Risk. Reinsurance. Human Resources.

Aon Benfield

Evolving CriteriaRating agency, regulatory, and financial trends

September 2015

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

Industry Outlooks & Rating Activity . . . . . . . . . . . . . . . . . . . . . . . .2

Rating Criteria Updates. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4A.M. Best . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

Standard & Poor’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8

Moody’s . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Fitch . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Demotech . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

Regulatory Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10North America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Europe, the Middle East, and Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13

Asia Pacific . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Caribbean . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Latin America . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Accounting Developments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21International accounting standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Development of global Insurance Capital Standard . . . . . . . . . . . . . . . . . 21

Mergers and Acquisitions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22

Financial Trends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .24Operating performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Capital adequacy continues to grow . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Public company benchmarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Enterprise Risk Management Trends . . . . . . . . . . . . . . . . . . . . . .26Risk tolerance statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Catastrophe Risk Tolerance Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Stress scenarios . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

Looking Forward: Key Topics for 2015 and 2016 . . . . . . . . . . . .28

Contacts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

Contents

Aon Benfield 1

Introduction

Evolving Criteria provides a summary of key global rating agency criteria and regulatory developments over the last year. The report also explores accounting developments, mergers and acquisitions activity in the insurance sector, financial and capital adequacy trends, enterprise risk management, as well rating agency and regulatory themes for 2016.

Key topics addressed include:

All four rating agencies have a negative

outlook on the reinsurance sector

Rating movements by A.M. Best and Standard

& Poor’s have decreased significantly in 2014

and 2015 compared to the years prior where

severe weather volatility and the financial

crisis played roles in many downgrades

Rating agencies issued new or updated criteria

— A.M. Best released details of some components

of their stochastic-based BCAR model at their

conference in March 2015, followed by a series

of webinars, and we expect a draft model will be

released in the fourth quarter of 2015

— Cyber security is an important area of focus;

A.M. Best released a set of questions that all

companies should plan to answer

— Standard & Poor’s and Moody’s released criteria

for mortgage insurance companies

— Fitch expanded their use of their Prism model to

Asia Pacific companies and finalized changes to

their notching criteria

— Demotech released an update regarding credit for

catastrophe bonds

Global regulatory updates:

— Increasing regulatory standards is a theme globally

— Solvency II will be effective on January 1, 2016 for

insurers and reinsurers in the European Union

— Risk-based capital models are continually growing

in importance and evolving

— Own Risk Solvency Assessment reporting is a

common framework

Capital adequacy, as measured by rating

agency models, continues to grow

Companies are working to define

enterprise risk management stress scenarios

and risk tolerance statements

The industry is rapidly changing with increased

technology, altered distribution channels, large scale

merger and acquisition deals, and alternative capital

moving into the sector. Both rating agencies and

regulators continue to evolve as well. The impact of

rating agencies is well understood in the industry

and changes in their criteria are of key interest to the

companies they rate.

2 Evolving Criteria

The rating environment for US property casualty insurers continued its stable trend as all industry outlooks have remained unchanged during the past year. The reinsurance sector is viewed with a negative outlook by the four major rating agencies.

A.M. Best noted the reinsurance sector experienced

significant declines in pricing in 2014, and pressure will

remain throughout 2015. Intense competition is leading

to thinner underwriting margins while the sector remains

overcapitalized. As reinsurers need increased scale and

diversification in order to remain competitive and profitable,

A.M. Best believes the merger and acquisition trends in 2014

will continue and global companies will only get larger.

Standard & Poor’s echoes a similar negative outlook rationale

and believes earnings will suffer as a result of material price

reductions. In addition, Standard & Poor’s indicated that

the negative pricing trends could lead to a reassessment of

reinsurers’ competitive position on capital and earnings.

With the exception of the negative outlook by A.M. Best

on commercial lines, the rating agencies maintain a stable

view of the US property casualty sector. This is driven by

a combination of insurers’ commitment to underwriting

discipline and profitability, very strong capitalization, and

conservative investment portfolios despite the low interest

rate environment. Industry outlooks for US personal and

commercial lines have remained unchanged since last year.

A.M. Best continues to remain the sole rating agency with a

negative outlook on the commercial sector, despite noting

improved market conditions and pricing. They believe

underwriting results will be insufficient to overcome the

headwinds that the industry faces. A.M. Best indicated

that while they expect the majority of commercial carriers

to have their ratings affirmed, they expect more negative

rating actions than positive in 2015. Reserve adequacy,

low returns on fixed-income investments, and emerging

issues like terrorism and cyber risk are the main concerns.

