Industry Issues | ERM & Emerging Risks

A.M. Best Benchmarking Review Highlights Insurers' ERM Capabilities

Emerging Risk - Rating Agency
(risk assessment: financial, operational, regulatory, reputational, strategic, underwriting)

An A.M. Best analysis of the U.S. property/casualty industry under the rating agency's 2017 Best's Credit Rating Methodology (BCRM) update indicates most companies remain strongly capitalized and able to demonstrate patterns of stability that reflect their quality of capital, asset-liability management and diverse reinsurance programs.

Best's Special Report, titled, "U.S. Property/Casualty Benchmarking," discusses the impact on rated P/C insurers from updates to BCRM and Best's Capital Adequacy Ratio (BCAR). The assessment generated benchmarking statistics, which are detailed in the report. According to the report, more than one-third (35%) of the rated population had the "strongest" category of balance sheet strength, while 48% of rated entities were assessed in the "very strong" category. When split between commercial and personal lines, the percentage of companies in those two categories represent more than 88% of commercial writers and nearly 77% of personal lines writers. The difference, according to A.M. Best, is largely due to lower assessments for a few personal lines writers that specialize in nonstandard auto or are geographically concentrated for homeowners.

The primary quantitative tool that A.M. Best used to evaluate balance sheet strength is BCAR, which is used by the ratings agency to determine whether a company's capitalization is appropriate. A.M. Best states that it takes all the balance sheet components into consideration as the BCAR itself is not the sole determinant of the balance sheet strength assessment. Still, companies with lower overall balance sheet assessments were reported to generally lack other strengths to offset lower BCAR scores.

Along with balance sheet strength, the "key pillars" A.M. Best uses in its credit analysis are operating performance, business profile and enterprise risk management. The operating performance of nearly 52% of the rated population was assessed at the baseline assessment of "adequate," reflecting neutral operating trends, which can be equated to underwriting metrics near break-even. Additionally, nearly 55% of rated entities were found to have a limited business profile assessment. Among the key characteristics of these companies are a lack of geographic or product diversification, limited distribution and high competition with low barriers of entry.

Enterprise Risk Management is Critical to an Insurer's Long-Term Success, says A.M. Best.

In evaluating a company's ERM program, the ratings agency examines the risk framework, risk profile and makes an overall assessment. A company's risk management framework determines where an insurer can appropriately leverage the strategic advantages of risk-taking, according to A.M. Best. Key areas of focus are:

  • risk identification and reporting;
  • risk appetite and tolerances;
  • stress testing;
  • risk management and controls; and,
  • governance and risk culture.

1.4% of U.S. P/C insurers that A.M. Best evaluates practice "very strong" enterprise risk management (ERM). To obtain this assessment an insurer must show how its approach to ERM has been used effectively over the "medium-to-long term"; adds value to the organization; and, is "effective and embedded" within it. Companies with Very Strong ERM have robust and comprehensive capital modeling capabilities. Additionally, they use their models for strategic decision-making, such as capital planning, product development, and investment strategy.

More than 92% of rated U.S. P/C insurers were assessed to have an "appropriate" ERM framework in place. An effective ERM program needs to be dynamic and quickly responsive to new risks and resulting new challenges, adds A.M. Best. About 20% of rated U.S. P/C insurers are deemed as having risk identification "embedded" throughout the company, and more than 50% "developed" - the two highest ERM framework descriptors.

As part of its overall evaluation, A.M. Best assesses the insurer's risk management capabilities. The rating analyst will consider how the company actively identifies, addresses, mitigates, and controls its exposure to risks caused by concentration. Further, the analyst will evaluate the strength of reserves in the context of the company's risk profile and business underwritten.

The ratings agency identified areas of shortcomings to include a "lack the overall embeddedness [of ERM] within the organization"; breaching risk tolerances; not using stress testing enough; or subsidiary-specific issues. Inadequate stress testing including of investments, is also a problem in emerging markets, alongside governance and 'risk culture'.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=280733 .

For a video with AM Best Managing Director John Andre about the U.S. P/C benchmarking report, please visit http://www.ambest.com/v.asp?v=pcbenchmarking1218 .