Sep 14, 2015 - The availability and application of new and more sophisticated technology .... A.M. Best will continue to
Aon Benfield
Evolving Criteria Rating agency, regulatory, and financial trends September 2015
Risk. Reinsurance. Human Resources.
Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1 Industry Outlooks & Rating Activity. . . . . . . . . . . . . . . . . . . . . . . .2 Rating Criteria Updates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4 A.M. Best . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Standard & Poor’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Moody’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Fitch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 Demotech . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Regulatory Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10 North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Europe, the Middle East, and Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 Caribbean . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Latin America. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Accounting Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21 International accounting standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 Development of global Insurance Capital Standard. . . . . . . . . . . . . . . . . 21
Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22 Financial Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24 Operating performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Capital adequacy continues to grow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 Public company benchmarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Enterprise Risk Management Trends . . . . . . . . . . . . . . . . . . . . . .26 Risk tolerance statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Catastrophe Risk Tolerance Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Stress scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
Looking Forward: Key Topics for 2015 and 2016 . . . . . . . . . . . .28 Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29
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
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
of webinars, and we expect a draft model will be
enterprise risk management stress scenarios
released in the fourth quarter of 2015
and risk tolerance statements
—Cyber security is an important area of focus;
The industry is rapidly changing with increased
A.M. Best released a set of questions that all
technology, altered distribution channels, large scale
companies should plan to answer
merger and acquisition deals, and alternative capital
—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
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.
their notching criteria —Demotech released an update regarding credit for catastrophe bonds
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Industry Outlooks & Rating Activity 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
The personal lines outlook remains stable for all four rating
significant declines in pricing in 2014, and pressure will
agencies. Although the segment was profitable in the last
remain throughout 2015. Intense competition is leading
year, results for 2014 declined slightly relative to prior years
to thinner underwriting margins while the sector remains
due to slightly higher loss ratios. The segment continues to
overcapitalized. As reinsurers need increased scale and
be well capitalized and has increased surplus for the sixth
diversification in order to remain competitive and profitable,
consecutive year, driven by underwriting profitability and
A.M. Best believes the merger and acquisition trends in 2014
consistent net investment income. Favorable performance is
will continue and global companies will only get larger.
attributed to stable auto results and low catastrophe losses.
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.
Exhibit 1: Current industry outlooks Sector
A.M. Best
Fitch
Moody’s
S&P
Commercial
Negative
Stable
Stable
Stable
Stable
Stable
Stable
Stable
Negative
Negative
Negative
Negative
Personal
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
Reinsurance
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.
commercial lines have remained unchanged since last year.
For both A.M. Best and Standard & Poor’s, 2014 ended with
A.M. Best continues to remain the sole rating agency with a
upgrades outpacing downgrades for the first time since 2010,
negative outlook on the commercial sector, despite noting
although the total number of rating actions has declined
improved market conditions and pricing. They believe
significantly. From a personal lines perspective, favorable
underwriting results will be insufficient to overcome the
operating metrics resulted in the majority of ratings being
headwinds that the industry faces. A.M. Best indicated
affirmed with stable outlook. Some rating volatility occurred
that while they expect the majority of commercial carriers
for companies that write non-standard auto, which is consistent
to have their ratings affirmed, they expect more negative
with previous year trends. Excessive growth and deteriorating
rating actions than positive in 2015. Reserve adequacy,
operating performance were the primary reasons for downward
low returns on fixed-income investments, and emerging
rating movement. In the commercial lines segment, the
issues like terrorism and cyber risk are the main concerns.
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.
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Evolving Criteria
Exhibit 2: Rating activity: upgrades vs. downgrades A.M. Best
Standard & Poor’s
100
Upgrades
Downgrades
20
90
18
80
16
70
14
60
12
50
10
40
8
30
6
20
4
10
2
0
2007
2008
2009
2010
2011
2012
2013
2014
YTD 2015*
0
Upgrades
2007
2008
2009
2010
2011
2012
Downgrades
2013
2014
YTD 2015*
*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
Exhibit 3: A.M. Best “A-” upgrade and downgrade characteristics
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.
Key metrics—median 5yr Combined ratio (%)
“A-” to “B++” downgrades (year of downgrade)
All “A-” ratings (as of July 2015)
“B++” to “A-” own merit upgrades
113
99
94
-5
7
15
From 2010 to June 2015, 46 companies were downgraded from
5yr Pre-Tax ROR (%)
“A-” to “B++”. The median five-year combined ratio based upon
NPW / PHS (x)
1.2
0.6
0.7
BCAR (percent)
180
295
280
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.
Source: Aon Benfield Analytics, A.M. Best Bestlink Database
Conversely, for companies upgraded from “B++” to “A-” based on their own merit (i.e., no parental support), the median fiveyear 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.
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3
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.
A.M. Best A.M. Best is expected to issue draft criteria for the new,
The overall structure of the model is not intended to
stochastic BCAR model in October with a lengthy comment
change materially, but the goal is to generate risk factors
period and potential implementation by the third quarter of
using stochastic simulations from probability curves at
2016. The first model released will be the US property casualty
various confidence internals—98%, 99%, 99.5%, 99.8%,
statutory model. A.M. Best will also release criteria for the
and 99.9%. Exhibit 4 shows the layout of the new Stochastic
US life and health, Title, Universal, and two Canadian BCAR
BCAR model. The model was last updated more than 18
models in the months following. All six BCAR models will be
years ago. The availability and application of new and more
adopted concurrently.
sophisticated technology coupled with evaluating capital adequacy across consistent confidence intervals provides a more robust perspective of insurer balance sheet strength.
