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Carlos Wong-Fupuy and Yvette Essen, AM Best


The benefits of ratings A


M Best has seen an increasing interest in ratings in the past year, driven by a combination of regulatory factors and the challenging economic environment.


A heightened focus on corporate governance,


regulatory developments—not least Solvency II—and a variety of fronting requirements have contributed to a greater desire for an independent and informed opinion on a captive’s ability to meet its obligations and pay claims.


There are two basic drivers for a captive to seek a rating: to improve


its interface with the conventional market and to address the ever- growing pressure of corporate governance.


Many fronting companies and reinsurers prefer to deal with rated


counter-parties. They may be prepared to work with captives but this often affects the cost of the deal, the capacity available or the collateral demanded. A rated captive may be able to achieve preferential terms when arranging fronting or reinsurance protection.


The rating can also tell the other party about the credit risk inherent


in ceding business to the captive, or the quality of business for which reinsurance is sought. More generally, there may be a variety of stakeholders in the success of the captive who need reassurance that it is being run according to best practice. In some markets there may be a regulatory requirement that the captive is rated.


AM Best rates approximately 200 captives in 48 jurisdictions,


taking into account quantitative and qualitative considerations, and has specific rating methodologies for captives and protected cell companies (PCCs). In December 2011, a criteria report Alternative Risk Transfer was published, underlining the key rating considerations specific to alternative risk transfer entities such as single-parent captives and group captives.


Ratings can prove an invaluable aid to captives as they navigate the insurance landscape. AM Best outline their significance and how the rating agency assesses those firms within its remit.


The main features examined by AM Best as part of the ratings process for captives and PCCs are explained below.


Key components of an AM Best rating First, AM Best examines the balance sheet strength, measuring the


capitalisation of a company compared to the risks it is able to accept. Among the main tools used is our risk-based capital model and the Best capital adequacy ratio (BCAR). This ratio is a very important element to our quantitative analysis but is by no means the only one. We also need to analyse other factors including the quality of the reinsurance programme, the robustness of the reserving systems and the investment policy.


The second component is the operating performance of a


company. This captures the quality of the earnings, the main sources and how robust and resilient profitability trends are. There is a significant focus on the quality of the technical account (the strength of the technical profits), and while AM Best does not ignore the results from investments, a strong technical account tends to be preferable to a volatile investment result.


The third element refers to the business profile and is where the greatest difference between rating a captive and rating a traditional company can occur. Business profile relates to market position, the quality and diversity of the sources of income and the quality of the business that the entity is accepting. The challenges of a competitive environment and a company’s product and geographical concentration are also significant. In the particular case of captives, the significance of the business to the parent and the level of integration of the risk management function are highlighted.


No single element translates automatically into a particular rating.


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