“AM BEST’S COUNTRY RISK ASSESSMENT INCLUDES AN EVALUATION OF THE LOCAL REGULATORY ENVIRONMENT, AND OTHER FACTORS INCLUDING THE LEVEL OF DEVELOPMENT OF THE INSURANCE MARKET.”
The three components are examined together to see how they interact, paying particular attention to likely future heading. Ratings are prospective, so companies are analysed based on three to five-year projections, depending on the nature of the business.
Enterprise risk management (ERM) is an overarching element of the rating analysis and is embedded throughout the three components of the rating. ERM covers the framework, ie, the mechanisms that the company may have to monitor the risks that it accepts and how they impact on the three main areas cited above.
Captives and their parents AM Best analyses the relationship of a captive to its parent. The
rating of the parent is not a ceiling to the rating of a captive but is examined to understand the importance of the captive to the parent. Issues analysed include, for example, how much added value is provided and how is the captive integrated within the company’s risk management function.
AM Best will compare the stand-alone assessment of the captive
and the published rating, or shadow assessment (in the case of no published rating being available) for the parent.
If the parent is much weaker than the captive, reassurances may
be needed that the captive maintains its independence and is able to generate capital and retain it going forward. At the same time, if there are any loans back to the parent, AM Best needs to ensure that they have been set up under market conditions that allow it to be considered an arm’s length transaction.
Conversely, if the parent is much stronger than the captive, any potential parental support in the case of explicit guarantees, letters of credit or a track record of capital injections that support the captive’s operations could be supplemented.
The impact of reinsurance The rating of a captive’s reinsurers can also affect the analysis
and the rating outcome. One aspect will depend on the quality of the reinsurance programme, as part of the capitalisation analysis. Furthermore, AM Best may need to consider how exposed the company could be to large retentions and how these may impact on the BCAR score on a stress basis.
However, if the captive’s entire reinsurance arrangements are with
reinsurers with an A rating, this does not automatically mean the captive will achieve a similar rating level. The three areas mentioned above—capitalisation, operating performance and business profile, along with ERM—will be important for attaining a high rating.
If most of the business is being ceded or retroceded to a highly rated
reinsurer, the BCAR scores are likely to be very high because there is virtually no insurance risk retained while the credit risk remains low. For ratings purposes, this would increase the need to focus on the quality of gross business written. Other key issues specific to captives, such as the nature of the insurance risks covered and the integration with the parent’s overall risk management programme, will also need to be considered.
How domiciles affect ratings
The domicile of the captive and/or its parent can be significant in AM Best’s country risk tier (CRT) analysis. Countries are placed into one of five tiers, ranging from CRT-1, denoting a stable environment with the least amount of risk, to CRT-5, the most risky jurisdictions.
AM Best’s country risk assessment includes an evaluation of the
local regulatory environment, and other factors including the level of development of the insurance market and political and economic stability. AM Best does not favour one domicile over another, although it will closely examine the reporting standards in place.
For captives, the most likely locations in Europe fall into the CRT-1 or
CRT-2 category. In these cases, it is unlikely that the CRT will act as a drag on the final published rating.
Rating PCCs The main issue for PCCs is to ensure that any ring-fencing between
cells is clear cut, particularly the potential exposure that a particular cell may have to the liabilities of other cells.
Depending on the complexity of the PCC structure, an understanding
of the whole system may be required. A rating may apply to a core PCC company or to individual cells.
Factors that could affect ratings Although the rating is subject to an annual cycle of reappraisal there may
be circumstances in which the rating has to be reassessed within a shorter period. This will be when significant or unexpected events occur and AM Best needs to assess their impact, for example, a change to the captive manager.
20 emea captive 2012
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