is unlikely to continue
Reserve redundancies may not be sustainable
More efficient operations
Reduces retro purchases (relative basis)
Greater ability to influence pricing, terms and conditions
Increased ability to provide UW expertise—Resources needed to exploit emerging risks
Accelerates growth into Lloyd’s, other lines of business such as insurance, A&H, life, crop as well as other territories
Better ability to manage earnings volatility and the underwriting cycle
Lowers capital requirements
May provide local expertise
Some ceding insurers are favoring a smaller panel of stronger reinsurers
Some ceding insurers are seeking multi-line covers, multi-year deals
Both traditional and alternative platforms are needed for some buyers
24 Evolving Criteria
Operating performanceDespite increased catastrophe losses and reduced benefit from
prior year reserve releases, the US property casualty industry is
expected to post a third consecutive year of underwriting profit.
A.M. Best believes 2015 will be a profitable year for the industry
as well, with a 99.1 percent expected industry combined ratio,
which includes 4.9 points for catastrophe losses. A.M. Best
notes continued concerns over loss reserve adequacy citing
declines in the level of favorable reserve development in
calendar year results: from USD 13.3 billion in 2013 to
USD 9.3 billion in 2014 and an expected USD 5 billion in 2015.
Exhibit 14: A.M. Best’s combined ratio comparison by segment
Combined Ratio (Reported)
Industry SectorOutlook
2013 Actual
2014 Estimated
2015 Projected
Commercial Negative 96.7% 97.7% 99.8%
Personal Stable 97.5% 98.4% 99.4%
Reinsurance* Negative 83.9% 88.0% 93.2%
*US and Bermuda, GAAP Basis Source: A.M. Best
For 2014, the US personal lines segment had the highest
estimated combined ratio, with higher catastrophe losses than
the other segments and a 2.8 percent decrease in net premiums
written. In commercial lines, rating agencies are anticipating the
contribution of prior year reserve releases to decrease as they
expect that the segment will soon reach a point where further
releases cannot be actuarially justified. A.M. Best is projecting
only 0.2 percent benefit to the 2015 combined ratio for reserve
releases, versus 2.2 percent and 4.2 percent in the prior two
years. The reinsurance segment continues to be very profitable
with an estimated 88 percent combined ratio for 2014 and 93.2
percent projected for 2015 (93.2 percent is the five-year average
for the US and Bermuda reinsurance segment). Despite rate
pressures, a lack of significant catastrophe activity and favorable
reserve releases have aided in the continued underwriting
profitability. Favorable reserve development has decreased this
combined ratio on average 6.1 points over the past five years.
Capital adequacy continues to growCapitalization continues to be very strong. As a benchmark,
we estimate the US Industry aggregate capital position as
redundant at the ‘AA’ level per Standard & Poor’s Capital
model and supportive of ‘A++’ capital per A.M. Best’s BCAR
model. From 2013, capital adequacy improved USD 11 billion
as measured by Standard & Poor’s Capital and USD 23 billion
per BCAR.
Exhibit 15 provides a distribution of Standard & Poor’s Capital
levels for 50 rated companies in the US and Bermuda. Thirty-
six percent of companies’ capital adequacy is considered
‘Extremely Strong’, indicating redundant capital at the
‘AAA’ level. Another 42 percent have ‘Very Strong’ capital
adequacy, representing redundant capital at the ‘AA’ level.
In addition, A.M. Best’s published BCAR scores continue to
increase for most rating levels (ironically, the highest two levels
of A+ and A++ show slight decreases from 2013 to 2014 but also
have the fewest data points per category). Median BCAR results
by rating category are roughly double published minimum
standards. In addition, results at the 25th percentile are on
average 76 points higher than the respective minimums, which
is equivalent to four rating levels (each rating level = 15 BCAR
points). The following charts show these medians can vary
significantly when broken down by surplus size and segment.
