Jennifer Marshall Senior Financial Analyst Property/Casualty Division February 12, 2009 Treatment of Investments in the A.M. Best Rating Process NYIA Educational Seminar

Discussion Topics Rating Process Overview Capital Model Overview Treatment of Investments in the Capital Model 2008 Review / 2009 Preview

Rating Process Overview

Objective of A.M. Bests Financial Strength Ratings To perform a constructive and objective role in the insurance industry toward the prevention and detection of insurer insolvency

A.M. Bests Rating Evaluation Key Components Balance Sheet Strength Operating Performance Business Profile Bests Rating

A.M. Bests Rating Evaluation Rating Considerations Secure A++ B+ Vulnerable B D Balance Sheet Strength Operating Performance Business Profile Outstanding Very Stable/Strong Strong / Sustainable Advantages Well-Diversified Weak Volatile/Poor Questionable Viability Competitive Disadvantages Concentrated Risk

A.M. Bests Rating Evaluation Balance Sheet Strength Leverage Capital structure / holding company Quality & appropriateness of reinsurance Adequacy of loss reserves Quality and diversification of assets Liquidity Growth Risk Adjusted Capitalization (BCAR)

A.M. Bests Rating Evaluation Operating Performance Level of Profitability - Historical - Prospective Stability/Volatility of Earnings Revenue Composition/Quality of Earnings Ability to Meet Plan

A.M. Bests Rating Evaluation Business Profile Market risk Spread of risk Event risk Competitive advantages Management

Capital Model Overview

Best Capital Adequacy Ratio - BCAR Comprehensive Tool to Evaluate Risk Components Simultaneously Generates Overall Estimate of Required Level of Capital to Support Risks

Economic (Adjusted) Surplus Reported Surplus (PHS) Equity Adjustments: Unearned Premiums Loss Reserves Assets Debt Adjustments: Surplus Notes Debt Service Requirements Stress Adjustments: Future Operating Losses Potential Catastrophe Exp. Other Net Required Capital Gross Required Capital (B1) Fixed Income Securities (B2) Equity Securities (B3) Interest Rate (B4) Credit (B5) Loss and LAE Reserves (B6) Net Premiums Written (B7) Off-Balance Sheet Covariance Adjustment BCAR Model Overview Economic (Adjusted) Surplus Net Required Capital BCAR =

Capital Model Treatment: Net Required Capital

Net Required Capital Investment Risk Bonds Equities Interest Rate Risk Other Issues Single Large Asset Spread of Risk Common Stock Leverage

Investment Risk (B1): Bonds Grouped by NAIC SVO Class US Treasury Bonds separate from other Class 1 bonds Risk Factor varies from 0% to 30% for unaffiliated bonds, based on SVO class

Bond Risk Charges US Treasury (Cl. 1)0.0% Class 11.0% Class 22.0% Class 34.0% Class 44.5% Class 510% Class 630% Security Type/ClassRisk Charge

Investment Risk (B1): Other Cash Risk Charge: 0.3% Mortgage and Contract Loans Risk Charge: 5% Short-term investment Risk Charge: 1%

Investment Risk (B2): Equities Publicly-traded equities have a 15% risk charge Private equity generally carries a 100% risk charge due to limited liquidity Preferred and common equities generally treated the same

Investment Risk (B2): Other Real Estate Risk Charges Company Occupied: 10% Investment: 20% Other Investments: 20% Title Plants: 10% EDP & Other Tangibles: 20% Foreign Exchange Rate Asset: 20% Aggregate Write-Ins: 20%

Additional Asset Considerations Single Large Asset Spread of Risk Adjustment High Common Stock Investment Leverage

Interest Rate Risk (B3) Identifies potential stress for companies that maintain a high exposure to short- term cash needs Often greatest for companies with a high gross catastrophe PML Estimates impact of a 120 point increase in interest rates on market value of bonds Multiplies by ratio of gross PML to liquid assets, with a minimum charge of 10% of the decrease in market value

Capital Model Treatment: Adjusted Policyholder Surplus

Fixed Income Equity Adjustment Reflects Difference between Market and Book Value of Bonds Based on General Interrogatory #28 – reported only in year-end statement If difference is: Positive, capped at 10% of surplus Negative, capped at 15% of surplus This adjustment has been positive (e.g., it has increased surplus) for the industry overall and for most companies individually

Fall, 2008 Investment Survey Credit market issues had significant negative impact on market price of bonds Reviewed fixed income adjustment with caps in place and without the caps (stress scenario) Recalculated BCAR with revised FI equity adjustment and under stress scenario

Fall, 2008 Investment Survey Reviewed the recalculated BCAR in the context of each companys Overall liquidity and cash flows Operating fundamentals Business profile, including exposure to shock losses Contacted companies with potential rating concern

Review of 2008/Preview of 2009

2008 In the Rear-View Mirror Capital Adequacy Remains Adequate Soft Market Conditions Underwriting Losses Investment Market Turmoil Financial Flexibility in Hibernation

2009 Market Expectations Modest stabilization in pricing Underwriting results rebound, but remain negative Continued uncertainty in financial markets Limited growth in investment earnings

Questions?

For More Information: Financial Strength Methodology for P/C Insurers Understanding BCAR for P/C Insurers Contact your companys rating analyst Contact me: