March 17, 2013 Rating Captives: A.M. Best’s Perspective Andrew F. Colannino Vice President June 3, 2014

 A.M. Best Company Overview  A.M. Best Ratings  How Captives are Rated Differently  Captive Analysis Contents

 Established in 1899, pioneered the concept of insurer financial strength ratings in 1906  Provider of ratings, financial data, and news specific to the insurance industry  Multiple channels for obtaining public information from A.M. Best: daily and weekly newsletters, monthly publications, special technical reports, webinars, in-person appearances at industry events, annual publications  Coverage of approximately 3,500 companies in more than 70 countries  Only rating agency focused on the insurance industry:  methodologies are specific to the insurance environment  analysts are industry specialists A.M. Best Overview

A.M. Best Ratings  Financial Strength Rating (FSR)  an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance obligations based on a comprehensive quantitative and qualitative evaluation  Issuer Credit Rating (ICR)  an independent opinion of an issuer’s ability to meet its ongoing senior financial obligations  All ratings are forward looking in nature  Ratings are composed of three key areas:  Balance Sheet Strength  Operating Performance  Business Profile

A.M. Best Rating Scales FSR = Financial Strength Rating ICR = Issuer Credit Rating FSRICR Secure Investment Grade A++ aaa aa+ A+ aa aa- A a+ a A-a- B++ bbb+ bbb B+bbb-

 Rating Process  Rating Services Agreement  Obtain and review financial data (historical and projected)  Meeting with management  In-depth analysis including A.M. Best Quantitative Analysis Report and calculation of BCAR score  Recommendation developed by analyst  Presentation to rating committee and vote  Outcome conveyed to company  Rating release and publication of company report A.M. Best Ratings

Ratings Methodology Rating Balance Sheet Strength Operating Performance Business Profile INSURANCE COMPANY FINANCIAL STRENGTH Country Risk Enterprise Risk Management

Balance Sheet Strength Best’s capital adequacy ratio (BCAR) Capital structure/holding company Quality/soundness of reinsurance Adequacy of loss reserves Quality/diversification of assets Liquidity

Operating Performance Profitability –Historical –Prospective Revenue composition/quality of earnings Sustainability of earnings Ability to meet plan

Business Profile Market risk Competitive advantages Spread of risk Event risk Regulatory risk Management experience and objectives

Why Business Profile & Operating Performance are Important Strong Business Profile and Operating Performance Weak Business Profile and Operating Performance Date of last Balance Sheet TodayTime

Country Risk Impact Poor asset choices Challenges unique to the country’s operating environment and must be explicitly addressed “Burdensome” regulation Inefficient legal system Poor business infrastructure Inadequate data High vulnerability to financial crisis High risk to financial strength without extraordinary preparation (capital) Inadequate regulation Opacity in Legal System Societal Instability & Violence Potential to be completely destabilizing for any company (Most companies would be in the vulnerable range.) Government Corruption Weak economic structure

What is Risk Management? Let’s keep it simple…every company does some form of risk management AMB defines risk management as the risk and capital management process(es) and practice(s) employed by a company Risk Management = (Identify + Understand + Measure + Manage) Risk No two companies are exactly alike AMB’s assessment of risk management respects the unique nature of every company we rate

Enterprise Risk Management ERM is the process through which insurers identify, quantify and manage risk on an enterprise-wide, holistic basis ERM takes into consideration the individual risks at hand, as well as any correlations and inter-dependencies of risk across the entire organization Insurers that create a more structured, integrated risk framework and apply it prudently can –Increase the value of the firm and –Provide financial security to the organization

Enterprise Risk Management Business Profile Operating Performance Balance Sheet Strength Enterprise Risk Management is the common thread that links balance sheet strength, operating performance, and business profile. Risk Management = (Identify + Understand + Measure + Manage) Risk

Risk Management…A Wide Spectrum Wide spectrum of tools, techniques, approaches to risk management Differences in geographic and product complexity/diversity, as well as management team skill sets and mind sets, must be considered –Approaches range from a traditional “silo” mentality to an integrated ERM platform with ICM, with many hybrids in between –Companies may migrate from one approach to another over time as their profile, skill set and the business environment changes Bottom line: a company’s process must fit its profile and provide a stable, sustainable operating platform in good times and bad