Exhibit 15: Distribution of Standard & Poor’s capital adequacy
Source: Standard & Poor’s
Extremely Strong36%
Very Strong42%
Strong11%
Moderately Strong7%
Upper Adequate2% Lower Adequate
2%
Financial Trends
Aon Benfield 25
Exhibit 16: BCAR medians
FSRPublished Minimum
25th Percentile Median
75th Percentile
A++ 175 251 283 374
A+ 160 207 312 399
A 145 254 315 446
A- 130 225 300 465
B++ 115 188 229 293
B+ 100 158 199 284
Sources: A.M. Best, Aon Benfield Analytics. Data as of June 15, 2015
Exploring the ‘A’ rating level deeper, shown above with a 315
percent median BCAR, the chart below shows that the median
of ‘A’ rated companies below USD 100 million of surplus is 76
points higher at 391 percent. Companies at this rating level
with greater than USD 1 billion of surplus have a median BCAR
of 272 percent, or 43 points less than the overall group. Larger
companies tend to have superior business profile attributes like
geographic or product line diversification, scale of operations
and financial flexibility/access to capital and are therefore rated
as highly as a smaller company with a higher capital score.
Exhibit 17: ‘A’ rated entities: BCAR median by size
Size Median Diff. From Total Count
< USD100 M 391 76 69
UDS100 M - USD500 M 310 -5 97
USD500 M - USD1 B 304 -11 32
>USD1 B 272 -43 30
All 315 228
Sources: A.M. Best, Aon Benfield Analytics. Data as of June 15, 2015
Additionally, we look at the ‘A’ rated composite broken down
into segment. The personal property composite is well over
the median BCAR likely due to additional capital requirements
in the A.M. Best stress test that are not captured in the
published score. Medical professional insurers have had several
years of excellent operating performance reflected in their
scores. However, the medical liability composite has also seen
shrinking premium volume due to consolidation in the health
care industry. While not good for the segment, mechanically
in the BCAR model the scores increase as companies write less
premium. The workers’ compensation segment is the only
group materially lower than the overall median due to reserve
adequacy and the recent poor operating results.
Exhibit 18: ‘A’ rated entities: BCAR median by industry composite
268
307
310
314
315
342
455Personal Property (26)
Medical Prof Liability (23)
Commercial Property (17)
Priv Pass Auto & HO (41)
Private Pass Auto (9)
Commercial Casualty (51)
Workers' Compensation (19)
Median BCAR = 315
Source: A.M. Best, Aon Benfield Analytics
Public company benchmarksThe median scores of ‘A’ rated publically traded P&C companies
in the US is 223 percent, 92 percentage points lower than the
median of all ‘A’ rated US property casualty companies. We
believe this is mainly driven by the publicly traded population’s
typical characteristics: larger size, strongly developed enterprise
risk management capabilities, and proven financial flexibility.
Exhibit 19: BCAR and financial leverage metrics for ‘A’ rating publicly traded companies
Guideline25th
Percentile Median75th
Percentile
BCAR (%) 315* 202 223 274
Debt to Capital (%) <45 14.2 17.5 22.7
Interest Coverage >3x 5.9x 8.9x 14.4x
* Guideline for BCAR refers to 2015 Industry Median Source: Aon Benfield Analytics
The above analysis involves 21 public holding companies.
The holding company normally is assigned a lower issuer
credit rating than the operating company due to the
greater degree of risk taken by senior unsecured creditors
relative to that of the operating company. Financial
strength ratings of the operating company is mapped to
the issuer credit rating of holding company guidelines.
26 Evolving Criteria
Enterprise Risk Management is an area that has evolved significantly for many insurance companies in recent years. Rating agencies and regulatory authorities continue to stress the importance of management identifying and evaluating risks throughout the organization.
Risk tolerance statementsOne of the first steps to establish a robust ERM practice is
identifying a risk tolerance statement that defines an amount that
management is willing to risk over typical business operations.
Although rating agencies prefer these to be quantitative, a risk
tolerance statement can be qualitative in nature. A.M. Best in
particular outlined the importance of a stated risk tolerance
statement by requiring a disclosure on the first page of the
2014 updated Supplemental Rating Questionnaire. This request
was originally included in the 2010 through 2012 SRQ, but was
removed for the 2013 version.
