Ensuring Capital Adequacy for Captives

Scot Sterenberg, Dawne Davenport & Rodney George

March 11, 2014 3:45pm

Capital Adequacy for Captives

• Why Is This Important?

• General Considerations

• Understanding Key Areas Of Risk

• Capital Adequacy Metrics

• Capital Adequacy Benchmarks

• Case Study

• Questions?

Why is this important?

“Expect the best, plan for the worst” unknown

• Adequacy of capital most important measure of an insurance company

• Insurance is promise to pay

• Ability to pay matters

• Proper exercise of fiduciary responsibilities of directors & officers

• Cost of capital

General Consideration to Ensuring Capital Adequacy

• Consider multiple views and perspectives

• Seek independent advice

• Appropriately document

• Robust infrastructure sufficiently flexible to accommodate changing tests

• Regularly maintain and update and assess independently

Capital Adequacy Audience

– Regulators

• Policyholder

• Liquidation

– Management

• Owner

• Going concern

– Insureds/Investors

– Rating agency

Understanding Key Areas of Risk Four Primary Areas of Risk

Reserve Risk

Underwriting Risk

Asset Risk

General Operational Risk

Other Areas of Risk

Reinsurance Risk

Management Risk

External Risks

Understanding Key Areas of Risk

• Subjective

• Varies by entity

– “Comprehensive stress testing programs should consider the institution’s most material and significant risks”-OSFI

• Varies by insurance type (life, health, PC)

• Consistent across frameworks

– Terminology and categorization differ

Primary Causes of P/C Impairments

Deficient Loss

Reserves, 37%

Rapid Growth, 17%

Alleged Fraud, 9%

Overstated Assets,

8%

Significant Change,

5%

Reinsurance

Failure, 4%

Catastrophe

Losses, 7%

Impairment of an

Affiliate, 4%

Miscellaneous,

10%

Source: AM Best

Composition of Gross Required Capital

Loss & LAE

Reserves,

33%

Premiums

Written, 31%

Investments,

29%

Credit, 7%

Source: AM Best

Capital Adequacy Metrics

• Impact of stress test needs to be measurable

• Satisfy obligations?

– Yes/No

– X% probability

– By margin of Y%

• Meet minimum capital requirements?

– Regulatory

– Rating agencies

– Economic

Capital Adequacy Benchmarks Overview

• Accounting Ratios

• Regulatory Minimums

• Risk-Based Capital Ratios

• Probabilistic

Capital Adequacy Benchmarks Accounting Ratios

• Premium to Surplus

– P:S = NWP / PHS

– Casualty industry rule of thumb~2:1

– Not to exceed 3 or 4:1

• Reserves to Surplus

– R:S = (UPR + Loss & LAE Reserves) / PHS

– Not to exceed 4:1

Capital Adequacy Benchmarks NWP:PHS By Industry

Capital Adequacy Benchmarks Risk-Based Capital Ratios

• “RBC represents an amount of capital based on an assessment of risks that a company should hold to protect customers against adverse developments”-NAIC

• NAIC-RBC

• AM Best-BCAR

• Fitch-PrismScore

• Moody’s-MRAC

• S&P-CAR

Capital Adequacy Benchmarks NAIC-RBC

Action Levels

– RBC ratio Action

– ≥200% No Action

– 150%200% Company Action Level

– 100%150% Regulatory Action Level

– 70%100% Authorized Control Level

– <70% Mandatory Control Level

Capital Adequacy Benchmarks

P/C Industry Results – Action level

Table 1 Industry Results By Action Level, 2008–2012

2008

2009

2010

2011

2012

No Action 2,566 2,571 2,545 2,538 2,532 Company Action Level 29 19 13 14 16 Regulatory Action Level 16 10 17 13 14 Authorized Control Level 10 10 5 9 8 Mandatory Control Level 29 29 26 26 31 Total 2650 2639 2606 2600 2601

Percentage at 'No Action' Level

96.8%

97.4%

97.7%

97.6%

97.4%

Capital Adequacy Benchmarks Probabilistic

• Probability of ruin

• VAR - value at risk

• TVAR - tail VAR

• EPD - expected policyholder deficit

Case Study

• The Everett Clinic (The Parent)

• Sentinel Assurance Risk Retention Group (The Captive)

Why we measured capital adequacy….

• Comply with minimum state requirements

• Understanding what is excess capital/surplus

• Knowing and recognizing your risk tolerance

• Preparing for the worst – every risk instrument/ profile is capable of bearing loss

• Gearing up for change in risk profile, if necessary

• Better and more timely management decisions

How we went about doing the study….

• Engaging the board at an early stage

• Understanding the reasons for doing it

• Engaging your Captive Manager and Actuary

• Looking at various adverse scenarios

• Creating a policy for Board to adopt

Our experience after adopting policy…..

• Had worst loss experience in history!

• Management able to better react and make sound decisions (underwriting and investment)

• Using it as a tool to continue monitoring

Questions?

Speakers Scot Sterenberg Office Head Marsh Management Services Hawaii scot.sterenberg@marsh.com Phone 808-585-3591 Dawne Davenport, ACAS, MAAA Actuarial Consultant dawne.davenport@marsh.com Phone 312-627-6924 Rodney George Controller – Operations/Subsidiaries Sentinel Assurance Risk Retention Group rgeorge@everettclinic.com Phone 425-339-5465, ext. 2077