Q4 2015
Review historical trends under new model
Industry webinars on progress
Analyzing and testing model output
Issue Request for Comment on property casualty model
Q2 2016 Share draft model output with companies
Finalize and test other BCAR models (life and health, Canadian, Title, and Universal)
Q2 and Q3 2015
Timeline is subject to change based upon model testing results and level of industry feedback
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Evolving Criteria
Receive and evaluate industry feedback
Issue Request for Comment on other BCAR models
Q1 2016
Transition to new model Release criteria
Q3 2016
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
Currently, A.M. Best includes the net retention of the greater
across all five confidence intervals and have determined the
of a 1 in 100 wind event or a 1 in 250 earthquake event,
financial strength rating mapping in relation to each interval,
both on an occurrence basis. In March 2015, A.M. Best was
see exhibit 5. A.M. Best expects to update the model in phases.
considering using an aggregate, all-perils TVaR metric and the rest of the model would have been on a TVaR basis. A.M.
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 risk measure will be moved to the
position or the numerator is the same for all confidence
vary by confidence interval and higher rated companies
levels. A.M. Best commented that there will continue to
(A- or above) are expected to have more tail coverage.
be a catastrophe stress test. Exhibit 6 summarizes the evolution of the catastrophe risk charge over the last year.
Exhibit 5: Mapping by rating level
Catastrophe charge
consistency, will switch to VaR for the other model components.
current practice of subtracting it from surplus, so the capital
impact for many companies. The return period will
Rating level
an occurrence, all-perils VaR view of catastrophe risk and for
denominator of the BCAR calculation as opposed to the
The catastrophe charge is expected to have the biggest
Confidence Interval
Best changed the plan in May and announced they will use
98%
99%
99.5%
99.8%
99.9%
B
B+ / B++
A- / A
A+
A++
50yr
100yr
200yr
500yr
1,000yr
Source: A.M. Best
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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
Exhibit 7 by A.M. Best shows the average risk factors for a
scenario generator with inputs reflecting a company’s
sample of property casualty companies compared to the
duration and asset quality as provided in the supplemental
current model. The public common stock baseline factor
rating questionnaire (SRQ). Common stock default risk
increases from the current 15 percent to 43.8 percent at
factors will be based on an economic scenario generator
the 99.5% (A/A-) confidence interval and 48.3 percent at
with inputs reflecting the type of stocks held by a
the 99.9% confidence interval (A++). Schedule BA assets or
company based on the beta provided in the SRQ.
alternative investments will receive a starting charge of
A.M. Best saw significant increases in these asset risk factors, particularly in equities. They noted that the investment charge
60 percent at all confidence intervals (increased from the current 20 percent) unless further reviewed by an analyst.
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: 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
6
Evolving Criteria
Risk charges for reinsurance recoverables will reflect the
A.M. Best reinforced that BCAR will remain only one component
type of recoverable, the duration of recoverables up to 30
of the overall rating assessment; although as their key metric
years, and the rating of each reinsurer. The model simulates
for balance sheet strength, it is a very important measure
10,000 impairment scenarios for each reinsurer and only uses
companies use to set capital management strategies.
impairments occurring during the first 10 years. The amounts
In addition, given the overhaul of the BCAR model, scores
will also be measured at present value. As an example,
from the new BCAR model are not directly comparable
recoverables on workers’ compensation, long tail, losses will
to the current model. For example, if a company’s current
be subject to a higher risk charge than property, short tail,
BCAR score is 300 percent and the new BCAR ratio at the
losses. A.M. Best commented that the charges are slightly
99% confidence interval is 200 percent, it will not be viewed
higher than the current model, depending on the reinsurer
as a 100 point drop in BCAR as the model results are not
and the duration of the liabilities. However, the combination
comparable. In fact, it will indicate the company’s capital
of discounting and assuming no impairments beyond 10 years
adequacy is very strong at the 99% confidence interval (double
has reduced the initial charges slightly. A.M. Best noted they
the required capital), but the key and new perspective will
will incorporate a risk charge for concentration of recoverables
be capital adequacy at the higher confidence intervals.
from a reinsurer. Credit will continue to be provided for collateral on reinsurance recoverables.
Companies we believe that are most at risk from a change to the
Property casualty premium and reserve risk factors will begin
to their rating level as there is less room to absorb the impact
with 84 industry probability curves (21 Schedule P lines and
of more conservative factors, especially at higher confidence
four size categories for each—very small, small, medium,
intervals. In addition, higher rated companies (A- or above)
and large). The size categories are based on a company’s
whose current catastrophe reinsurance program exhausts
net premium written or net reserves in each line of business.
near the 100-year return period will likely see a material drop
The curves will be made company specific based on their
in capital adequacy at higher confidence intervals, which will
profitability for premium, or volatility for reserves. Ten thousand
influence A.M. Best’s view of their balance sheet strength.
BCAR model are those with lower current BCAR scores relative
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
Cyber security
the auto risk factors are lower than the current BCAR, which
A.M. Best has increased its focus on the emerging trends
is not surprising due to changes in the auto line of business in
surrounding cyber security and views it as an essential element
the last 20 years. They also stated that workers compensation,
of enterprise risk management. Companies are now asked
general liability, and medical professional liability are slightly
to complete a new section of the SRQ reflecting what each
higher under the new stochastic model than the current model.
company is offering and the amount of protection purchased. A.M. Best stated that it will seek answers to additional questions
A.M. Best will continue to incorporate a catastrophe stress test.
regarding susceptibility to cyber attacks and measures in
The goal is to see what a company looks like after a catastrophe
place if an incident occurs, see Exhibit 8. Companies that
event occurs. A.M. Best intends to incorporate this by using the
offer cyber security insurance are also requested to disclose
same event and return period for each confidence interval and
specifics about their policies, including policy limits, expected
subtracting the retention (plus any reinstatement costs, net of
losses, and policy type as separate versus bundled.
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.