Catastrophe Risk Tolerance StudyMany public companies disclose some type of risk tolerance
specifically around catastrophe exposure. This type of risk
is easily quantifiable due to computer models and vast data
availability. The disclosures are typically presented as a
percentage of equity given a stated return period. Aon Benfield
has been tracking these disclosures since 2007, and aggregates
the results annually in the Catastrophe Risk Tolerance Study. The
most recent version of the study features 102 global insurers
and reinsurers. Eighty-four percent of these companies report
some type of catastrophe risk exposure through 10K, annual
statements, investor presentations, etc. Of the 102 companies,
nearly half or 46 percent state their risk tolerance as a net
PML figure. Exhibit 20 shows reinsurers tend to have higher
catastrophe exposure relative to equity.
Companies are more mindful of how peer companies disclose
their risk tolerances and ensure they fall in line. Comparing peers
against a set metric, such as net PML to equity, can help reduce
the inconsistencies found in public risk tolerance disclosures.
Stress scenariosThrough the ERM process, companies should have the
ability to quantify how adverse events impact results. Rating
agencies and regulators perform stress scenarios when
evaluating companies and may run in-house modeling to
share impacted financials from various stress scenarios.
Companies must identify major risks before determining the
best stress scenarios to use. Exhibit 21 can provide insight
into major risk categories and what metrics, including
stress testing, may be useful to help measure impact.
ORSA has currently been adopted by 35 states, with three
under consideration. As one component of the ERM process,
ORSA provides a framework for companies to quantify stress
scenarios. ORSA requirements highlight how ERM has evolved
from a list of operational and financial controls, to a process of
analyzing stress scenarios and impact to capital adequacy.
A.M. Best removed all ERM information from their SRQ for
the 2013 year, as many ERM conversations are discussed in
companies’ annual ratings meetings.
Enterprise Risk Management Trends
Exhibit 20: Catastrophe risk tolerance diclosure analysis
0%
5%
10%
15%
20%
25%
30%
HighMean
5%
14%17%
18%
8%
16%
26%25%
Insurers Reinsurers
1:100 after tax net PML as a percent of equity 1:250 after tax net PML as a percent of equity
0%
5%
10%
15%
20%
25%
30%
HighMean
Source: Company filings, Aon Benfield Analytics
Aon Benfield 27
Exhibit 21: Risk identification and prioritization
Underwriting Reserve Market Credit Operational
Risk elements
Pricing risk
Parameter risk
Loss process risk
Catastrophe risk
Product design risk
Long-tailed lines
Latent risks (A&E)
Equity
Interest rate (GAAP)
Currency
Reinsurance recoverables
Receivables
Bond defaults
Downgrade migration
Basel II banking definition:“the risk of loss resulting from inadequate or failed internal processes, people, or systems, or from external events
Excludes strategic risk and reputational risk
Metrics Risk adjusted target combined ratios
Catastrophe risk PML target
Exposure capacity guidelines
Scenario stress tests
Conservative reserving
Reserve risk quantification
Reserve process validation
Mix and asset concentration limits
Equity and interest rate risk quantification
Scenario stress tests
Detailed exposure monitoriing
Rating migration impact quantification
Scenario stress tests
Disaster recovery plans
IT robustness testing
Compliance monitoring
Source: Aon Benfield Analytics
For the most recent 2014 SRQ, A.M. Best added back one
related question regarding risk tolerance statements. ERM
continues to be an important aspect of an A.M. Best rating.
During the 2015 Review & Preview conference, A.M. Best
discussed emerging risks that they believe companies’
should be considering through their ERM process:
Mergers and acquisitions—Key issues and related risks
Alternative capital—Use and permanence
Regulation—Ability to respond to
increasing regulatory demands
Meta data—Use of technology in making ERM decisions
Cyber risks—There are various unique exposures
and levels are quickly increasing
Alternative investments—Considering hedge funds or
private equity investments to improve returns still has risk
Standard & Poor’s has released an updated ERM report in
June 2015. The report continues to provide commentary
on how Standard & Poor’s views ERM and trends seen in
the industry. Standard & Poor’s highlights that ERM should
not be a check the box exercise, and that every company is
different. Companies are expected to focus on the following
areas during ERM assessment; risk management culture, risk
models, strategic risk management, risk controls, emerging risk
management. Overall, there has been modest improvement in
the ERM scores of Standard & Poor’s rated companies. As the
graph below highlights, the percentage of Weak ERM scores
have decreased while Strong scores have increased with three
companies upgraded to Strong over the year. Both Very Strong
and Adequate ERMS scores have remained stagnant from 2013.
