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Balance sheet strenght
- in determining a company’s ability to meet its current and ongoing obligations to policyholders, the most important area to evaluate is balance sheet strength
- it is the foundation for policyholder security
- performance determines how it will be enhanced, maintained or eroded over time
- it measures the exposure of a company’s surplus to its operating and financial practices
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Underwriting leverage
- generated from the current premium writings, reinsurance recoverables and loss reserves
- therefore consider
- type of business written
- quality and appropriateness of reinsurance program
- adequacy of loss reserves
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Financial leverage
- created through debt-like instruments (incl. financial reinsurance)
- review in conjunction with a company’s underwriting leverage
- asset leverage measures exposure of surplus to investment, interest rate and credit risks
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Overview of BCAR approach
- adapted specifically to Canadian P&C-1 and P&C-2
- capital formula takes a risk-based capital approach
- net required capital supports investment, credit and UW risk
- formula contains adjustment for covariance
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BCAR vs MCT
- a significant portion of capital is required to support future premium risk
- this reflects A.M. Best’s view that balance sheet strength must support the risks associated with a company’s current book of business as well as those it plans to insure
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Investment risk
- includes fixed-income securities, equities, interest rate
- capital charges are applied to different asset classes based on risk of default, illiquidity and market-value declines
- higher capital charges are ascribed to affiliated investment holdings, real estate, below-investment-grade bond and nonaffiliated, privately traded common and preferred shares because of illiquid nature and/or volatility of the reported value
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Credit risk
- ascribed to recoverables from all registered and unregistered reinsurers, including affiliates
- required capital may be modified after considering:
- any collateral offsets for reinsurance balances
- quality of the reinsurers
- company’s dependence on its reinsurance program
- also include charges for premium receivables (agents, brokers, policyholders, instalment)
- also include funds held by residual market entities (FA / PRR) and other misc receivables
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Underwriting risk
- largest risk category and typically accounts for 2/3 of gross required capital
- encompasses both loss and loss adjustment expense reserves and NWP
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Total capital required
- investment, credit and underwriting risk generate > 99% of gross required capital
- latest component reflects off-balance-sheet items
- gross amount reflects capital required if all risks were to develop at the same time
- square root rule covariance accounts for statistical independence and reduces by 35-45%
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Additional stress testing
- test for second catastrophic event
- incorporate natural catastrophes and/or man-made events (e.g. terrorism)
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