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.
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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
The ratings reflect A.M. Best’s judgment on an insurance-
Residual Value Insurance. The report introduces factors specific
linked fund’s vulnerability to losses and credit quality. Funds
to the residual value insurance book of business, particularly
may include surplus notes, catastrophe bonds, loss warranties,
the calculations of loss reserve risk and premium risk, which
and various other securities. The three main determinants of a
are dependent upon asset quality. While risks of most insurers
fund’s ILFR are the attachment probability, fair value of assets
are mainly independent, physical assets underwritten by
and liabilities, and term to maturity.
insurers tend to be correlated in nature. For example, aviation and shipping industries are highly correlated because they are
Standard & Poor’s
dependent upon global GDP. This results in a positively skewed
Standard & Poor’s has released seven criteria reports since
loss distribution with significant tail risk. A.M. Best assesses
September 2014, many of which provide minor changes
the loss distribution based on the specific risks being insured.
and refined discussions. These include updates to the
The criteria also highlights the use of Monte-Carlo simulations
treatment of operational leverage, capital charges for
for claims and a modification to the covariance formula to
residential and commercial mortgage-backed securities,
consider the correlation between investment and reserve risk.
and special considerations given to title insurance companies. Standard & Poor’s also addressed its view of
In September 2014, A.M. Best finalized criteria titled Rating
life insurance reserves in the US, more specifically, how
Reinsurance/Insurance Transformer Vehicles that focuses on the
they treat affiliated reinsurers. In general, Standard &
unique characteristics of transformer vehicles. A key aspect
Poor’s analyzes reserves on a consolidated basis unless an
to the rating process is conducting a risk analysis based on
affiliated reinsurer is considered sufficiently isolated.
the type of vehicle, as well as the instrument and mechanism being employed. A.M. Best requires a detailed report
The most impactful update applies specifically to mortgage
outlining loss sensitivity analysis, projected premium and
insurance companies and insurers that write a significant
loss ratios, and attachment and exhaustion probabilities.
amount of mortgage business. In March 2015, Standard & Poor’s issued criteria on an updated model to analyze
For insurance-linked securities, A.M. Best published Insurance-
capital adequacy for mortgage insurers. The capital model is
Linked Fund Ratings (ILFR) in December 2014. These differ
applied within Standard & Poor’s broader insurance criteria
from issuer ratings since insurance-linked funds have little
framework. Specific considerations are now given to the
to no risk of default.
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
8
Evolving Criteria
where adjusted capital is compared to required capital, and
In July 2015, Fitch finalized changes to notching criteria
is determined to be either redundant or deficient at various
due to regulatory changes in Europe and other markets
target rating levels. The following are key considerations
subject to the Solvency II framework. Areas with little
Standard & Poor’s uses to determine MI capital adequacy.
regulatory changes, such as the US, will not be meaningfully
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’s In 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.
Fitch Following the release of Prism Factor-Based Model for Europe, the Middle East, and Africa insurers in September
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.
Demotech In 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
2014, Fitch launched the model for Asia Pacific companies
A fully executed copy of the Reinsurance Trust Agreement
in May 2015. The model will be used as the primary tool
A management narrative on the replacement
to assess an insurer’s capital strength and will enable the
of the catastrophe bond should an early season
agency to use a single framework to compare companies
storm exhaust the catastrophe bond
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.
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. Aon Benfield
9
Regulatory Developments 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 America First 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.
Exhibit 9: Current ORSA enactment status States with Actions Pending
WA
ORSA Enacted States
ND
MT
MN
ME VT
WI
OR WY IA
NE NV
KS
OH
IN
KY TN AR MI
AK
Source: NAIC and AMERICAN FRATERNAL ALLIANCE
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Evolving Criteria
LA
AL
GA
RI NJ DE
VA
CA
TX
PA
MO
OK
MA
CT IL
UT
NH
NY
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 SarbanesOxley 404 compliance and financial reporting
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
controls orientated) into a more risk-focused and
Offer additional evidence regarding how the management
process-driven risk management documentation
team utilizes the information in the ORSA Summary Report
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
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.).
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
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US risk-based capital catastrophe risk charge
NAIC group capital standard
Discussions of key components for calculating the risk-based
In July 215, the NAIC released an updated draft on approaches for
capital catastrophe risk charge have been ongoing but are
a group capital standard for US domiciled insurers that operate
nearing finalization. The NAIC still does not have a definitive
internationally. There are three approaches discussed in the draft.
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.
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
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
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.
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
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
— Insured value—property that includes earthquake or hurricane coverage in catastrophe prone areas is less
signed into law by President Obama on January 12, 2015 with a retroactive effective date of January 1, 2015.
than 10 percent of surplus The six year extension features the following changes: 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 riskbased capital formula including: fire following earthquake, tsunamis, extreme convective storm including tornadoes,
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
winter storm, flood, wildfire, terrorism, cyber risk, and
Revision to government recoupment mechanism
liability catastrophes—mass torts such as asbestos and
USD 2 billion per year from USD 27.5 billion to
environmental. Expanding the catastrophe risk charge in this
USD 37.5 billion, phased in starting 2015
manner impacts both property and casualty companies. 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.
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Evolving Criteria
Canada
Europe, the Middle East, and Africa
The Canadian regulator, Office of Superintendent of Financial
January 1, 2016 will bring the long awaited Solvency II
Institutions (OSFI), continues their journey to enhance its
regulations for insurers and reinsurers in the European Union
risk-based approach to supervisory oversight. In 2014, OSFI
(EU) while Solvency Assessment and Management comes
revised its capital solvency model, minimum capital test and
into effect in South Africa. In the Middle East, as the insurance
branch asset adequacy test to be effective January 1, 2015.
industry continues its rapid growth, new regulations continue
The enhanced model incorporated changes updating the risk
to be introduced with existing ones strengthened to improve
factors as well as becoming more in line with the Solvency II
market stability, transparency, and policyholder security. While
concept. At the same time, ORSA was introduced for all federally
some regulators are adapting Solvency II regulations to fit their
regulated companies to complement the revised capital model.
markets, others are looking to the International Association of Insurance Supervisors (IAIS) and its insurance core principles.