Standard & Poor attributes the modest uplift in part to newly
adopted ORSA requirements for the large companies that
comprise the majority of Standard & Poor’s portfolio.
Exhibit 22: Standard & Poor’s May 2015 enterprise risk management report
*Note: YTD 2015 as of May 15, 2015 Source: S&P
In June 2014, Standard & Poor’s received a comprehensive
ERM survey they had sent to US and Bermudan companies.
The survey asked both qualitative and quantitative questions
around risk culture, risk controls, risk models, emerging risk,
and strategic risk. In September 2014, Standard & Poor’s
summarized the findings from the surveys and found that many
companies had more work to do in order to prepare for the
2015 ORSA requirements, with higher ERM rated companies
being more prepared than their lower ERM rated counterparts.
201120102009 2012 2013 2014
0%
25%
50%
75%
100%
WeakAdequateStrongVery Strong
28 Evolving Criteria
As companies continue to operate within a very competitive market, there will be a number of key rating agency and regulatory themes when looking forward into 2016:
New stochastic-based BCAR: With an expected release
of draft in October of 2015 and implementation in mid-
2016, both life and non-life companies globally will be
evaluated under a new capital model. We expect it will
be an adjustment for those familiar with BCAR to calibrate
companies’ scores under the new model. As the new
model is released, there will be a flurry of activity as
companies try to understand not only their own BCAR,
but also how it relates to the industry as a whole.
Reinsurance segment pressures: Between the new
alternative capital entrants and low catastrophe activity,
capital in the reinsurance market is at a high and is squeezing
margins. All four rating agencies have negative outlooks on
this sector as they are concerned about pricing trends.
Further emphasis on ERM and capital models: With
continued requests from both regulators and rating
agencies, companies continue to work towards defining risk
tolerance statements, implementing and documenting risk
management practices and using internal capital models.
Mergers and acquisitions: M&A activity in the industry
is expected to continue in the next year as companies
have record capital levels and looking for ways to grow.
Acquisitions are offering opportunities for companies to
achieve geographic expansion, product diversification,
cost efficiencies from scale and profitable growth.
Increasing global regulation. Regulators around
the world continue to evolve their criteria, including
increasing capital requirements, catastrophe exposure
thresholds and evaluations under updated risk-based
capital models. Additionally, regulation is becoming more
global in nature with the rules in some regions impacting
other countries that want to do business there.
Looking Forward: Key Topics for 2015 and 2016
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Benfield helps empower results, please visit aonbenfield.com.
About Aon Benfield
© Aon Benfield Inc. 2015.All rights reserved. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. This analysis is based upon information from sources we consider to be reliable, however Aon Benfield Inc. does not warrant the accuracy of the data or calculations herein. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Benfield Inc. disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Members of Aon Benfield Analytics will be pleased to consult on any specific situations and to provide further information regarding the matters.
ContactsGlobal
Greg HeerdeHead of Analytics & Inpoint, AmericasAon Benfield+1 312 381 5364greg.heerde@aonbenfield.com
Patrick MatthewsHead of Global Rating Agency AdvisoryAon Benfield +1 215 751 1591 patrick.matthews@aonbenfield.com
Americas
Kathleen ArmstrongDirector, US Rating Agency AdvisoryAon Benfield+1 513 562 4508kathleen.armstrong@aonbenfield.com
EMEA
Ankit DesaiHead of Rating Agency Advisory, EMEAAon Benfield+44 207 522 8268ankit.desai@aonbenfield.com
APAC
Sifang ZhangDirector, Head of Rating Agency Advisory, APACAon Benfield+852 2861 6493sifang.zhang@aonbenfield.com
Canada and Caribbean
Raymond LuiSenior Vice PresidentAon Benfield+1 416 598 7320raymond.lui@aonbenfield.com
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© Aon plc 2015. All rights reserved.The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate profes-sional advice after a thorough examination of the particular situation.
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