0. THE FUTURE OF A.M. BEST RATINGS
A.M. BEST'S PROPOSED RATINGS METHODOLOGY & CAPITAL MODEL
Mark Murray
Strategic Advisory
Guy Carpenter
June 2, 2016

1. Discussion Topics Overview of Rating Methodology / BCAR Update
Recent Developments
Best’s Model Changes and Rollout Process
RISK
CAPITAL

2. Background and Overview
On March 10, 2016, A.M. Best released its draft criteria for its new Stochastic BCAR model for U.S. property/ casualty companies and its credit ratings methodology - Best’s Credit Rating Methodology (BCRM).
The new Credit Rating Methodology and P&C Stochastic BCAR Model is expected to go “live” in the first quarter of 2017 and will have far-reaching implications for the industry.  
Companies need to be proactive and understand the implications of the proposed BCRM and BCAR changes to their business plans, property exposure and PML analysis, reinsurance structures, asset management, ERM and risk tolerance statements.
The new A.M. Best Criteria has effectively increased the capital requirements for most companies and has a greater impact on catastrophe exposed companies.
Catastrophe PML and Asset Capital Charges have the largest marginal impact relative to the current BCAR model.
Under the new BCRM, some companies may start with a lower “baseline” Balance Sheet Strength rating than their current published ratings – and will be able to achieve positive adjustments for Operating Performance, Business Profile and/or ERM to support their current ratings.

3. Recent Developments
New Commentary – based on A.M. Best’s May 5th Market Briefing & GC Insights
On May 5th, A.M. Best released a Market Briefing that provided a short update on the direction it may take on its pending changes to Stochastic BCAR and BCRM.
A.M. Best is reconsidering its initial plans of “hard coding” its Stochastic BCAR Model at the 99.8 VaR (1:500) and 99.9 VaR (1:1000) levels due to the growing realization that the model output for high return periods contains too much uncertainty, volatility and model risk due to the limited amount of historical or scientific data as well as concerns around developing a rating assessment based on “false precision.”
The use the of the 99.8 (1:500) and 99.9 VaR (1:1000) Stochastic BCAR Scores will instead be used as part of their evaluation of a company’s Enterprise Risk Management (ERM) and the linkage to a company’s risk tolerance and risk appetite statements.
The timing of the transition to the new BCRM and BCAR may be impacted if this material change is made to the methodology at the conclusion of the first comment period.

4. A.M. Best’s Proposed BCAR Changes Objectives of Stochastic-Based BCAR
Incorporate stochastic simulations into the calculation of industry baseline capital factors.
Incorporate company-specific risk profile adjustments to industry baseline capital factors.
In assessing risk-adjusted capital adequacy (e.g. BCAR Score), align capital factors across risk categories to a confidence level in assessing the capital required to support a company's rating.
Consistently measure risk-adjusted capitalization across A.M. Best’s P&C, L&H and universal BCAR models.
A.M. Best is testing and finalizing capital factors within its next generation BCAR model with the aim of developing a more robust assessment of risk-adjusted capitalization that will further differentiate companies.
Sources: A.M. Best and Guy Carpenter

5. Stochastic-Based BCAR Ratio Definitions and Scale Under Proposed Criteria
Current PC BCAR Calculation
Ratio to Net Required Capital:
Ratio Definition:
BCAR = (APHS – Potential Cat Loss)
Net Required Capital
Potential Scores:
Low of 0.0 to Max of 999.9
Planned PC BCAR Calculation
(Ratio to Available Capital):
BCAR = (Available Capital – Potential Cat Loss –NRC)
Available Capital
Low of to Max of 100.0
New BCAR Ratio Measures Excess or Deficiency of Available Capital