Key guideline and procedure updates since September 2014. Regulatory compliance management: updates
Europe
enterprise-wide framework appropriate for identifying
As we approach the final few months before Solvency II goes
risks and the duties of the Chief Compliance Officer
live, the European Insurance and Occupational Pensions
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
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
and procedures and residential mortgage
internationally active insurance groups that have operations
insurance practices and procedures: provides
in the EU. There are three areas in Solvency II where
guidance on the enhancements of the underwriting
equivalence status pertains: solvency calculation, group
and risk management of mortgage insurance
supervision, and reinsurance.
Currently, OSFI is in the process of developing an
Under solvency calculation, if a non-EU country (e.g., Brazil)
operational risks guideline and revising the guideline
is deemed equivalent, an EU-based group’s subsidiary in
for the role of the Chief Agent. In 2015, OSFI is focusing
Brazil can use Brazil’s solvency calculation rules instead of
their resources on certain administrative items that are
Solvency II rules. For group supervision, if a non-EU country
arising from the recently implemented guidelines and
(e.g., Australia) is deemed equivalent, then a group based in
new minimum capital test framework, including:
Australia with operations in Europe is exempt from some of the
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
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
insurance, OSFI is also in the process of developing a revised
Group Supervision
Non-EU domiciled groups having EU operations
minimum capital test framework for mortgage insurance.
Reinsurance
Non-EU domiciled reinsurers reinsuring EUdomiciled companies
for lending institutions to de-risk their mortgage portfolios and implement more stringent lending criteria for mortgage
Source: EIOPA and Aon Benfield Analytics
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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
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
Switzerland
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.
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Evolving Criteria
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.
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
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
strategy, policy, procedures, and risk assessment
move is seen as a way to stabilize the sector and strengthen
including emerging risks and a risk appetite statement
insurers’ ability to write larger risks. The regulator is also in
to be determined by the board of directors
the midst of updating the existing Insurance Act from 2006.
The changes have been viewed positively by the rating agencies with A.M. Best noting that “the new rules are well
The changes are expected to address governance and risk management frameworks, as well as actuarial-based reserving.
placed to address these issues [significant exposure to high-
The Sultanate of Oman has also increased the minimum
risk assets, inadequate and varied treatment of accounting
capital requirements for insurers to RO 10 million, from
principles, unsophisticated measurement of technical reserves
RO 5 million. Companies will also need to make at least
and weak ERM practice].” Moody’s finds the new regulations
40 percent of shares listed on the Muscat Stock Market and
to be a credit positive “because they will strengthen several
separate legal entities must be created for life and non-life
credit characteristics of insurers, including capital, asset
business as composite companies will no longer be allowed.
quality (by reducing risk-taking) and reserve adequacy.”
The mandatory listing of the shares should bring additional financial flexibility for companies and greater transparency for
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
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
consultation document in April, comment period closed on
Foreign reinsurer (including Lloyd’s)
Downgrade by three notches
June 1, 2015, where it plans to have lower capital requirements
Foreign reinsurer with local branch
Downgrade by two notches
for risks reinsured via a local reinsurer as opposed to a
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
regulator, Financial Services Board (FSB), released 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
Source: Financial Services Board
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.
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15
Asia Pacific
CIRC commented that the solvency level for the industry was
The global insurance industry is undergoing significant
adequate, the risk indicators properly reflected the real risks
regulatory changes, and Asia Pacific is no exception, where
the industry faced, and C-ROSS guided the insurers to improve
a number of markets are reviewing and undergoing changes
their business model, marketing strategy, and risk management.
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.
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.
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.
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
China
residential property is parametric based, ranging from CNY
This year has been remarkable for China’s insurance regulatory
28 million to CNY 420 million, depending on the earthquake
evolution. The China Insurance Regulatory Commission
magnitude. Death payment is capped at CNY 100 thousand
(CIRC) finalized the China Risk Oriented Solvency System also
per person, with aggregate limit at CNY 80 million per year.
known as China’s “Solvency II” (C-ROSS), began building a
Insurers form earthquake pool and utilize reinsurance. Insurers
national earthquake scheme, liberalized motor pricing, and
need to accumulate cat reserve, as a percentage of premium
strengthened management of reinsurance credit risk.
income and excessive underwriting profit.
In February 2015, CIRC issued the final version of C-ROSS
In June 2015, an experiment of motor de-tariff began in six
rules and the transition period started right after. During the
provinces or cities. Each insurer in these experiment zones
transition period, insurers report solvency under both the
needs to have its pricing formula reviewed and approved
expiring scheme and C-ROSS, while supervision decisions are
by CIRC. The insurers can adjust the price within a range to
still based on the expiring scheme. The three-pillar C-ROSS
reflect their unique underwriting and distribution profile.
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.
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
16
Evolving Criteria
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
Insurance companies will be permitted to raise new capital through instruments other than equity shares. Insurance agents will be included in the definition of
Quantitative Impact Study are expected to be covered in later
insurance intermediaries and will be regulated, as will
consultation. According to the accompanying FAQ issued by
key aspects of insurance company operations in areas like
Insurance Authority, the risk-based capital regime would be
solvency, investments, expenses, and commissions.
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
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.