The personal lines outlook remains stable for all four rating

agencies. Although the segment was profitable in the last

year, results for 2014 declined slightly relative to prior years

due to slightly higher loss ratios. The segment continues to

be well capitalized and has increased surplus for the sixth

consecutive year, driven by underwriting profitability and

consistent net investment income. Favorable performance is

attributed to stable auto results and low catastrophe losses.

Exhibit 1: Current industry outlooks

Sector A.M. Best Fitch Moody’s S&P

Commercial Negative Stable Stable Stable

Personal Stable Stable Stable Stable

Reinsurance Negative Negative Negative Negative

Source: Respective rating agency reports

In 2015, the number of A.M. Best rating changes has increased

slightly from the same time period last year. Downgrades are

outpacing upgrades for the year, contrasting last year’s trend.

For both A.M. Best and Standard & Poor’s, 2014 ended with

upgrades outpacing downgrades for the first time since 2010,

although the total number of rating actions has declined

significantly. From a personal lines perspective, favorable

operating metrics resulted in the majority of ratings being

affirmed with stable outlook. Some rating volatility occurred

for companies that write non-standard auto, which is consistent

with previous year trends. Excessive growth and deteriorating

operating performance were the primary reasons for downward

rating movement. In the commercial lines segment, the

majority of companies also had their ratings affirmed. Drivers

of positive rating actions include improved earnings and

strong capital position, while drivers of negative rating action

include adverse development and decline in capitalization.

Industry Outlooks & Rating Activity

Aon Benfield 3

Exhibit 2: Rating activity: upgrades vs. downgrades

*Note: YTD 2015 as of July 1, 2015 Source: A.M. Best and Standard & Poor’s

Aon Benfield completes an annual study of A.M. Best “A-” rating

activity for US companies in order to analyze financial rating

drivers and identify key benchmarks. For many companies, an

“A-” rating is a key rating threshold, and given A.M. Best’s market

presence and the availability of US statutory financials, there is

credible data available to analyze the underwriting trends.

From 2010 to June 2015, 46 companies were downgraded from

“A-” to “B++”. The median five-year combined ratio based upon

the year of downgrade was 113 percent, and the median BCAR

was 180 percent. Poor underwriting results and subsequent

deterioration of capitalization drove the negative rating action.

Conversely, for companies upgraded from “B++” to “A-” based

on their own merit (i.e., no parental support), the median five-

year combined ratio was 94 percent, or 5 percentage points

better than the overall “A-” population.

In addition to producing favorable underwriting results,

increased emphasis is placed on management’s ability to

execute their business plan and meet projections. Companies

whose ratings were downgraded often consistently missed

projections provided to A.M. Best, which undermines the

credibility of future initiatives.

Exhibit 3: A.M. Best “A-” upgrade and downgrade characteristics

Key metrics—median

“A-” to “B++” downgrades

(year of downgrade)

All “A-” ratings

(as of July 2015)

“B++” to “A-”

own merit upgrades

5yr Combined ratio (%) 113 99 94

5yr Pre-Tax ROR (%) -5 7 15

NPW / PHS (x) 1.2 0.6 0.7

BCAR (percent) 180 295 280

Source: Aon Benfield Analytics, A.M. Best Bestlink Database

0

10

20

30

40

50

60

70

80

90

100

YTD 2015*

20142013201220112010200920082007

Upgrades Downgrades

0

2

4

6

8

10

12

14

16

18

20

YTD 2015*

20142013201220112010200920082007

Upgrades Downgrades

A.M. Best Standard & Poor’s

4 Evolving Criteria

A.M. BestA.M. Best is expected to issue draft criteria for the new,

stochastic BCAR model in October with a lengthy comment

period and potential implementation by the third quarter of

2016. The first model released will be the US property casualty

statutory model. A.M. Best will also release criteria for the

US life and health, Title, Universal, and two Canadian BCAR

models in the months following. All six BCAR models will be

adopted concurrently.

The overall structure of the model is not intended to

change materially, but the goal is to generate risk factors

using stochastic simulations from probability curves at

various confidence internals—98%, 99%, 99.5%, 99.8%,

and 99.9%. Exhibit 4 shows the layout of the new Stochastic

BCAR model. The model was last updated more than 18

years ago. The availability and application of new and more

sophisticated technology coupled with evaluating capital

adequacy across consistent confidence intervals provides a

more robust perspective of insurer balance sheet strength.

Rating Criteria Updates

The most significant criteria update is the pending release of A.M. Best’s long-awaited stochastic BCAR model. A.M. Best released details of some components of the model at their conference in March of 2015, followed by a series of webinars. The draft model has not been released and is expected in the fourth quarter of 2015. Standard & Poor’s and Moody’s released criteria for mortgage insurance companies. Fitch expanded their Prism model for Asia Pacific companies and finalized changes to their notching criteria. Demotech released an update regarding credit for catastrophe bonds.