Enterprise Risk Management HIGH RISK MODERATE RISK LOW RISK MINIMAL RISK Risk Profile Risk Management Capability A company’s risk management capability needs to meet its risk profile Superior Strong Good Weak

Bringing it all Together 18 Balance sheet strength is most important Sustained, stable operating profitability ensures future strength Well-diversified, strong business profile ensures stability and profitability –Management depth, experience and stability influences profile Risk Management links strategy to factors above

Dedicated team of 5 financial analysts that only cover captives Captives and ART (Alternative Risk Transfer) have a separate rating methodology Market profile assessment has the greatest divergence Operating performance stresses preservation of capital and reduction of insurance cost to insured’s of profitability and return measures How Captives Are Rated Differently Than Commercial Insurers

Criteria for obtaining a captive rating are similar for all insurance entities, however the rating process does recognize and incorporate the unique characteristics of captives. Based on comprehensive analysis of balance sheet strength, operating performance and business profile

How Captives Are Rated Differently Than Commercial Insurers Analysis of non-insurance parent included assessment of –Publicly available credit measures (other CRA’s) –Market based credit measures (CDS) –Independently performed financial analysis including peer analysis Analysis can result in lift or drag to the rated insurance entity

How Captives Are Rated Differently Than Commercial Insurers Treatment of Letters of Credit for ART (Alternative Risk Transfer) entities. –Generally must have all of the following characteristics: Stand-Alone Irrevocable Evergreen Funded - In favor of the ART entity Drawn on a highly rated bank.

How Captives Are Rated Differently Than Commercial Insurers Customary definition of market profile does not apply to captives. Capital –Loan backs –Long term commitment ERM in captive should be part of overall parent risk management solution

A.M. Best Single-Parent Captives Industry Diversification

Captive Composite Population Definition SAP Basis 2012 Number of Companies203 Net Written Premium$8.3 billion Net Income$1.6 billion Admitted Assets$53.0 billion Loss & LAE Reserves$18.3 billion Year-end Surplus$24.7 billion

Captive Composite vs. Commercial Composite Leverage Analysis 2012 CaptiveCommercialFav/(Unfav) Net Written Premium to Surplus0.3 to 10.8 to 10.5 to 1 Net Liabilities to Surplus1.1 to 12.2 to 11.1 to 1 Net Leverage1.4 to 13.0 to 11.6 to 1 Ceded Leverage0.4 to 10.9 to 10.5 to 1 Gross Leverage1.8 to 13.9 to 12.1 to 1

Captive Composite vs. Commercial Composite Operating Performance Analysis 5-year Average CaptiveCommercialFav/(Unfav) Loss & LAE Ratio68.1%73.0%4.9% Underwriting Expense Ratio20.1%30.0%9.9% Combined Ratio Before PHD88.2%103.0%14.8% Policyholder Dividends4.1%0.3%(3.8%) Combined Ratio After PHD92.3%103.3%11.0% Investment Ratio16.3%14.8%1.5% Operating Ratio76.0%88.5%12.5%

Captive Composite vs. Commercial Composite Operating Performance Analysis 10-year Average CaptiveCommercialFav/(Unfav) Loss & LAE Ratio73.6%73.1%(0.5%) Underwriting Expense Ratio19.9%28.7%8.8% Combined Ratio Before PHD93.5%101.8%8.3% Policyholder Dividends4.2%0.2%(4.0%) Combined Ratio After PHD97.7%102.0%4.3% Investment Ratio16.2%14.4%1.8% Operating Ratio81.5%87.6%6.1%

Captive Composite vs. Commercial Composite Return Measures Analysis 5-year Average CaptiveCommercialFav/(Unfav) Investment Yield (Including Realized Capital Gains 3.2%4.4%(1.2%) Return on Revenue20.6%8.5%12.1% Return on Equity8.4%6.7%1.7%