India
The New Insurance Law, passed by Indonesia’s parliament
In March 2015, the Indian Parliament passed the Insurance
on September 23, 2014, effective a month later, sets out
Laws (Amendment) Bill raising the ceiling for foreign
a comprehensive regulatory framework for Indonesia’s
investment in the insurance sector. The enactment of the bill
insurance sector. In broad terms, the new law updates the
will raise the foreign investment cap in the pension sector
1992 law in various significant areas and provides a stronger
as it was linked to the ceiling in the insurance sector.
consolidated legal foundation to the insurance sector, covering all insurance business companies, whether they
Increasing the foreign investment in insurance enhances
are insurers, reinsurers, brokers, agents, or loss adjusters.
the industry prospects that struggle due to lack of capital. It will increase infrastructure funding as only an insurance
The summary below outlines the key changes introduced
entity can fund long-term public projects. The passing of the
by the New Insurance Law for insurance companies:
bill will give more powers to the insurance regulator—the Insurance Regulatory and Development Authority of India. Key points of the bill:
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
The foreign direct investment cap in an Indian insurance
period of five years from the promulgation of the New
company will be increased from 26 percent to
Insurance Law. Alternatively, the joint venture company must
49 percent but ownership and control of the insurance
conduct an initial public offering within the same period.
company will remain with Indian residents. The law is silent on foreign ownership limits, presumably The bill amends the definition of foreign company to include a company or body established under a law of any country
indicating that the existing 80 percent limit is still valid, although this could be revised in future regulations.
outside India, and includes Lloyd’s of London, established under the Lloyd’s Act, 1871, or any of its members.
Consideration must be given to the controlling party concept and an assessment must be made as to whether
Foreign reinsurers will be permitted to conduct reinsurance business through setting up branch offices in India.
existing shareholders or parties may be classified as such as a result of certain contractual or other arrangements.
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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.
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
The Indonesian government is moving forward on an
Contracts.” Under such circumstances, it is important to
earlier announced plan to merge state-owned reinsurers
establish a regulatory framework suitable to Japan, paying
PT Reasuransi Internasional Indonesia (Reindo) with PT Asei
attention to the nature of the Japanese insurance market.
Reasuransi Indonesia, to create Indonesia Re. PT Nasional
Introducing the economic value-based solvency regime
Reasuransi Indonesia also will be merged at a later date. This
requires some revisions to the business management and
will boost domestic reinsurance capacity, with plans to inject
risk management methods used by insurance companies.
an initial IDR 1.5 trillion in capital for the new company.
Therefore, the JFSA will make steady efforts to establish a new framework through dialogue with relevant parties
Japan In June 2014, the Japan Financial Service Agency (JFSA) announced the implementation of its second field tests with
in various situations to ensure a smooth introduction.
Malaysia
the aim of introducing an economic value-based solvency
Malaysia’s non-life sector is gearing up for the expected
regime, and requested all insurance companies to implement
removal of tariffs for motor and fire insurance by 2016. The
them, following the results of the first field tests which were
details of the de-tariff of the motor and fire insurance premiums
disclosed in 2011. The purpose of the tests is to grasp the
are still being finalized and would incorporate premium
status of preparations of insurance companies as well as to
bands to prevent the risk of under-pricing of premiums.
identify practical issues and problems that may arise in the
Industry players expect the de-tariff to be implemented
process by requesting all insurance companies calculate the
by the middle of next year. It is believed that the de-tariff
value of their insurance liabilities based on economic value.
will be a partial and gradual one and there could be slight margin erosion, although the risk of severe erosion in the
JFSA disclosed the results in June 2015 noting that although
industry due to irrational competition has been eliminated.
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’
In a circular dated March 13, 2015, The Securities and
interests in the economic value-based solvency regime and risk
Exchange Commission of Pakistan announced a planned
management remain strong, and that they are making progress
increase in the minimum paid-up capital requirements
in developing systems for such calculation. On the other hand,
for life insurance and non-life insurance companies. The
the questionnaire results from individual companies suggested
increases, which will take place incrementally in semiannual
that sufficient preparation time would be necessary before
intervals until December 2017, are aimed at strengthening
the actual introduction of the regime, and that there are many
the insurance sector. For non-life insurers, the minimum
issues which need to be solved regarding system building
paid-up capital has to be PKR 300 million by December 31,
and burdens on practical operations. Furthermore, some
2015, increasing by PKR 50 million at semiannual intervals
companies requested that a scheme be developed reflecting
until it reaches PKR 500 million by December 31, 2017.
the differences in the risk management systems and other factors of each company, such as the use of internal models.
18
Pakistan
Evolving Criteria
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
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.
3 billion paid in cash of which at least 50 percent is paid-up
Sri Lanka
and the remaining portion thereof is contributed surplus,
The minimum regulatory capital of insurance companies
which in no case shall be less than PHP 400 million or such
has been increased to LKR 500 million from LKR 100 million
capitalization as may be determined by the Secretary of Finance,
per class of insurance business. However, a newly formed
upon the recommendation of the Insurance Commission.
insurance company that complies with the segregation
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
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.
lead to the merger and consolidation of small players in the
The Insurance Board of Sri Lanka issued the final risk-based
industry to meet the minimum capitalization requirements.
capital framework for insurers in October 2013, following
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-
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.
based capital 2-Quantitative Impact Study starting with
Composite insurers are required to split their business into
financials as of December 31, 2014. This will allow the
separate non-life and life companies by February 2015.
Insurance Commission an opportunity to engage the
Some insurers have created new holding companies with
industry in a meaningful dialogue and obtain feedback
separate non-life and life subsidiaries, while others have
prior to the full implementation date on June 30, 2016.
created new subsidiaries of their existing organizations. The split of composites will, however, increase overall
Singapore
costs and put pressure on smaller insurance companies.