Analyzing and testing model output

Issue Request for Comment on property casualty model

Release criteria

Industry webinars on

progress

Finalize and test other BCAR models

(life and health, Canadian, Title,

and Universal)

Receive and evaluate industry feedback

Review historical

trends under new

model

Transition to new model

Share draft model output with companies

Issue Request for Comment on other BCAR models

Timeline is subject to change based upon model testing results and level of industry feedback

Q4 2015

Q3 2016Q1 2016Q2 and Q3 2015

Q2 2016

Aon Benfield 5

Exhibit 4: Stochastic BCAR layout

Confidence intervals = 98%, 99%, 99.5%, 99.8%, and 99.9%

B1: Fixed income Risk factors to increase and will vary more by credit quality and duration

B2: Equity securities Common stock risk factor more than doubles (34 to 48%)

B3: Interest rate risk Based on gross PML; May incorporate varying levels of change in interest rates

B4: Credit risk Risk factor on recoverables to reflect tail (e.g., property versus work compensation)

B5: Reserve risk Risk factors vary by confidence interval; Diversification from correlation matrices

B6: Premium risk Risk factors vary by confidence interval; Diversification from correlation matrices

B7: Business risk

B8: Catastrophe risk All Perils Occurrence net PML after-tax; To vary by confidence interval

Gross required capital Sum of B1 to B8

Covariance adjustment Remain the same for now; B8 to be outside the covariance formula

Net required capital Denominator = Gross required capital minus Covariance

Reported surplus Equity

Stress event Occurrence net PML, after-tax; For stress BCAR analysis only

Other adjustments Loss reserve equity, fixed income equity, etc.

Adjusted surplus Numerator: Equity plus adjustments

BCAR score Score = Adjusted surplus / Net required capital Source: A.M. Best

A.M. Best indicated they intend to publish the BCAR scores

across all five confidence intervals and have determined the

financial strength rating mapping in relation to each interval,

see exhibit 5. A.M. Best expects to update the model in phases.

Phase 1 will include updated stochastic factors for bonds,

common stock, reinsurance recoverables, premium and reserve

risk, as well as the new measurement of catastrophe risk. Phase 2

will update the remaining asset classes like preferred stock, real

estate, and mortgage loans, as well as the life and annuity risks.

The catastrophe charge is expected to have the biggest

impact for many companies. The return period will

vary by confidence interval and higher rated companies

(A- or above) are expected to have more tail coverage.

Exhibit 5: Mapping by rating level

Confidence Interval 98% 99% 99.5% 99.8% 99.9%

Rating level B B+ / B++ A- / A A+ A++

Catastrophe charge 50yr 100yr 200yr 500yr 1,000yr

Source: A.M. Best

Currently, A.M. Best includes the net retention of the greater

of a 1 in 100 wind event or a 1 in 250 earthquake event,

both on an occurrence basis. In March 2015, A.M. Best was

considering using an aggregate, all-perils TVaR metric and

the rest of the model would have been on a TVaR basis. A.M.

Best changed the plan in May and announced they will use

an occurrence, all-perils VaR view of catastrophe risk and for

consistency, will switch to VaR for the other model components.

The catastrophe risk measure will be moved to the

denominator of the BCAR calculation as opposed to the

current practice of subtracting it from surplus, so the capital

position or the numerator is the same for all confidence

levels. A.M. Best commented that there will continue to

be a catastrophe stress test. Exhibit 6 summarizes the

evolution of the catastrophe risk charge over the last year.

6 Evolving Criteria

Exhibit 6: Catastrophe risk charge evolution

Category Current Approach Initial Proposed March 2015 Current Proposed May 2015

Peril Peak Peril All Perils All Perils

Return Period 100yr HU/Wind or 250yr EQ Vary by confidence interval (20yr, 40yr, 100yr, etc.)

Vary by confidence interval (50yr, 100yr, 200yr, etc.)

VaR or TVaR VaR (loss at a specific return period) TVaR (avg of losses beyond a return period) VaR

Agg or Occ Occurrence Aggregate Occurrence

BCAR Impact Reduction to surplus Addition to net required capital Addition to net required capital Source: Aon Benfield Analytics

Bond default risk factors will be based on an economic

scenario generator with inputs reflecting a company’s

duration and asset quality as provided in the supplemental

rating questionnaire (SRQ). Common stock default risk

factors will be based on an economic scenario generator

with inputs reflecting the type of stocks held by a

company based on the beta provided in the SRQ.