Captive Performance Analysis Where Does Captive Surplus Growth Come From? Captive Surplus Grew $7.5 billion over the Last 5-year Period Ended 12/31/2012. Net Underwriting Income$3.5 billion Net Investment Income (Including Realized and Unrealized Capital Gains $7.9 billion Income Tax($2.5) billion Contributed Capital$1.5 billion Owner Dividends($4.2) billion Other Surplus Gain/(Loss)$1.3 billion Surplus Increase$7.5 billion

Captive Investment Portfolio Analysis Year End 2012 Long-Term Bonds$29.6 billion64% Equities$6.0 billion13% Real Estate$0.1 billionNm Cash and Short Term$4.1 billion9% Other$6.3 billion14% Total Non-affiliated Investments$46.1 billion100%

RRG Composite Population Definition SAP Basis 2012 Number42 Net Written Premium$1.3 billion Net Income$321 million Admitted Assets$7.6 billion Loss & LAE Reserves$2.7 billion Year-end Surplus$3.4 billion

RRG Composite vs. Commercial Composite Leverage Analysis 2012 RRGCommercialFav/(Unfav) Net Written Premium to Surplus0.4 to 10.8 to 10.4 to 1 Net Liabilities to Surplus1.2 to 12.2 to 11.0 to 1 Net Leverage1.6 to 13.0 to 11.4 to 1 Ceded Leverage1.7 to 10.9 to 1(0.8 to 1) Gross Leverage3.3 to 13.9 to 10.6 to 1

RRG Composite vs. Commercial Composite Operating Performance Analysis 5-year Average RRGCommercialFav/(Unfav) Loss & LAE Ratio53.7%73.0%19.3% Underwriting Expense Ratio27.5%30.0%2.5% Combined Ratio Before PHD81.2%103.0%21.8% Policyholder Dividends3.9%0.3%(3.6%) Combined Ratio After PHD85.1%103.3%18.2% Investment Ratio17.5%14.8%2.7% Operating Ratio67.6%88.5%20.9%

RRG Composite vs. Captive Composite Operating Performance Analysis 5-year Average RRGCaptiveFav/(Unfav) Loss & LAE Ratio53.7%68.1%14.4% Underwriting Expense Ratio27.5%20.1%(7.4%) Combined Ratio Before PHD81.2%88.2%7.0% Policyholder Dividends3.9%4.1%0.2% Combined Ratio After PHD85.1%92.3%7.2% Investment Ratio17.5%16.3%1.2% Operating Ratio67.6%76.0%8.4%

Single-Parent Captive Composite vs. Commercial Composite Operating Performance Analysis 5-year Average SPCCommercialFav/(Unfav) Loss & LAE Ratio61.2%73.4%12.2% Underwriting Expense Ratio6.1%29.3%23.2% Combined Ratio Before PHD67.3%102.7%35.4% Policyholder Dividends19.3%0.8%(18.5%) Combined Ratio After PHD86.6%103.5%16.9% Investment Ratio14.8%15.6%(0.8%) Operating Ratio71.8%87.9%16.1%

Single-Parent Captive Composite vs. Captive Composite Operating Performance Analysis 5-year Average SPCCaptiveFav/(Unfav) Loss & LAE Ratio61.2%68.1%6.9% Underwriting Expense Ratio6.1%20.1%14.0% Combined Ratio Before PHD67.3%88.2%20.9% Policyholder Dividends19.3%4.1%(15.2%) Combined Ratio After PHD86.6%92.3%5.7% Investment Ratio14.8%16.3%(1.5%) Operating Ratio71.8%76.0%4.2%

Take Aways: Captive and RRG composite operational leverage is approximately half of the commercial composite leverage. Captive composite operating performance substantially outperforms the commercial composite (12.5 points) on a 5- year basis and significantly outperforms (6.1 points) on a 10- year basis. RRG composite operating performance blows away the commercial composite (20.9 points!) on a 5-year basis. RRG composite operating performance significantly outperforms the captive composite (8.4 points) on a 5-year basis.

Take Aways (cont.) Single-parent captives operating performance substantially outperforms the commercial composite (16.1 points) on a 5- year basis. Single-parent captives operating performance incrementally outperforms the captive composite (4.2 points) on a 5-year basis. No matter how you slice it, alternative risk outperforms!

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