6. A.M. Best’s Proposed BCAR Changes P&C Model Overview
XYZ P&C Insurance Company: Current BCAR Summary
Net Required Capital (NRC)
Risk Component
Req'd Capital
% of GRC
(B1) Fixed Income Investments
18,125 5%
(B2) Equity Investments
18,168
(B3) Interest Rate
5,875 2%
(B4) Credit
26,250 7%
(B5) Loss and LAE Reserves
149,375
41%
(B6) Net Premiums Written
147,250
40%
(B7) Business Risk
3,000 1%
(B8) Potential Cat Losses (After Tax)
Gross Required Capital (GRC)
368,043
100%
Less: Covariance Adjustment
-143,668
-39%
224,375
61%
Adjusted Policyholder Surplus (APHS)
Surplus Component
Adjusted Amt.
% of APHS
Reported Surplus
455,400
80%
UPR Equity (Net of Tax)
46,875 8%
Loss Reserve Equity (Net of Tax)
60,625
11%
Fixed Income Equity (Net of Tax)
52,500 9%
Surplus Notes
(7,500)
-1%
Potential Cat Losses (Net of Tax)
(38,750)
-7%
Adjusted Surplus (APHS)
569,150
Best's Capital Adequacy Ratio (BCAR)
BCAR % (APHS - NRC)/APHS
60.6%
Shaded = Underlying Risk Factors Will Change in Phase 1
P&C Risk Definitions: No change
Fixed Income Investments: default risk
Equity Investments: price volatility risk
Interest Rate: asset illiquidity risk from rising interest rates
Reinsurance Credit: uncollectible recoverable risk
Loss & LAE Reserves: potential reserve development risk
NPW Pricing: potential UW loss risk on business written
Cat Exposures: potential catastrophe loss risk
P&C Model Structure: Modest change
A new Net Required Capital category (B8) Potential Cat Losses (After-Tax) has been added to net required capital (NRC) rather than being subtracted from Adjusted Policyholders Surplus (APHS).
New BCAR Treatment for Potential Cat Loss
Capital Factors: Material increases
Baseline capital factors will be based on consistent VaR risk metrics established across most risk categories.
Adjusted capital factors may vary greatly based on company-specific volatility and concentrations.
Sources: A.M. Best and Guy Carpenter
Illustrative

7. Stochastic-Based BCAR: Summary of Key Changes
Capital factors are based on Value at Risk (VaR) metrics calibrated at four confidence intervals and associated Return Periods:
95% (1:20), 99% (1:100), 99.5% (1:200), 99.6% (1:250)
A.M. Best intends to run two additional BCAR scores at the 99.8% (1:500) and 99.9% (1:1000), but these scores will be evaluated as part of the ERM assessment – not the Balance Sheet Assessment
Reserves and NPW Capital Charges are based on industry loss curves adjusted for a company’s reserve volatility and underwriting profitability.
Asset capital factors are based on the simulated volatility of the S&P 500 adjusted for a company’s specific duration and credit quality portfolio characteristics.
Potential cat losses will driven by company-specific concentrations.
Cat risk will be measured using an “All Perils” versus “Largest Peril” Occurrence Basis
PAMIC companies that do not run “all perils” cat analysis will need to confirm their cat exposure is not materially higher than their “largest peril”
For PAMIC companies - the “All Perils” PML impact may be significant and will be heavily dependent on reinsurance coverage as BCAR captures cat risk on a net basis.
Source: Guy Carpenter & A.M. Best Rating Methodology