A.M. Best saw significant increases in these asset risk factors,

particularly in equities. They noted that the investment charge

increases have been tested on property casualty companies and

there is no material impact for most, however companies with

high equity concentrations may be impacted adversely.

Exhibit 7 by A.M. Best shows the average risk factors for a

sample of property casualty companies compared to the

current model. The public common stock baseline factor

increases from the current 15 percent to 43.8 percent at

the 99.5% (A/A-) confidence interval and 48.3 percent at

the 99.9% confidence interval (A++). Schedule BA assets or

alternative investments will receive a starting charge of

60 percent at all confidence intervals (increased from the

current 20 percent) unless further reviewed by an analyst.

Exhibit 7: Stochastic model investment charges

Asset Risk Factor Current VaR 98 VaR 99 VaR 99.5 VaR 99.8 VaR 99.9

US Gov’t 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%

NAIC Class 1 Bonds 1.0% 1.2% 1.5% 1.7% 2.0% 2.4%

NAIC Class 2 Bonds 2.0% 5.4% 6.2% 6.8% 7.5% 8.4%

NAIC Class 3 Bonds 4.0% 10.0% 11.0% 11.8% 12.8% 13.7%

NAIC Class 4 Bonds 4.5% 23.3% 24.7% 25.8% 27.0% 27.8%

NAIC Class 5 Bonds 10.0% 37.6% 38.3% 38.9% 39.5% 39.9%

NAIC Class 6 Bonds 30.0% 45.5% 46.6% 47.5% 48.3% 49.2%

Public Common Stocks 15.0% 33.9% 39.1% 43.8% 47.3% 48.3% Source: A.M. Best

Aon Benfield 7

Risk charges for reinsurance recoverables will reflect the

type of recoverable, the duration of recoverables up to 30

years, and the rating of each reinsurer. The model simulates

10,000 impairment scenarios for each reinsurer and only uses

impairments occurring during the first 10 years. The amounts

will also be measured at present value. As an example,

recoverables on workers’ compensation, long tail, losses will

be subject to a higher risk charge than property, short tail,

losses. A.M. Best commented that the charges are slightly

higher than the current model, depending on the reinsurer

and the duration of the liabilities. However, the combination

of discounting and assuming no impairments beyond 10 years

has reduced the initial charges slightly. A.M. Best noted they

will incorporate a risk charge for concentration of recoverables

from a reinsurer. Credit will continue to be provided for

collateral on reinsurance recoverables.

Property casualty premium and reserve risk factors will begin

with 84 industry probability curves (21 Schedule P lines and

four size categories for each—very small, small, medium,

and large). The size categories are based on a company’s

net premium written or net reserves in each line of business.

The curves will be made company specific based on their

profitability for premium, or volatility for reserves. Ten thousand

underwriting profit and loss scenarios will be simulated for each

line of business. Diversification for premium and reserve risk

will be based upon correlation matrices. A.M. Best noted that

the auto risk factors are lower than the current BCAR, which

is not surprising due to changes in the auto line of business in

the last 20 years. They also stated that workers compensation,

general liability, and medical professional liability are slightly

higher under the new stochastic model than the current model.

A.M. Best will continue to incorporate a catastrophe stress test.

The goal is to see what a company looks like after a catastrophe

event occurs. A.M. Best intends to incorporate this by using the

same event and return period for each confidence interval and

subtracting the retention (plus any reinstatement costs, net of

tax) from surplus. Therefore, surplus would continue to remain

the same for the catastrophe stress test by confidence interval.

This is done in conjunction with the B8 charge described above.

A.M. Best reinforced that BCAR will remain only one component

of the overall rating assessment; although as their key metric

for balance sheet strength, it is a very important measure

companies use to set capital management strategies.

In addition, given the overhaul of the BCAR model, scores

from the new BCAR model are not directly comparable

to the current model. For example, if a company’s current

BCAR score is 300 percent and the new BCAR ratio at the

99% confidence interval is 200 percent, it will not be viewed

as a 100 point drop in BCAR as the model results are not

comparable. In fact, it will indicate the company’s capital

adequacy is very strong at the 99% confidence interval (double

the required capital), but the key and new perspective will

be capital adequacy at the higher confidence intervals.

Companies we believe that are most at risk from a change to the

BCAR model are those with lower current BCAR scores relative

to their rating level as there is less room to absorb the impact

of more conservative factors, especially at higher confidence

intervals. In addition, higher rated companies (A- or above)

whose current catastrophe reinsurance program exhausts

near the 100-year return period will likely see a material drop

in capital adequacy at higher confidence intervals, which will

influence A.M. Best’s view of their balance sheet strength.