The risk-based capital framework for insurers was first
All insurance companies must be listed on the Colombo
introduced in Singapore in 2004. While the risk-based capital
Stock Exchange by February 2016. This presents a big
framework has served the Singapore insurance industry well,
challenge for small entities and foreign players that desire
the Monetary Authority of Singapore (MAS) has embarked
exemption from mandatory listing, since it provides
on a review of the framework (risk-based capital 2 review)
greater transparency and promotes better governance,
in light of evolving market practices and global regulatory
thereby improving policyholder protection.
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 riskbased capital framework, updating the earlier version from
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.
Aon Benfield
19
Caribbean
personal lines and of 15 percent for commercial lines, less
Most Regulators in the Caribbean have been moving towards
reinsurance plus a 10 percent safety margin. Regulators are
Solvency II Framework based regimes or alternatives such as:
considering moving to a modeled PML based approach.
Canadian minimum capital test or an equivalent risk based model. The pace of the regulatory reforms is slower due to political and economic influences.
Colombia Insurance regulation is laying the foundation for more
At the same time, improving the level of capitalization coupled
risk based solvency framework. It is possible that they will
with more stable earnings and the lack of hurricane activities
consider following Chile’s lead on a modeled PML approach
in the Caribbean has resulted in the upgrade of a number
for catastrophe exposure. Additionally, Colombia may be
of companies by A.M. Best. The most notable changes were
moving toward a similar approach as Chile for homeowners
from “A-” to “A” ratings, as “A” companies are less common
purchasing catastrophe insurance in conjunction with
in this market. However, economic conditions continue to be
individuals buying a home. These exposures would be
challenging in this area and market conditions remain extremely
pooled and then insurance is purchased on the entire pool
competitive. Companies continue to face difficulties with
with the costs being passed back to the individuals.
growth and diversification. Even with the improving levels of capitalization there continues to be reliance on proportional
Mexico
reinsurance to provide capital support and risk mitigation.
On April 4, 2015, the Mexican regulators officially adopted
This strategy is likely to continue going forward. Also, there
the new Insurance and Surety Institutions Law (Ley de
is continued expectation of merger and acquisition activities
Instituciones de Seguros y Fianzas, or LISF). Under the new
should opportunities arise.
law, regulation authority will be shifted from the Ministry
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 intercompany 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
20
Evolving Criteria
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.
Accounting Developments International Accounting Standards It has been anticipated that the International Accounting
Development of global Insurance Capital Standard
Standards Board (IASB) would issue the finalized IFRS 4
While the banking industry is seen as the predominant source
“Insurance Contracts” this year with the standard becoming
of the 2008 financial crisis, there is a growing concern that there
effective in 2019. Last year, the Board finalized IFRS 9 “Financial
are risks in the insurance industry that could lead to a crisis of
Instruments” and set its effective date at January 1, 2018, raising
similar proportions. As in banking, there are key institutions
concerns from insurers. Both standards impact insurers, so the
(referred by IAIS as Global Systemically Important Insurers or
IASB has spent a considerable time this year addressing concerns
G-SIIs) that play a significant role in the global economy.
about temporary accounting mismatches and volatility in profit or loss due to the differing effective dates of the two standards.
To reduce the risk of their failure and thus trigger another
Although the impact would be limited to only a select group of
crisis, the IAIS took on the task of developing a global
companies, the IASB is considering various optional solutions.
capital and supervisory framework known as the Common
These include amending the existing IFRS 4 or deferral of
Framework, ComFrame, for the supervision of Internationally
IFRS 9 for insurers until the effective date of the new IFRS 4.
Active Insurance Groups. They are defined as groups with:
Amending the existing IFRS 4 means the IASB will need
Premiums written in less than three jurisdictions,
to go through its due process, including the issuance
and percentage of gross premiums written outside
of an exposure draft, allow for a comment period and
the home jurisdiction is at least 10 percent of the
then finalize changes based on the comments. This
group’s total gross written premium; and
will not impact the finalization of the new IFRS 4.
Total assets of at least USD 50 billion, or gross
The rating agencies continue to follow the development of
written premiums of not less than USD 10 billion
the new standard as it will significantly change the way the
(based on a rolling three-year average)
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
The quantitative portion of the ComFrame is the riskbased 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.
pick, and so expect disclosures to be critical. All three of
The feedback was overwhelming—1,321 pages—and has
the rating agencies do not expect any rating actions as a
forced the IAIS to reconsider their aggressive timeline
result of the new standard but do expect discussions in
for the ICS. As a result, the IAIS announced in June that
their rating meetings and some impact on their analysis.
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.
Aon Benfield
21
Mergers & Acquisitions 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
The reinsurance market has gone through a period of
rationale for the acquiring entity. Several of the deals are
unprecedented change over the past three years. The
focused on expansion of the acquirer’s Lloyd’s platform that
pressure on rates, terms, and conditions due to alternative
provides access to the global market with a relatively efficient
market capital and low catastrophe losses in recent years
capital structure. Both the Fosun and Ironshore, and EXOR and
has squeezed margins. These challenges do not appear to
Partner Re deals stem from multi-industry companies looking
be short-term but rather will be issues for the foreseeable
to enter or grow their insurance platforms in the hopes of
future. There are very few “pure” reinsurance companies
modeling the Berkshire Hathaway structure.