8. Interpreting Stochastic BCAR
BCAR Scores by VaR Level
Illustrative
New Commentary – based on A.M. Best’s May 5th Market Briefing & GC Insights
The charts shown on the right reflect A.M. Best’s latest stochastic BCAR update – combined with our insights on how A.M. Best will likely proceed.
We believe A.M. Best will introduce a new VaR level of 99.6 (1:250) as its highest return period in calculating required capital
The 1:500 & 1:1000 Scores will be run – but not published
We believe A.M. Best will also introduce a “capital cushion” of 30% or greater at the 1:250 to achieve an ICR of “a+”, which is A.M. Best’s highest Initial BSS Assessment. (Note: the 30% is Guy Carpenter’s estimated threshold - subject to A.M. Best’s final determination)
A positive score at the highest confidence level ties to A.M. Best’s Initial Balance Sheet Strength (BSS) Assessment
Stochastic BCAR % = (Available Capital – Net Required Capital)/ Available Capital.
VaR 95.0
1:20
VaR 99.0
1:100
VaR 99.5
1:200
VaR 99.6
1:250
BCAR Conversion Table (Revised Basis)
BCAR Score at 1:500 & 1:1000 will not be used to determine BSS rating – but will be used in evaluating ERM
As we stated in a prior slide – A.M. Best’s new BCRM starts with “rating” a company’s Balance Sheet Strength – which for most mutuals will be based on their Stochastic BCAR Score.
The “rating” is based on the highest VaR Return Period that the company “passed” with excess capital. The table coverts the Score into the indicative Balance Sheet Strength (BSS) “rating”.
Many highly rated mutuals (A and A+) – with high property cat exposures will be starting with a BSS “rating” that is below their current rating – and will need to gain positive rating adjustments through the balance of the rating evaluation process in order to maintain their current rating.
In the sample shown – this company would likely start with a strong A- Financial Strength Rating.
Source: Guy Carpenter & A.M. Best Rating Methodology

9. Stochastic BCAR: Which Risk Profiles Are Affected the Most?
Higher potential net property cat losses
- Companies with natural cat concentrations, particularly NE regionals with hurricane tail exposures
- Companies with outsized net PMLs due to limited reinsurance coverage above 99.0% VaR (1:100)
Higher loss reserve and net premium risk charges - Business concentrations in lines exhibiting greater volatility on a VaR basis (WC; GL) and/or
- Companies exhibiting higher case reserve development and/or higher accident-year loss ratios
Higher reinsurance default risk
- Companies with elevated reinsurance recoverable leverage
- Companies with recoverable concentrations tied to long-tailed lines and lower-rated reinsurers
Higher common stock volatility
- Companies with elevated common stock leverage and volatility compared to the S&P 500 Index
- Higher-rated companies held to incrementally higher capital charges at higher confidence intervals
Higher bond default risk
- Elevated below-investment grade leverage; concentrations in long duration and lower-quality bond holdings
- Higher-rated companies held to higher capital charges at higher confidence intervals
Higher interest rate spike risk
- Higher interest rate charges ( bps) will adversely impact companies with long duration fixed income assets
- Companies with greater illiquidity posed by outsized gross PMLs and potential risk of selling bonds “under water” 1 2 3 4 5 6

10. Average Stochastic BCAR Scores
Stochastic-Based BCAR Estimation of Capital Scores Under Proposed Criteria
GC's NAMIC BCAR Index
Average Stochastic BCAR Scores
1:200
1:250
1:500
1:1000
Number of Cos.
VaR 99.5
VaR 99.6
VaR 99.8
VaR 99.9
[B++/A-]
[A-/A]
Composite of Companies 88
43.2%
32.0%
9.7%
-24.0%
Central/Midwest 30
47.8%
44.2%
37.0%
24.7%
Mid-Atlantic/New England 38
34.9%
15.8%
-22.4%
-77.8%
National 10
48.4%
43.5%
33.5%
19.9%
"A+" Rated Companies 12
52.7%
40.4%
-19.0%
"A" Rated Companies 33
52.6%
44.8%
29.0%
5.4%
"A-" Rated Companies 27
32.3%
17.7%
-11.6%
-50.9%
Commercial Casualty 16
45.6%
38.6%
24.5%
2.1%
Personal Property 28
20.0%
-14.0%
-63.9%
Private Passenger SA & HO 34
46.6%
36.7%
16.9%
-14.1%