Cyber security

A.M. Best has increased its focus on the emerging trends

surrounding cyber security and views it as an essential element

of enterprise risk management. Companies are now asked

to complete a new section of the SRQ reflecting what each

company is offering and the amount of protection purchased.

A.M. Best stated that it will seek answers to additional questions

regarding susceptibility to cyber attacks and measures in

place if an incident occurs, see Exhibit 8. Companies that

offer cyber security insurance are also requested to disclose

specifics about their policies, including policy limits, expected

losses, and policy type as separate versus bundled.

Other updates

From September 2014 through August 2015, A.M. Best

released nine criteria updates and currently has three draft

criteria in a request for comment period. Most updates are

minor changes to existing criteria and are not considered

material. While these updates offer minimal impact to the

overall industry, there are three significant updates applicable

to specialty insurers and insurance-linked securities.

8 Evolving Criteria

Exhibit 8: Sample A.M. Best inquiries on company’s cyber risk management

1 Has your company been a target of data breach or cyber attack?

8 During the past five years, how much have you invested in upgrading hardware and software systems?

2 If yes, how many times and how quickly were they identified? 9 How much of such investment was specifically dedicated to preventive measures on cyber attacks and data breaches?

3 What remedial measures were taken? 10 How much are you planning to invest during the next two years?

4 Where does the responsibility to manage cyber security reside? 11 If you use TPA’s, cloud, shared devices, storage or otherwise, how are you managing their risks?

5 What internal and external controls, and policies and procedures do you have in place to manage a data breach or cyber attack?

12 Briefly describe your efforts to ensure up to date “best practices” and latest preventive methods are used.

6 How often do you conduct penetration testing? 13 Do you buy cyber security insurance for your company?

7 How often do the company’s cyber security professionals receive training?

14 If yes, what are the policy limits and what is covered and excluded under such policy?

Source: A.M. Best

In March 2015, A.M. Best released draft criteria titled Rating

Residual Value Insurance. The report introduces factors specific

to the residual value insurance book of business, particularly

the calculations of loss reserve risk and premium risk, which

are dependent upon asset quality. While risks of most insurers

are mainly independent, physical assets underwritten by

insurers tend to be correlated in nature. For example, aviation

and shipping industries are highly correlated because they are

dependent upon global GDP. This results in a positively skewed

loss distribution with significant tail risk. A.M. Best assesses

the loss distribution based on the specific risks being insured.

The criteria also highlights the use of Monte-Carlo simulations

for claims and a modification to the covariance formula to

consider the correlation between investment and reserve risk.

In September 2014, A.M. Best finalized criteria titled Rating

Reinsurance/Insurance Transformer Vehicles that focuses on the

unique characteristics of transformer vehicles. A key aspect

to the rating process is conducting a risk analysis based on

the type of vehicle, as well as the instrument and mechanism

being employed. A.M. Best requires a detailed report

outlining loss sensitivity analysis, projected premium and

loss ratios, and attachment and exhaustion probabilities.

For insurance-linked securities, A.M. Best published Insurance-

Linked Fund Ratings (ILFR) in December 2014. These differ

from issuer ratings since insurance-linked funds have little

to no risk of default.

The ratings reflect A.M. Best’s judgment on an insurance-

linked fund’s vulnerability to losses and credit quality. Funds

may include surplus notes, catastrophe bonds, loss warranties,

and various other securities. The three main determinants of a

fund’s ILFR are the attachment probability, fair value of assets

and liabilities, and term to maturity.

Standard & Poor’sStandard & Poor’s has released seven criteria reports since

September 2014, many of which provide minor changes

and refined discussions. These include updates to the

treatment of operational leverage, capital charges for

residential and commercial mortgage-backed securities,

and special considerations given to title insurance

companies. Standard & Poor’s also addressed its view of

life insurance reserves in the US, more specifically, how

they treat affiliated reinsurers. In general, Standard &

Poor’s analyzes reserves on a consolidated basis unless an

affiliated reinsurer is considered sufficiently isolated.

The most impactful update applies specifically to mortgage

insurance companies and insurers that write a significant

amount of mortgage business. In March 2015, Standard

& Poor’s issued criteria on an updated model to analyze

capital adequacy for mortgage insurers. The capital model is

applied within Standard & Poor’s broader insurance criteria

framework. Specific considerations are now given to the

Insurance Industry and Country Risk Assessment (IICRA),

competitive position, capital and earnings, and liquidity.

Standard & Poor’s assesses capital and earnings based on a

specific mortgage insurance (MI) capital adequacy model.

