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

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

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.

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.

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

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 -999.9 to Max of 100.0 New BCAR Ratio Measures Excess or Deficiency of Available Capital

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

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

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

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 (170 - 310 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

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%

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

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

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 Q1 2017 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

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.

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.

QUESTIONS?