Evolving Criteria - Reinsurance Thought Leadership | Aon Benfield

Evolving Criteria
A.M. Best
A.M. Best released a number of methodology criteria
papers during the past year and many were updates to
existing criteria. For example, A.M. Best updated the
catastrophe stress test calculation by lessening the
impact on credit and reserve risk. The rating agency
also stated a greater tolerance for a lower stress BCAR
score. These changes eased the capital requirements for
companies with material catastrophe exposure as
compared to the previous approach. A.M. Best made
minor updates to methodology criteria regarding
treatment of terrorism risk and rating insurance groups
among others.
In April 2010, A.M. Best released a draft criteria paper
regarding new company formations. The framework of
this criteria paper was built off the initial criteria
methodology released in March 2004, but with one very
important distinction. In the current draft methodology,
A.M. Best introduces the use of contingent capital to
support upfront capital requirements. Historically,
A.M. Best required a new company to raise initial capital
that would support the first five years of operations (at
the appropriate capital adequacy level) without the need
for additional capital contributions. Coupled with other
new company requirements, such as a 50 percent
growth charge applied to reserve and premium risk, this
created a high capital hurdle to obtain an initial rating of
“A-” or higher. However, the current draft methodology
puts forth consideration for use of contingent capital in
years four and five to support initial capital requirements.
Specifically, companies will be able to reduce initial
on-balance sheet capital requirements if the following
conditions exist (credit for contingent capital):
> Fully executed, binding legal agreement
> Irrevocable for the term of the agreement
> Must be equity capital
> Drawdown of capital must be unrestricted
> Must have on-demand access to capital (within 20
business days)
> A risk-adjusted capital surcharge of 10 percent on
the outstanding balance of the capital commitment
will be assessed in the initial and subsequent BCARs
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Given the current market environment, which is more
geared toward mergers and acquisitions and less
toward new company formations, the impact of this
proposed criteria change is yet to be seen.
Additionally, A.M. Best has a new draft methodology
that addresses transfer and convertibility risk, which
evaluates the likelihood of a sovereign disrupting the
ability to convert local currency into foreign currency
and/or transfer funds to nonresident creditors. In
assessing transfer and convertibility risk, A.M. Best
reviews a government’s current capital and trade
controls, a country’s integration into the global
economy, the strength of the local rule of law, and a
sovereign’s use of price controls. The criteria may
impact holding company issuer credit ratings and debt
ratings, but is not expected to impact operating
company financial strength ratings since it is designed
to evaluate the ability to meet policyholder claims,
which are normally in local currency.
Fitch
In December 2009, Fitch published a new global
master criteria report detailing their insurance rating
methodology for insurance organizations. This master
criteria was then supplemented by various sector
specific criteria including a global non-life insurance
rating methodology published in March 2010. Fitch has
stated that they must review their criteria a minimum
of every three years.
The main change in the new master criteria is the
introduction of the total financing and commitment
ratio (TFC) relative to capital as part of the analysis of
the financial profile of a company.
This is a comprehensive measure of debt-related
leverage, making use of a broad definition of debt to
include essentially all financing activities. This definition
includes various financing types such as long-term
notes, bank borrowings, commercial paper, repurchase
agreements, “match-funded” debt at the holding
company, letters of credit, securitizations, and
guarantees of other debt issued by other entities.
This ratio is designed to measure the debt, financing and
capital markets “footprint” of an organization, and its
overall reliance and ongoing access to funding sources.