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
Acquiring Fireman’s Fund’s personal lines insurance
Chubb
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
Secure a top five position in the Lloyd’s market
American Safety
Growth in environmental casualty, E&S, and property lines
Various QBE European operations
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)
Entry into the Lloyd’s market
Valiant 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
22
Entry into US specialty insurance on admitted and E&S basis
Evolving Criteria
All these changes will likely mean that there is significant
The implications of the insurance entity’s and the group’s
pressure on the smaller reinsurers as:
ratings are an important factor as well. When an acquisition is announced, the target is generally placed ‘under review’
They will not have the economies of scale of larger
with positive, negative, or developing (neutral) implications
organizations
based on the rating agency’s view of the likely outcome at
They may have a more limited product offering and less expertise in local markets and emerging risks
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
They may not be able to make the same investments
impact to the insurance entity’s business profile. Rating agencies recognize the possible benefits of cost savings and
in technology
enhanced competitive position but also note the challenges Potential increased regulations may raise operating
surrounding execution risk, legacy reserve exposures, impact
costs and contribute to their inability to compete
to capital position and financial flexibility, and enterprise risk
More limited ability to adapt to changing market conditions Some of these smaller reinsurers may become acquisition targets.
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.
Primary companies are also well capitalized and are retaining more risk now than in recent years. As interest rates remain
As we continue to see the industry consolidate, it will mean fewer
low and provide cheap financing for deals, companies are
choices for buyers, but more solid balance sheets.
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.
Underwriting margins are being eroded by increased competition Investment returns continue to decline
Earnings Drivers
Diversification
Benign catastrophe activity is unlikely to continue Reserve redundancies may not be sustainable
M&A Influences
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
Scale
Changing Buying Habits
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
Aon Benfield
23
Financial Trends Operating performance
Capital adequacy continues to grow
Despite increased catastrophe losses and reduced benefit from
Capitalization continues to be very strong. As a benchmark,
prior year reserve releases, the US property casualty industry is
we estimate the US Industry aggregate capital position as
expected to post a third consecutive year of underwriting profit.
redundant at the ‘AA’ level per Standard & Poor’s Capital
A.M. Best believes 2015 will be a profitable year for the industry
model and supportive of ‘A++’ capital per A.M. Best’s BCAR
as well, with a 99.1 percent expected industry combined ratio,
model. From 2013, capital adequacy improved USD 11 billion
which includes 4.9 points for catastrophe losses. A.M. Best
as measured by Standard & Poor’s Capital and USD 23 billion
notes continued concerns over loss reserve adequacy citing
per BCAR.
declines in the level of favorable reserve development in
Exhibit 15 provides a distribution of Standard & Poor’s Capital
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.
levels for 50 rated companies in the US and Bermuda. Thirty-
Exhibit 14: A.M. Best’s combined ratio comparison by segment
‘Extremely Strong’, indicating redundant capital at the
six percent of companies’ capital adequacy is considered ‘AAA’ level. Another 42 percent have ‘Very Strong’ capital adequacy, representing redundant capital at the ‘AA’ level.
Combined Ratio (Reported) Industry Sector
Commercial Personal Reinsurance*
Outlook
2013 Actual
2014 Estimated
2015 Projected
Negative
96.7%
97.7%
99.8%
Stable
97.5%
98.4%
99.4%
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
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
expect that the segment will soon reach a point where further Upper Adequate 2%
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
Moderately Strong 7%
Lower Adequate 2%
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
Strong 11%
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. Very Strong 42% Source: Standard & Poor’s
24
Evolving Criteria
Extremely Strong 36%
Exhibit 18: ‘A’ rated entities: BCAR median by industry composite
Exhibit 16: BCAR medians
FSR
Published 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
Workers' Compensation (19)
268
Commercial Casualty (51)
307
Private Pass Auto (9)
310
Priv Pass Auto & HO (41)
314
Commercial Property (17)
315 342
Medical Prof Liability (23)
455
Personal Property (26)
Exploring the ‘A’ rating level deeper, shown above with a 315 Median BCAR = 315
percent median BCAR, the chart below shows that the median of ‘A’ rated companies below USD 100 million of surplus is 76
Source: A.M. Best, Aon Benfield Analytics
points higher at 391 percent. Companies at this rating level with greater than USD 1 billion of surplus have a median BCAR
Public company benchmarks
of 272 percent, or 43 points less than the overall group. Larger
The median scores of ‘A’ rated publically traded P&C companies
companies tend to have superior business profile attributes like
in the US is 223 percent, 92 percentage points lower than the
geographic or product line diversification, scale of operations
median of all ‘A’ rated US property casualty companies. We
and financial flexibility/access to capital and are therefore rated
believe this is mainly driven by the publicly traded population’s
as highly as a smaller company with a higher capital score.
typical characteristics: larger size, strongly developed enterprise risk management capabilities, and proven financial flexibility.
Exhibit 17: ‘A’ rated entities: BCAR median by size Size
Exhibit 19: BCAR and financial leverage metrics for ‘A’ rating publicly traded companies
Median
Diff. From Total
Count
< USD100 M
391
76
69
UDS100 M - USD500 M
310
-5
97
USD500 M - USD1 B
304
-11
32
BCAR (%)
315*
202
223
274
>USD1 B
272
-43
30
Debt to Capital (%)
3x
5.9x
8.9x
14.4x
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
Guideline
25th Percentile
Median
75th Percentile
*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.
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.
Aon Benfield
25
Enterprise Risk Management Trends 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.
Exhibit 20: Catastrophe risk tolerance diclosure analysis Insurers
1:100 after tax net PML as a percent of equity
1:250 after tax net PML as a percent of equity
30%
30%
25%
25%
20%
18%
17% 14%
15%
0%
26% 25%
20%
16%
15%
10% 5%
Reinsurers
10%
5%
8%
5% Mean
High
0%
Mean
High
Source: Company filings, Aon Benfield Analytics
Risk tolerance statements
Companies are more mindful of how peer companies disclose
One of the first steps to establish a robust ERM practice is
their risk tolerances and ensure they fall in line. Comparing peers
identifying a risk tolerance statement that defines an amount that
against a set metric, such as net PML to equity, can help reduce
management is willing to risk over typical business operations.
the inconsistencies found in public risk tolerance disclosures.
