Casualty Actuarial Society
November 12, 2007
Mark Rouck, CPA, CFA

Background on Prism
Prism’s Catastrophe Risk Component
What Does it Mean for Ratings?

Background on Prism
Prism’s Catastrophe Risk Component
What Does it Mean for Ratings?

The Road to Implementation
US: November 2007
Nov-2007
Fully Implemented with “cure” period
Late 06-Early 07
 Beta Models tested and calibrated
Prism
 A robust, global, stochastic model for evaluating the capital adequacy of insurers
 Represents a significant step forward from existing regulatory and rating agency methodologies
2 nd QUARTER, 2006
 Executive Summary of Methodology
 Technical Document of Prism
 Assessment of Insurer In-house Economic Capital Models
 Defining Available Capital
 Calibration to Rating Thresholds
 Enterprise Risk Management
PRIOR TO 2006
 Commits to building a Global Economic Capital Model (September 2004)
 Releases Variable Annuities Capital Model (August 2005)
 Publishes Catastrophic Risk and Capital Requirements (November 2005) and New
Catastrophe Risk Analysis Increases Capital Needs by 10%. (May 2006)
3

Prism’s Unique Strengths and Features
1.
 Current list of countries: FR, GER, UK, US
 Consistent assumptions and structure allows us to bolt on others
 Recognizes country specific products and parameters
2.
 Risks are modeled simultaneously – captures both diversification and compounding effects
 Economic Scenario Generator / Correlated Random Numbers
3.
 5,000 simulation scenarios
 TVaR approach considers “tail” events
 Calibration based on historical default rates
 Wave of the future – Solvency 2
4

Modeling Methods – Risk Elements Captured
Underwriting Risk
 Use a collective risk model of frequency and severity of losses.
 Relies on ELR,
Attachments, Limits
 Factors one year of new business.
Reserve Risk
 Incorporates reserve adequacy analysis
 Use Mack Method to
Estimate Volatility
 Utilize several checks to ensure data integrity
 Asbestos &
Environmental Losses
Evaluated Separately
Catastrophe Risk
 Use Company
Provided PMLs
 Use AIR (Catrader) software.
 Consideration of up to
1 in 10,000 event
ALM (Market) Risk
 Incorporates risk-free yield curve (bonds, mortgages), real estate and equity returns (DAX, FTSE,
CAC).
 Use a proprietary, integrated scenario generator.
Credit Risk
 Incorporates defaults, migration and spread volatility
 Use common market indices to establish parameters for asset type and quality
 Over 50 asset buckets.
 Stochastically model reinsurer default risk
Each Company will potentially have unique risk curves
“Aggregator”
 Consistent economic scenario set
 Similar Cat event set
 Correlated random numbers
5

Two Core Outputs Determine Prism Scores
1.
Available Capital or “AC”
 Economic, not accounting based number

What is amount of liquid capital in a controlled run-off situation
2.
Required Capital or “RC”
 Distribution table produced by the simulation
 RC is not a single number but a range of outcomes
 Derived by applying the appropriate T-VaR against distribution
Simulation calculates PV of cash inflows and outflows over 30 year balance sheet run-off (with one year of new business)
 Cash outflows: claims and expenses
 Cash inflows: investment earnings and premiums on new business
Prism Score is point where AC intersects RC

The highest rating level at which that occurs is your Prism Score
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Capital “Score” Required vs. Available
Defined by
Balance Sheet
Assessment
BBB-
REQUIRED CAPITAL
BBB BBB+ AA
FITCH AVAILABLE CAPITAL
A+ AAAA AA+ AAA
9,000,000
8,000,000
7,000,000
6,000,000
5,000,000
4,000,000
3,000,000
2,000,000
1,000,000
0
Defined by
Model Results
7

Prism: 2006 US Non-Life Results
 Confirmed overall existing capital assessment of
Fitch universe
 Limited (~10% of group’s reviewed) Prism related rating actions
 Certain sectors performed better than expected e.g. personal auto
PRISM SCORES: DISTRIBUTION AT YEAREND 2006
US: Non-Life Groups
# of Non-Life Percent of Total
Prism Score Insurer Groups (%)
AAA
AA+
AA
AA-
A+
A
A-
BBB+
BBB
BBB-
Non-investment grade
Total
4
0
6
3
20
7
2
1
0
0
0
43
47
16
5
2
14
7
9
0
0
0
-
100
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Background on Prism
Prism’s Catastrophe Risk Component
What Does it Mean for Ratings?