The model output remains the same as the general model

Aon Benfield 9

where adjusted capital is compared to required capital, and

is determined to be either redundant or deficient at various

target rating levels. The following are key considerations

Standard & Poor’s uses to determine MI capital adequacy.

Standard & Poor’s uses a 10 year profit and

loss statement projection period as the basis

for the mortgage insurance model

Capital charges reflect individual loan characteristics such

as: vintage, loan-to-value, credit score, employment,

product type, loan type, property type, and occupancy

Capital charges also consider the following regional

attributes: market structure characteristics, regulatory

environment, borrower recourse, and funding sources

Moody’sIn October 2014, Moody’s published revised rating

methodologies for global reinsurers, title insurers, trade

credit insurers, and US health insurance companies. In April

2015, they released an update relating to mortgage insurers.

The updates offer more clarity concerning rating action due

to sovereign credit quality and parental/affiliate support.

Specifically, an insurer’s relation to sovereign risk is analyzed

based on geographic diversification, government debt, and

lines of business. Companies that Moody’s views favorably

in these categories could have an insurer financial strength

(IFS) rating of up to two notches above the sovereign. Factors

regarding parental support include level of commitment, brand

name distribution, operating company size compared to the

group, geographic vicinity, type of ownership, and integration

with group level operations. Moody’s generally elevates a

company’s IFS rating one or two notches, with the potential

of three or more notches if there is strong explicit support.

FitchFollowing the release of Prism Factor-Based Model for

Europe, the Middle East, and Africa insurers in September

2014, Fitch launched the model for Asia Pacific companies

in May 2015. The model will be used as the primary tool

to assess an insurer’s capital strength and will enable the

agency to use a single framework to compare companies

in different regions using distinct accounting methods.

While part of Asia Pacific, companies in Indonesia and

Sri Lanka will not be subject to the model until later in

2015 due to specific risk characteristics. There is currently

no time frame for implementation in Latin America.

In July 2015, Fitch finalized changes to notching criteria

due to regulatory changes in Europe and other markets

subject to the Solvency II framework. Areas with little

regulatory changes, such as the US, will not be meaningfully

impacted. Many rating changes are anticipated outside the

US, with most limited to one notch. Fitch projects that the

majority of European holding companies will experience

a one notch upgrade in the issuer default rating.

The new criteria define regulation as group solvency, ring

fencing, or other, with the latter two demonstrating strong

regulation. This results in more geographically defined ratings.

Group solvency—operating level and

group level capital requirements

Ring fencing—operating company only

Other—limited capital and solvency requirements

At the holding company level, a one notch reduction to the

issuer default rating will only take place under group solvency at

non-investment grade levels, while a one or two notch drop will

occur if the regulatory environment is ring fencing. No notching

will take place if the regulatory framework is determined to be

other. For operating companies, Fitch will base the IFS ratings

one notch above the issuer default rating if regulation is strong.

DemotechIn December 2014, Demotech released an update regarding

credit for catastrophe bonds. Demotech noted that catastrophe

bonds have become more prevelant in reinsurance programs

and outlined information they require for their review. If a

Demotech rated company utilizes a catastrophe bond in its

reinsurance program, Demotech requires the following:

A management narrative on factors considered

in issuing a catastrophe bond

A fully executed copy of the Reinsurance Agreement

A fully executed copy of the Reinsurance Trust Agreement

A management narrative on the replacement

of the catastrophe bond should an early season

storm exhaust the catastrophe bond

Structure chart of the reinsurance program

displaying and describing the catastrophe bond

Additionally, Demotech requires that the event trigger be

indemnity based (no basis risk). Investment guidelines must

include restrictions for holding highly liquid, investment grade

only securities as stipulated in the Reinsurance Trust Agreement.

10 Evolving Criteria

Regulatory developments remain an important topic for companies globally. Regulators continue to increase capital requirements by raising minimum capital standards, creating or refining capital models, and expanding their reviews to assess companies’ risk management practices. This section reviews key regulatory developments by region.

North AmericaFirst required filings of Own Risk Solvency Assessment (ORSA) summary reports are due before the end of this year for non-exempt

companies domiciled in states that already have legislation passed. As of the publication release date, 35 states, up from 19 a

year ago, adopted the model act and three states have actions pending. In the August national meeting, the National Association

of Insurance Commissioners (NAIC) placed ORSA on the agenda for it to be voted for adoption into the NAIC’s Accreditation

Standards—Part A. (Accreditation is a certification process utilized by the NAIC to enforce uniform regulatory standards for its

member states.) Adoption of ORSA as one of the required model laws in the NAIC’s accreditation standards will ultimately result in

most, if not all, states passing ORSA legislations. The NAIC’s next task will focus on finalizing review and evaluation procedures for

regulators that are receiving the reports.

