Presentation on theme: "Collateral Analysis & Negotiations: An Actuary’s Perspective"— Presentation transcript:
1 Collateral Analysis & Negotiations: An Actuary’s Perspective Aon Global Risk ConsultingRon Schuler FCAS, MAAAAssociate Director & Actuary
2 OverviewAt a minimum, the process of estimating and evaluating collateral amounts should seek to achieve the following objectives:Provide quantitative or qualitative information to be used for decision-making by risk management and its partners, constituents, and counter-parties.Improve clarity, understanding, and eliminate ambiguities underlying the collateral determination process.Provide a robust set of supportable and understood analytics and information which can be used to better understand and support the determined collateral position(s) as well as other related estimates and costs that impact the Total Cost of Risk (TCOR).
3 OverviewUnderstanding A Company’s Collateral Position: Why is it relevant?Actual costs, credit capacity, and opportunity costs.Managing expectations, effective communication, and negotiations require information (that will be provided to and used by various parties).Defines positional arguments.Components of Total Cost of Risk (TCOR) shouldn’t be viewed in isolation, and thus, collateral impacts other risk financing decisions.Provides risk management perspective on performance relative to prior expectations, performance metrics, and/or benchmarks.Quantifies statistical information which provides insight into trends, operational changes, or changes in risk profile.Facilitates efficient audit, accounting, and risk management processes.Provides prospective guidance for risk management and other financial purposes.Assist with brokerage support, guidance, and recommendations.Provide the necessary actuarial documentation which is consistent with actuarial, financial, and accounting standards of practice.
4 Overview Outputs are directly related to information provided to: Financial ReportingAccounting / BudgetRisk Management (General)Benchmarking / Performance MetricsInternal / External AuditInsurers / RegulatorsInsurance Placement (Brokerage / Captive / Other )Loss Control / Claims ManagementOther Parties (M&A+D / Vendors)
5 The Basics: Collateral Calculation Foundation of the Collateral Calculation:Actuarial Loss Reserve Analysis – RetrospectiveLoss Forecast Analysis – ProspectiveRisk Load Analysis – Retrospective & ProspectiveRoll-Forward Analysis – ProspectiveFinancial Strength / Credit Risk Analysis – ProspectiveCollateral = Ultimate Loss + Loss Forecast + Risk Load – Actual Paid – Expected Paid – Working Fund (+/ – ) Other (+/ – ) Credit AdjustmentOther: Overdue Premium, Audit Premium, Retro Adj, LCF, LBA, etc.
6 The Basics: Collateral Calculation Collateral Calculation & Negotiation Process: The ChallengeDon’t be a spectator: Actively manage the process.Challenge the experts.Challenge the methods, assumptions, data, and considerations underlying the various analyses.Challenge the status quo.Analysis vs. ApproachRetrospective & Prospective ComponentsCore Assumptions: Credibility, Complement, Risk, Coverage, Characteristics , Availability of Statistics, & OtherDetermination & translation of credit risk to a probability of default (or vice versa)Other Considerations: Technical and ContractualOther General: e.g. Funding OptionsEvery item underlying the collateral calculation can be quantified:Quantify, Challenge, Understand, Communicate, Repeat.
9 Financial Strength / Credit Risk Analysis Used to assess financial strength and/or creditworthiness of insuredInsurer Perspective: There are two types of risk (Reserve, Credit). Insurer is in the business of insurance (i.e. not a bank), thus primary goal is to eliminate exposure to credit riskUtilized by insurers to determine viability of writing program and/or underwriting surcharge / discountGenerally based on insurer judgment versus a more technical evaluation of credit strengthConsideration of relevant factors such as general economic conditions and how they impact the insured, insured pro forma statements, the probability and timing of default, variance / risk in loss estimates, expected recovery rates, interest yields, and time value of money.
10 Financial Strength / Credit Risk Analysis Type of financials and information provided impact credit evaluation (Audited, Reviewed, Compiled, & Internal)Preferred financials to review: Latest Audited, Interim, and supplemental informationOther Information reviewed:Public Information: S&P, Moody’s, Fitch, D&BCompany Specific Information: SEC filings, Pro Formas, Interview, etcIndustry Specific Information: Competitive, Industry, Key Economic VariablesFinancial credit review results in credit “rating” which, in turn, should be converted to expected probabilities of defaultProbabilities of Default similar to Rating Agencies (S&P, Moody’s, Fitch)BBB+ and Above: Investment Grade / SuperiorBBB to BBB-: Speculative / AverageB and Below: Distressed / In Default
11 Financial Strength / Credit Risk Analysis Types of financial ratios: Liquidity, Leverage, Profitability, and Cash FlowLiquidity Ratios: Measure ability to meet short-term obligations.Net Working Capital = Current Assets less Current LiabilitiesCurrent Ratio = Current Assets / Current LiabilitiesRules of Thumb:NWC > 0 for Y year periodCR > 2Leverage Ratios: Measure the extent to which a company is financed with debt.Long-term debt (LTD) to Equity or LTD to Tangible Equity : Provides an indication of long-term solvency. Tangible Equity = Equity less Goodwill less Intangible AssetsTimes Interest Earned (TIE) = EBIT / Interest ExpenseLTD / E < 1 is acceptable; LTD / E > 2 implies a potential issue to pay interest and principle3 < TIE < 5 is acceptable; TIE < 3 is poor and TIE > 5 is good
12 Financial Strength / Credit Risk Analysis Profitability Ratios: Measure ability to meet short-term obligations.Return on Sales = Net Income / Revenue; measures operating marginOperating Margin = EBIT / Revenue; measures operating margin before interest & taxReturn on Total Assets = Net Income / Total Assets or EBIT / Total Assets; measures how effectively firm assets are used.Return on Equity = Net Income / Equity; measure the return on invested capitalRules of Thumb:Need to review short- and long-termROE > Industry BenchmarkCash Flow Ratios: Measure whether firm is a cash generator or user.Net Cash Flow: CF > 0 (generator), CF < 0 (user)CF to Revenue = CF / Revenue; measures the cash generating ability of revenuesCF to CMLTD = CF / CMLTD; measures firms ability to generate sufficient cash to meet short-term fixed obligations; CMLTD = Current maturity of LTDCF / Revenue > 0 is acceptable