11. BCRM: A.M. Best’s New Ratings Process
A.M. Best’s building block approach allows companies to see how the four core components of the ratings process come together to determine a Best’s Issuer Credit Rating (ICR) and ultimately the Financial Strength Rating (FSR)
Refer to next slide for
conversion table of ICR to FSR
Country Risk
Balance Sheet Strength
(BSS)
Baseline ICR:
(“Strong” or “a”)
Operating Performance
(OP)
+2/-3
ICR Notches
Business
Profile
(BP)
+2/-2
ICR Notches
Enterprise Risk Management
(ERM)
+1/-4
ICR Notches
Published ICR & FSR Rating
Overall Rating
e.g.
ICR = a
FSR = A
Long-Term
FSR
ICR
A++
aaa
aa+ A+ aa
aa- A a+ a A- a-
B++
bbb+
bbb B+
bbb-
Key Assessment Areas by Core Rating Component
BSS
BCAR assessment
Other rating unit factors
Holding company impacts
Country risk impact OP
Historic results
Trends
Financial forecasts
Volatility
Country risk impact BP
Market position
Distribution
Management
Pricing & data
Product/ geographic concentration
Country risk impact
ERM
Risk culture/ governance
Risk identification/ controls
Risk measurement
Are ERM capabilities > company risk profile?
Source: Guy Carpenter & A.M. Best Rating Methodology

12. BCRM: What are the Impacts?
A.M. Best’s new BCRM has far-reaching impacts that may require companies to address many relevant risk and capital management issues in order to maintain or enhance their rating.
Will impact A.M. Best’s external views of a company’s:
Risk-adjusted capital requirements and tail risk
Operating performance and volatility
Business profile and competitive market position
ERM, risk tolerances and capital modeling
Overall Rating & Ratings Outlook
Will impact a Company’s internal views and:
Affect reinsurance and capital management decisions
Increase importance of underwriting and earnings stability
Increase importance of PML modeling & cat accumulation management
Accelerate risk tolerance benchmarking and usage of stochastic capital models
Foster strategic risk management decisions within a stronger ERM framework

13. BCRM Timeline to Implementation
Timeline for BCRM Rollout
AM Best Analysts Provide Stochastic BCAR Output & Communicate Rating Concerns
March, 2016
Q1 2017
Remainder of 2016
BCRM & PC
BCAR Only
Draft criteria released for comment
Comment
Period #1:
Ends June 30th
Public updates
Specific issues raised
Comment
Period #2:
Extend to YE
Tied to other BCAR model releases
Comment
Period Ends
Target YE 2016
Incorporate comments as justified
BCRM &
All BCARs
Criteria is published and becomes effective
Effectively, both of A.M. Best’s new Criteria will have Comment Periods that will last roughly 12 months.
A.M. Best has shared YE14 Stochastic BCAR output with companies, which will be followed by the A.M. Best analysts identifying potential rating concerns with companies with “material issues” in the course of a company’s annual rating meeting.
Stochastic BCAR and the final BCRM become effective in Q after the “industry comment period” is closed.
Once the criteria becomes effective, companies with “material issues” could be placed Under Review, with up to six months to take corrective action before A.M. Best finalizes their ratings.
Source: Guy Carpenter & A.M. Best Rating Methodology

14. A.M. Best Wants Your Feedback – Submit to Commentary@ambest.com
A.M. Best’s latest Briefing encourages companies to respond to these three questions:
Do you understand the Building Block approach outlined in the BCRM and is it sufficiently transparent?
Are there any parameters outlined for Balance Sheet Strength, Operating Performance, Business Profile, Enterprise Risk Management, or Comprehensive Adjustment in the BCRM that you disagree with?
What are your views on using VaR metrics for risk modeling in general? Do your views concerning the value of these metrics change as one goes out into the tail (e.g. VaR 99.8 & 99.9)?
Guy Carpenter strongly urges all rated PAMIC members to submit feedback to A.M. Best during the current comment period – that ends June 30th - to ensure its new BCAR and Credit Rating Methodology appropriately utilizes modeled values at the higher confidence levels in the rating evaluation process.

15. Conclusion
Many strategic decisions are influenced in part by A.M. Best criteria
There is still uncertainty as to exactly how capital or operating performance will be measured but the proposed changes will undoubtedly increase the focus on “tail risk”
Upcoming capital model changes are likely to foster a shift in key benchmarks and guidelines that serve as the basis for many rating decisions
Communications with Best in the future should reflect the proposed BCRM rating roadmap
Change creates challenges but also opportunities.

16. QUESTIONS?