Regulatory Developments

Exhibit 9: Current ORSA enactment status

Source: NAIC and AMERICAN FRATERNAL ALLIANCE

ORSA Enacted StatesStates with Actions Pending

CA

NVUT

GAALMI

AR

LA

AK

WY

MTWA

OR

ND

NE

KS

OK

TX

MO

MN

IA

WI

IL IN

KY

OHPA

NY

TN

VA

ME

NH

CTRI

DE

VT

NJ

MA

Aon Benfield 11

Based on our experience assisting clients with preparing their

ORSA reports, common obstacles companies face include:

Reorganizing sections of a well-established enterprise

risk management program, (which mostly are Sarbanes-

Oxley 404 compliance and financial reporting

controls orientated) into a more risk-focused and

process-driven risk management documentation

Linking and consolidating the relatively fragmented risk

assessment, controls, and reporting processes already in

place into a more coherent risk management system

Regardless of the obstacles noted above, we believe that

this process is a good exercise for companies to realign

and reassess their strategic goals and operational risk

management processes. The process of completing ORSA

appears to be fulfilling NAIC’s initial intention, which was

to gain insights in insurers’ own assessment of current

and future risks and insurers’ own judgment about risk

management and the adequacy of their capital position.

Some examples of best practices we have seen in ORSA

reports include:

Executive summary highlights key risk management

functions, strategies, and explains why they work best for

the organization

Concisely articulate the group’s strategic vision, business

plan, and strategic priorities that tie to overall risk

management goals

Provide a thorough overview of the organization’s

risk governance structure with specific functions and

responsibilities of each risk management level

Include descriptions of ongoing risk monitoring, reporting

and assessment process, and describe process and frequency

of risk identification

Provide detailed risk assessment and controls for key risks

In July, the NAIC made available the results from its latest

ORSA pilot project to help the industry prepare their

ORSA reports. Feedback on areas for improvement in the

reports included:

Provide additional explanation of risk management strategy in

the context of the key business strategy objectives

Highlight the maturity of the enterprise risk management

processes and status of development

Maintain consistency between the key risks identified

in all sections

Provide additional support for the methodologies and

assumptions on assessing risk, stress testing, and quantifying

risk capital

Offer additional evidence regarding how the management

team utilizes the information in the ORSA Summary Report

to pursue its business strategy objectives

Corporate Governance Annual Disclosure Model Act

The NAIC is also actively pushing into state regulations another

corporate governance related model regulation—the Corporate

Governance Annual Disclosure (CGAD) Model Act. The main

purpose of this act is to provide a means for insurance regulators

to receive additional information on the corporate governance

practices of US insurers on an annual basis. The model act

was adopted on August 18, 2014 and set to commence in

2016 in states that adopted this act. Currently there are

three states—Indiana, Iowa, and Vermont—that have passed

legislation adopting CGAD. Three additional states—California,

Lousiana, and Rhode Island—have pending state legislation and

the remaining states with no action. However, the NAIC has

adopted this act into the accreditation standards beginning in

2020 that will require all states to pass this act in order to be

certified by the NAIC. The CGAD contains four main sections:

Organization’s corporate governance framework

Board of directors and committee policies and practices

Management policies and practices

Management and oversight of critical risk areas

CGAD is applicable to all insurers without exemptions.

Companies may choose to provide information at the ultimate

controlling parent level, an intermediate holding company

level and/or the individual legal entity level—depending on

the level where decisions are made and oversight provided.

To avoid filing redundant information, insurers may provide or

reference to other existing documents (e.g., ORSA Summary

Report, Holding Company Form B or F Filings, etc.).

12 Evolving Criteria

US risk-based capital catastrophe risk charge

Discussions of key components for calculating the risk-based

capital catastrophe risk charge have been ongoing but are

nearing finalization. The NAIC still does not have a definitive

timeline for including the catastrophe charge into the actual

risk-based capital calculation, therefore it will again be filed on

an informational basis for the 2015 reporting year. Currently, the

2016 reporting year is the tentative target for implementation

of the inclusion of the catastrophe charge. The following key

decisions made in the past year may have significant impact on

a company’s risk-based capital results when the catastrophe

charge is implemented as part of the requirements.