Prism’s Catastrophe Risk Component
> Insurer provided modeled annual aggregate catastrophe losses at various return periods
– Frequency / Severity Assumptions = Near-term
– Demand Surge = Occurrence base
> AIR Catrader models gross annual aggregate catastrophe losses at various return periods based on by state premium distribution and AIR event sets
> Interpolation generates modeled annual aggregate gross loss distribution ranging from 20-10K year return periods
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Prism’s Catastrophe Risk Component (cont.)
> Catastrophe reinsurance program applied against gross losses to create annual aggregate modeled net loss distribution
– Alternatively will use insurers full net annual aggregate catastrophe loss distribution if provided
> Alternatives to traditional reinsurance (i.e. catastrophe bonds, ILWs) added to catastrophe reinsurance program based on perils and attachment points
11

Year
2
1
.
.
30
Total
> Modeled net catastrophe losses combined with other risk components to determine each scenario’s additional capital needs
Asset
Balance
5,491
5,394
485
116
-
Net
Premium
2,013
-
-
-
-
Investment
Income Claims
1,245
216
19
4
-
3,203
2,017
388
153
43
CAT
Losses
152
-
-
-
-
Asset
Balance
Ending
5,394
3,593
116
(33)
(43)
Added
Required
Capital NPV
-
-
-
-
33
43
22
27
49
12

Background on Prism
Prism’s Catastrophe Risk Component
What Does it Mean for Ratings?

What Does this Mean for Ratings?
> Capital required to support catastrophe risk varies by company and rating category
– Fitch does not have single by rating category catastrophe exposure related capital requirements
REQUIRED CAPITAL
Stress Level T-VaR Total ($000)
AAA
AA+
AA
AA-
A+
A
99.8450%
99.7260%
99.5890%
99.4090%
99.2060%
99.0710%
14,934,448
13,329,592
12,199,723
11,220,677
10,304,747
9,590,155
A-
BBB+
BBB
BBB-
98.6840%
96.7180%
95.1420%
93.4310%
8,641,148
6,604,306
5,411,341
4,262,938
< BBB92.4120% 3,532,840
FITCH AVAILABLE CAPITAL: 9,675,413
2006
70%
78%
86%
93%
101%
109%
121%
158%
193%
245%
295%
14

What Does this Mean for Ratings? (continued)
> Catastrophe related “stress test” implicitly considered through
– Use of annual aggregate modeled catastrophe losses
– T-VaR approach applied to overall required capital distribution
– In unique cases, modeled catastrophe results can also be stressed by shifting company supplied or CATRADER generated loss distributions upward
15

Catastrophe Findings from 2005 Beta Testing
> Insurers with large homeowners or coastal property coverages have tremendous capital exposure to extreme tail events
– For these insurers required capital can materially exceed 100 year and 250 year PML used in factor based models
> Others such as specialty liability underwriters have virtually no catastrophe exposure
> For universe in aggregate, catastrophe related required capital was equal to 8.9% of aggregate exposure
> Ignoring insurers without catastrophe exposure, range of required catastrophe capital / exposure was 6% - 37%
16

Results of 2005 Beta Testing by Sector
At highest rating level "passed"
Exposure:
Aggregate New
Business ($000)*
100 year PML / AC 250 year PML / AC
** ** Sector
Commercial Lines
Large Cap
Regional
Specialty
Subtotal
Personal Lines
National
Regional - Auto
Subtotal
Total
179,706,446
14,698,229
25,339,872
219,744,547
146,660,851
12,872,352
159,533,203
379,277,750
11.9%
8.9%
8.0%
9.2%
12.6%
7.3%
10.1%
9.5%
17.7%
21.8%
13.4%
16.5%
19.7%
10.7%
15.5%
16.2%
5000 year PML /
AC **
Catastrophe
Required Capital /
Exposure
23.2%
39.3%
18.4%
24.6%
27.1%
16.9%
22.4%
23.9%
5.6%
15.1%
4.8%
7.4%
11.2%
13.6%
12.3%
8.9%
* For consistency, premium figures have not been adjusted to reflect only those lines that are affected by catastrophes
** PML = Probable Maximum Loss are Fitch's best estimate using AIR's Catrader software and our assessment of reinsurance or Company-supplied figures.
*** Results are straight averages and are not weighted.
17

Takeaways
> Fitch uses Prism to determine capital requirements for natural catastrophe risk
> Prism considers modeled annual aggregate catastrophe loss distributions rather than select points along the distribution to develop capital requirements
> Capital required to support catastrophe risk varies by insurer and by rating category
> “Stress Tests” implicitly considered through annual aggregate and T-VaR approaches employed by Prism
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Dedicated Website: www.fitchratings.com/prism
Access to this portion of our website is free – requires only a registration.
19

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