Effect of Reinsurance on BCAR
Case Study
CARe Seminar on Reinsurance
May 20, 2008
Thomas M. Mount, ACAS, MAAA
A. M. Best Company
Outline
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Quick review of BCAR
Baseline scenario
Reinsurance “Solution”
What can possibly go wrong???
Summary
BCAR - Structural Overview
BCAR Ratio = Economic Surplus / Net Required Capital
Economic Surplus
Reported Surplus (PHS)
Equity Adjustments:
Unearned Premiums
Loss Reserves
Assets
Debt Adjustments:
Surplus Notes
Debt Service Requirements
Stress Test Adjustments:
Future Operating Losses
Potential Catastrophe Exp.
Other
Net Required Capital
Gross Required Capital (GRC):
(B1) Fixed Income Securities
(B2) Equity Securities
(B3) Interest Rate
(B4) Credit
(B5) Loss and LAE Reserves
(B6) Net Premiums Written
(B7) Off-Balance Sheet
Covariance Adjustment
Net Required Capital (NRC)*
Economic Surplus (APHS)
*NRC=  (B1)²+(B2)²+(B3)²+(0.5*B4)² +[(0.5*B4)+B5)]²+(B6)² +B7
Minimum Capital
Requirements
Rating Level
A++
A+
A
AB++
B+
B/BC++/C+
Minimum BCAR
175
160
145
130
115
100
80
60
Baseline Scenario
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Monoline liability insurer
Writes in 3 states
20+ year history
$2M per occurrence net retention
Softening market conditions
Current rating = AHistorical BCARs 145, 140, 135 (prior yr end)
Selected minimum required BCAR = 135
Baseline Scenario
Reported Surplus
Net Loss Reserves
NPW
2007 YE
w/o ASL
300,000
600,000
300,000
(B1) Fixed Income Risk
(B2) Equities Risk
(B3) Interest Rate Risk
(B4) Credit Risk
(B5) Reserve Risk
(B6) Premium Risk
(B7) Business Risk
Gross Required Capital
3,500
0
6,000
2,700
230,931
112,036
0
355,167
Net Required Capital
257,986
APHS
330,042
BCAR
128
What to do?
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Eliminate bad risks (re-underwrite)?
File new (higher) rates?
Diversify into more states?
Diversify into more lines?
Raise capital?
But I need help NOW !!!!!!
How About a
Reinsurance Solution?
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Prospective Aggregate Stop Loss
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Coverage begins 1/1/08
Reduces NPW risk
$50M of limit in risk layer = 17% of NPW
 Attaches 10 points over the ELR of 80%
 Low cost
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Increases BCAR now
Benefit of ASL
Reported Surplus
Net Loss Reserves
NPW
2007 YE
w/o ASL
300,000
600,000
300,000
2007 YE
w/ ASL
300,000
600,000
300,000
(B1) Fixed Income Risk
(B2) Equities Risk
(B3) Interest Rate Risk
(B4) Credit Risk
(B5) Reserve Risk
(B6) Premium Risk
(B7) Business Risk
Gross Required Capital
3,500
0
6,000
2,700
230,931
112,036
0
355,167
3,500
0
6,000
2,700
230,931
61,036
0
304,167
Net Required Capital
257,986
240,271
APHS
330,042
330,042
BCAR
128
137
NPW Risk
Line
Other Liability
Line
Other Liability
BEFORE ASL Adjustment
Capital Required
NPW
Factor
Capital
300,000
0.373
112,036
1.00 Diversification Factor
1.00 Growth Factor
112,036 Adjusted Required Capital
AFTER ASL Adjustment
Capital Required
NPW
Factor
Capital
300,000
0.203
61,036
1.00 Diversification Factor
1.00 Growth Factor
61,036 Adjusted Required Capital
Origin of NWP Risk
Capital Factors
Lognorm(1.9607, 0.11756) Shift=-2.0183
6
5
1% in tail
4
3
2
1
0
-0.5
-0.4
-0.3
-0.2
-0.1
0
0.1
0.2
0.3
(Profit)/Loss % (All years)
industry
mean
break
even
Capital factor
99%
0.4
NPW Risk
140%
120%
10%
Loss & LAE Ratio
100%
Retained Risk
37%
17%
10%
Ceded Risk Layer
80%
Retained Expected Losses
60%
40%
80%
80%
Before ASL
After ASL
20%
0%
as of 12/31/07
3 More Yrs Status Quo
Reported Surplus
Net Loss Reserves
NPW
2007 YE
w/ ASL
300,000
600,000
300,000
2008 YE
w/ ASL
300,000
600,000
300,000
2009 YE
w/ ASL
300,000
600,000
300,000
2010 YE
w/ ASL
300,000
600,000
300,000
(B1) Fixed Income Risk
(B2) Equities Risk
(B3) Interest Rate Risk
(B4) Credit Risk
(B5) Reserve Risk
(B6) Premium Risk
(B7) Business Risk
Gross Required Capital
3,500
0
6,000
2,700
230,931
61,036
0
304,167
3,500
0
6,000
2,700
230,931
61,036
0
304,167
3,500
0
6,000
2,700
230,931
61,036
0
304,167
3,500
0
6,000
2,700
230,931
61,036
0
304,167
Net Required Capital
240,271
240,271
240,271
240,271
APHS
330,042
330,042
330,042
330,042
BCAR
137
137
137
137
What could possibly go
wrong???
