BCAR.Cdn
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Reading: Understanding BCAR For Canadian Property/Casualty Insurers,” August 12, 2022
Authour: A. M. Best
Contents
Pop Quiz
Do you remember the 4 broad areas of risk from OSFI.MCT? Do you remember the definitions of each?
Study Tips=
A.M. Best's financial strength rating is an opinion of an insurer's ability to meet ongoing policyholder obligations. The components of this rating are BOB (Balance sheet strength, Operating performance, Business profile). The BCAR ratio (Best's Capital Adequacy Ratio) is an important part of evaluating balance sheet strength.
BattleTable
Based on past exams, here is what you need to know (in rough order of importance):
- BCAR risk categories: ICU
- BCAR components: BOB
- BCAR investment risk: FEI
- BCAR square-root rule
reference part (a) part (b) part (c) E (2018.Fall #21) A.M. Best vs MCT:
- future premium risklow BCAR value:
- company characterisiticsA.M. Best vs MCT:
- covariance adjustmentE (2017.Spring #23) BCAR investment risk: FEI BCAR risk categories: ICU BCAR square-root rule E (2016.Fall #21) BCAR risk categories: ICU E (2016.Fall #24) BCAR risk categories: ICU E (2015.Fall #24) BCAR components: BOB BCAR risk categories: ICU
Note: I didn't like this paper. I found it très confusing. You could maybe read the first page, but I wouldn't recommend much more than that: easy link to current (2016) source reading
In Plain English!
BattleHack #1
If you only have 5 minutes to spend studying this paper, here is what you should learn:
Question: what is the purpose of A.M. Best's financial strength ratings
- to provide an opinion on the financial strength of an insurer (and it's ability to meet ongoing obligations to policyholders)
Question: what are the BCAR risk categories [Hint: ICU]
- Investment risk
- Credit risk
- Underwriting risk (largest component of BCAR risk - accounts for 2⁄3 of required capital)
- Alice the actuary has no problem remembering this (unfortunately). Last winter, she was snowboarding at Whistler in BC and attempted a backside 1260.
- See backside 1260 for how she meant to do it.
- See Alice fails... for what really happened. (She didn't know I was taking a video!)
- Anyway, she took a risk, and ended up being airlifted to ICU (Intensive Care Unit) at the hospital. That's how she remembers the connection between BCAR risk & ICU.
- Note that you usually have to provide a brief description of these risk categories, but you can probably do that from general knowledge.
- A small point of confusion, however, is that in the IMCO (In My Crummy Opinion) memory trick in OSFI.MCT, "I" stands for insurance risk but here it stands for investment risk. You just have to remember that.
BattleHack #2
If you have 10 minutes to spend on this paper, here are a few more things to learn:
Question: what are the components of A.M. Best's financial strength ratings [Hint: BOB]
- Balance sheet strength
- Operating performance
- Business profile
Question: what are the components of investment risk, according to A.M. Best [Hint: FEI]
- Fixed income securities (insurance companies invest mainly in fixed income securities)
- Equity securities
- Interest rates
- Note: Here is "I" stands for Interest rates. (Sorry, I know that's a bit confusing because previously, the "I" stood for both Insurance risk & Investment risk)
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BattleHack #3
If you have 20 minutes for this paper, here is something that I think would be a great exam question, but is has never been asked:
Question: how is the Canadian version of BCAR different from the American version
- the Canadian interest rate risk component (part of BCAR investment risk FEI) considers...
- ...market-value decline of an insurer's fixed-income portfolio due to rising interest rates
- the Canadian U/W risk component (part of BCAR risk categories ICU) makes adjustments for...
- ...reported surplus (Ex: eliminates intangible assets)
- The title of this paper is: Understanding BCAR for Canadian P&C Insurers. The obvious question, before I even read the paper, is: how is the Canadian version different? I really can't understand why this hasn't been asked. Neither can Alice. (Please send her a 'Get Well Soon' card.)
Comparison of BCAR to MCT
Recall that from OSFI.MCT:
MCT ratio = CapAv / minCapReq
- it's based on an analysis of the risk factors: IMCO
A.M. Best calculates something similar, where NRC is Net Required Capital:
BCAR = (adjusted surplus) / (NRC after covariance adjustment)
- it's based on the BCAR risk categories: ICU
- note that the covariance adjustment corresponds loosely to the diversification credit in OSFI.MCT
- the numerator in both BCAR & MCT represents capital available
- the denominator in each represents minimum capital required
This brings us back to a prior exam question (2017.Spring #23c)
Question what is the purpose of the square-root rule (covariance adjustment) in the BCAR calculation
- provides a credit for diversification between risks (just like the diversification credit in the MCT formula: not all risks will suffer MAX loss at the same time)
- My 2 cents: I think (2017.Spring #23c) was a terrible question. There was once a paper on the syllabus on how to calculate BCAR, but it has been removed. If the CAS wants you to understand details of the BCAR formula, why did they remove that paper? If you knew how to do the calculation, this question on the square-root rule would have been easy.
One final point... (There are probably many different answers, but BCAR is not a major topic.)
Question what is 1 conceptual difference between BCAR & MCT regarding the time horizon
- BCAR: capital must support current & future premium risk
- MCT: focuses more on current year's risk
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Miscellaneous
Here are some final miscellaneous facts from the Canadian BCAR paper. As of Spring.2018 none of these has been asked even though 3 of them are from the first page of the paper. (If the CAS is looking for new questions, this may be something they'll pick out.)
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BattleCodes
Memorize: (All BattleCards, of course, but here's a summary of the memory tricks.)
More important:
- ICU: risk categories that BCAR NCR (Net Required Capital) supports
- Investment risk, Credit risk, U/W risk
- BOB: components of A.M. Best's financial strength rating
- B/S strength, Operating performance, Business profile
- FEI: components of investment risk
- Fixed income securities, Equity securities, Interest rate
Less important:
- UFA: types of leverage important to B/S strength
- U/W leverage, Financial leverage, Asset leverage
- ICI: things that asset leverage measures
- exposure of an company's surplus to: Investment risk, Credit risk, Interest rate risk
Conceptual:
- The title of this paper is: "Understanding BCAR for Canadian P&C InsRs". I keep thinking it would be a great exam question to ask what's different about the Canadian version. A couple of answers to that are:
- For InvRsk: The Cdn interest rate component considers market-value decline in InsR's fixed-income portfolio due to rising interest rates
- For U/W Rsk: Cdn BCAR makes adjustments for reported surplus (Ex: eliminate intangible assets)
- I think it's interesting to see how the MCT ratio compares to BCAR.
Calculational:
- Nothing to calculate since the paper on calculating BCAR was removed from the syllabus.
Full BattleQuiz You must be logged in or this will not work.
POP QUIZ ANSWERS
IMCO are the 4 broad areas of risk from OSFI.MCT. (IMCO = In My Crummy Opinion)
- Insurance Risk
- risk of loss FROM the potential for claims (from policyholders & beneficiaries)
- Market Risk
- risk of loss FROM changes in prices in various markets
- Credit Risk
- risk of loss FROM counterparty's potential (inability OR unwillingness) to fully meet contractual obligations due to the insurer
- Operational Risk
- risk of loss FROM inadequate or failed (internal processes, people, systems) OR FROM (external events)