Although rating agencies prefer these to be quantitative, a risk tolerance statement can be qualitative in nature. A.M. Best in
Stress scenarios
particular outlined the importance of a stated risk tolerance
Through the ERM process, companies should have the
statement by requiring a disclosure on the first page of the
ability to quantify how adverse events impact results. Rating
2014 updated Supplemental Rating Questionnaire. This request
agencies and regulators perform stress scenarios when
was originally included in the 2010 through 2012 SRQ, but was
evaluating companies and may run in-house modeling to
removed for the 2013 version.
share impacted financials from various stress scenarios.
Catastrophe Risk Tolerance Study
Companies must identify major risks before determining the best stress scenarios to use. Exhibit 21 can provide insight
Many public companies disclose some type of risk tolerance
into major risk categories and what metrics, including
specifically around catastrophe exposure. This type of risk
stress testing, may be useful to help measure impact.
is easily quantifiable due to computer models and vast data availability. The disclosures are typically presented as a
ORSA has currently been adopted by 35 states, with three
percentage of equity given a stated return period. Aon Benfield
under consideration. As one component of the ERM process,
has been tracking these disclosures since 2007, and aggregates
ORSA provides a framework for companies to quantify stress
the results annually in the Catastrophe Risk Tolerance Study. The
scenarios. ORSA requirements highlight how ERM has evolved
most recent version of the study features 102 global insurers
from a list of operational and financial controls, to a process of
and reinsurers. Eighty-four percent of these companies report
analyzing stress scenarios and impact to capital adequacy.
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.
26
Evolving Criteria
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.
Exhibit 21: Risk identification and prioritization
Risk elements
Underwriting
Reserve
Market
Credit
Operational
Pricing risk
Long-tailed lines
Equity
Parameter risk
Latent risks (A&E)
Interest rate (GAAP)
Reinsurance recoverables
Basel II banking definition: “the risk of loss resulting from inadequate or failed internal processes, people, or systems, or from external events
Loss process risk
Receivables
Currency
Bond defaults
Catastrophe risk
Downgrade migration
Excludes strategic risk and reputational risk
Mix and asset concentration limits
Detailed exposure monitoriing
Disaster recovery plans
Equity and interest rate risk quantification
Rating migration impact quantification
Scenario stress tests
Scenario stress tests
Product design risk Metrics
Risk adjusted target combined ratios Catastrophe risk PML target
Conservative reserving Reserve risk quantification Reserve process validation
Exposure capacity guidelines
IT robustness testing Compliance monitoring
Scenario stress tests
Source: Aon Benfield Analytics
For the most recent 2014 SRQ, A.M. Best added back one
companies upgraded to Strong over the year. Both Very Strong
related question regarding risk tolerance statements. ERM
and Adequate ERMS scores have remained stagnant from 2013.
continues to be an important aspect of an A.M. Best rating.
Standard & Poor attributes the modest uplift in part to newly
During the 2015 Review & Preview conference, A.M. Best discussed emerging risks that they believe companies’ should be considering through their ERM process:
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
Mergers and acquisitions—Key issues and related risks Alternative capital—Use and permanence
2009
2010
2011
2012
2013
2014
100%
Regulation—Ability to respond to increasing regulatory demands
75%
Meta data—Use of technology in making ERM decisions Cyber risks—There are various unique exposures
50%
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
25%
0%
Very Strong
Strong
Adequate
Weak
*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.
Aon Benfield
27
Looking Forward: Key Topics for 2015 and 2016 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
is expected to continue in the next year as companies
2016, both life and non-life companies globally will be
have record capital levels and looking for ways to grow.
evaluated under a new capital model. We expect it will
Acquisitions are offering opportunities for companies to
be an adjustment for those familiar with BCAR to calibrate
achieve geographic expansion, product diversification,
companies’ scores under the new model. As the new
cost efficiencies from scale and profitable growth.
model is released, there will be a flurry of activity as companies try to understand not only their own BCAR,
Increasing global regulation. Regulators around
but also how it relates to the industry as a whole.
the world continue to evolve their criteria, including
Reinsurance segment pressures: Between the new
thresholds and evaluations under updated risk-based
increasing capital requirements, catastrophe exposure
alternative capital entrants and low catastrophe activity,
capital models. Additionally, regulation is becoming more
capital in the reinsurance market is at a high and is squeezing
global in nature with the rules in some regions impacting
margins. All four rating agencies have negative outlooks on
other countries that want to do business there.
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.
28
Mergers and acquisitions: M&A activity in the industry
of draft in October of 2015 and implementation in mid-
Evolving Criteria
Contacts Global
EMEA
Greg Heerde Head of Analytics & Inpoint, Americas Aon Benfield +1 312 381 5364
[email protected]
Ankit Desai Head of Rating Agency Advisory, EMEA Aon Benfield +44 207 522 8268
[email protected]
Patrick Matthews Head of Global Rating Agency Advisory Aon Benfield +1 215 751 1591
[email protected] Americas
Kathleen Armstrong Director, US Rating Agency Advisory Aon Benfield +1 513 562 4508
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APAC
Sifang Zhang Director, Head of Rating Agency Advisory, APAC Aon Benfield +852 2861 6493
[email protected] Canada and Caribbean Raymond Lui Senior Vice President Aon Benfield +1 416 598 7320
[email protected]
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advisory. Through our professionals’ expertise and experience,
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we advise clients in making optimal capital choices that will
advisor. We empower our clients to better understand,
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Benfield helps empower results, please visit aonbenfield.com.
unparalleled investment in innovative analytics, including catastrophe management, actuarial and rating agency
© 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.
About Aon Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 69,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: http://aon.mediaroom.com. © 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 professional advice after a thorough examination of the particular situation.
Risk. Reinsurance. Human Resources.