Adverse Reserve
Development Scenario
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Limit used up on prior AY’s in CY 2010
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Recoverables increase $150M
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$50M each for 2008, 2009, 2010
Compounded by reinsurance dependence factor
Reserve risk analyzed pre ASL
Revised assessment of Expected Loss for NPW
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Reduces credit to capital factor
Adverse Development
Scenario
Status Quo
2010 YE
w/ ASL
300,000
600,000
300,000
Adverse
2010 YE
w/ ASL
300,000
600,000
300,000
Change
0
0
0
(B1) Fixed Income Risk
(B2) Equities Risk
(B3) Interest Rate Risk
(B4) Credit Risk
(B5) Reserve Risk
(B6) Premium Risk
(B7) Business Risk
Gross Required Capital
3,500
0
6,000
2,700
230,931
61,036
0
304,167
3,500
0
6,000
9,046
288,508
112,036
0
419,090
0
0
0
6,346
57,577
51,000
0
114,923
Net Required Capital
240,271
313,828
73,557
APHS
330,042
330,042
0
BCAR
137
105
(32)
Reported Surplus
Net Loss Reserves
NPW
Credit Risk
BEFORE Ceding Adverse Development to ASL
Credit Risk
Adjusted
Amount
Asset
Risk
Factor (%)
Adjusted
Required
Capital
Statement
Value
Adjustment
Agents' Balances
In Course of Collection
30,000
0
30,000
5.0
1,500
Reinsurance Recoverables (A)
All Other Insurers
Less: Funds Held By Company
Net Reinsurance Recoverables
30,000
0
30,000
0
0
0
30,000
0
30,000
4.0
4.0
4.0
1,200
0
1,200
Multiply: Reinsurance Dependence Factor (B)
Adjusted Net Reinsurance Recoverables
30,000
0
30,000
4.0
1.00
1,200
Company Total
60,000
0
60,000
4.5
2,700
Notes:
(A) - Includes ceded paid, case, IBNR, and unearned premium recoverables.
(B) - Excessive Reinsurance Dependence:
Non-Affiliated Reinsurance Recoverables / PHS
Company
0.1
Industry Expected
0.4
Excess
0.0
Credit Risk
AFTER Ceding Adverse Development to ASL
Credit Risk
Adjusted
Amount
Asset
Risk
Factor (%)
Adjusted
Required
Capital
Statement
Value
Adjustment
Agents' Balances
In Course of Collection
30,000
0
30,000
5.0
1,500
Reinsurance Recoverables (A)
All Other Insurers
Less: Schedule F Provision
Net Reinsurance Recoverables
30,000
0
30,000
150,000
0
150,000
180,000
0
180,000
4.0
10.0
4.0
7,200
0
7,200
Multiply: Reinsurance Dependence Factor (B)
Adjusted Net Reinsurance Recoverables
30,000
150,000
180,000
4.2
1.05
7,546
Company Total
60,000
150,000
210,000
4.3
9,046
Notes:
(A) - Includes ceded paid, unpaid, IBNR, and unearned premium recoverables.
(B) - Excessive Reinsurance Dependence:
Non-Affiliated Reinsurance Recoverables / PHS
Company
0.60
Industry Expected
0.40
Excess
0.20
Reserve Risk
Dollars (000s)
288,508
Capital Charge
230,931
112,500
90,000
150,000
Deficiency
Ceded Layer
Booked Reserves
600,000
600,000
Before ASL Adjustment
After ASL Adjustment
as of 12/31/2010
Reserve Risk
Baseline Industry Reserve Capital Factor Calc.
2.5
2
1% in tail
1.5
1
0.5
0
-60%
-40%
-20%
0%
30%
60%
90%
(Favorable)/Adverse Reserve Development % of Original Reserves
zero
defic.
capital factor
99%
120%
Revised NPW Risk
160%
140%
37%
120%
Loss & LAE Ratio
10%
100%
80%
ELR=107%
17%
10%
17%
ELR=80%
60%
40%
Retained Risk
80%
90%
20%
0%
Prior View of ASL Credit
Revised View of ASL Credit
Ceded Risk
Layer
Retained
Expected
Losses
Prospective Stop Loss
Rating/Capitalization Issues
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BCAR score initially improves due to the transfer
of risk to the reinsurer
Distorts true picture of risk when utilized
Exposure bases understated (NWP & Reserves)
 BCAR distorted/understated
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Adds reinsurance recoverable credit risk
Protects volatility but increases reins dependence
Short term solution to a long term problem
Summary
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Understand what the contract is trying to do
Understand the accounting of the contract
Understand the impact of that acctg on BCAR
Make the appropriate BCAR adjustments
Need to update adjustments each year
Any adjustments to assuming company?
Commutation of these contracts also requires
adjustments to BCAR
Never allow rating to be more than 1 rating level
above true picture before credit for risk transfer
Effect of Reinsurance
on BCAR
Questions/Comments?