Contingent credit risk charge was reduced

to 4.8 percent from 10 percent

Allows companies to report both occurrence exceedance

probability and aggregate exceedance probability modeled

results as opposed to aggregate exceedance probability only

Exemption criteria: If a company uses an intercompany

pooling arrangement or quota share arrangement

with affiliates covering 100 percent of its earthquake

and hurricane risks or any of the following:

— Zero percent net exposure for earthquake and

hurricane risks

— Ratio of insured value, or property to surplus,

is less than 50 percent

— Insured value—property that includes earthquake or

hurricane coverage in catastrophe prone areas is less

than 10 percent of surplus

During the NAIC national meeting in August, the catastrophe

risk subgroup placed another key discussion topic on

its agenda. The subgroup will discuss other catastrophe

risks for possible inclusion in the property casualty risk-

based capital formula including: fire following earthquake,

tsunamis, extreme convective storm including tornadoes,

winter storm, flood, wildfire, terrorism, cyber risk, and

liability catastrophes—mass torts such as asbestos and

environmental. Expanding the catastrophe risk charge in this

manner impacts both property and casualty companies.

NAIC group capital standard

In July 215, the NAIC released an updated draft on approaches for

a group capital standard for US domiciled insurers that operate

internationally. There are three approaches discussed in the draft.

Risk-based capital aggregation approach: globally

aggregates existing capital requirements for each entity and

sets a standard for any entities without a current framework

Statutory accounting principles consolidated filing for risk-based capital approach: creates a need for global

consolidated financial statements on a statutory accounting

basis for use in the risk-based capital calculation

GAAP consolidated filing for risk-based capital approach: creates a group risk-based capital formula based on GAAP

financial statements

These approaches will continue to be discussed

at the NAIC summer meeting.

Terrorism Risk Insurance Program Reauthorization Act extended after brief lapse

The Terrorism Risk Insurance Program Reauthorization Act

of 2007 (TRIPRA) lapsed on December 31, 2014 for the first

time in its 12 year history. There were no major disturbances

in the market as S. 2244, the TRIPRA of 2015, was passed

by the US House of Representatives and the US Senate on

January 7 and 8 of 2015, respectively. The bill was then

signed into law by President Obama on January 12, 2015

with a retroactive effective date of January 1, 2015.

The six year extension features the following changes:

Increase in insurer co-participation 1 percent per year

from 15 percent to 20 percent, phased in starting 2016

Increase in program trigger USD 20 million per year from

USD 100 million to USD 200 million, phased in starting 2016

Revision to government recoupment mechanism

USD 2 billion per year from USD 27.5 billion to

USD 37.5 billion, phased in starting 2015

The changes to the program raise questions on the future of

TRIPRA and the US government’s view of the private market’s

ability to absorb terrorism exposure. Rating agencies will

continue to analyze terrorism exposure without the benefit

of TRIPRA as the 2015 bill remains temporary in nature.

Aon Benfield 13

Canada

The Canadian regulator, Office of Superintendent of Financial

Institutions (OSFI), continues their journey to enhance its

risk-based approach to supervisory oversight. In 2014, OSFI

revised its capital solvency model, minimum capital test and

branch asset adequacy test to be effective January 1, 2015.

The enhanced model incorporated changes updating the risk

factors as well as becoming more in line with the Solvency II

concept. At the same time, ORSA was introduced for all federally

regulated companies to complement the revised capital model.

Key guideline and procedure updates since September 2014.

Regulatory compliance management: updates

enterprise-wide framework appropriate for identifying

risks and the duties of the Chief Compliance Officer

Related party transaction instructions: enhances the

administrative efficiencies for related-party transactions

and improves the movement from approval on a

transaction by transaction basis to an entity level basis

Residential mortgage underwriting practices and procedures and residential mortgage insurance practices and procedures: provides

guidance on the enhancements of the underwriting

and risk management of mortgage insurance

Currently, OSFI is in the process of developing an

operational risks guideline and revising the guideline

for the role of the Chief Agent. In 2015, OSFI is focusing

their resources on certain administrative items that are

arising from the recently implemented guidelines and

new minimum capital test framework, including:

Re-approval of all of the related-party transactions

Updating and correcting the validation

rules on regulatory returns

A comprehensive review of the ORSA process work plan

Provide guidance on any new directives at the 2015

Risk Management Seminar

Lastly, both the Federal Finance Department and OSFI are

increasingly concerned with the real estate market in Canada

and the mortgage insurance sector. While steps have been taken

for lending institutions to de-risk their mortgage portfolios

and implement more stringent lending criteria for mortgage

insurance, OSFI is also in the process of developing a revised

minimum capital test framework for mortgage insurance.

Europe, the Middle East, and AfricaJanuary 1, 2016 will bring the long awaited Solvency II

regulations for insurers and reinsurers in the European Union

(EU) while Solvency Assessment and Management comes

into effect in South Africa. In the Middle East, as the insurance

industry continues its rapid growth, new regulations continue

to be introduced with existing ones strengthened to improve

market stability, transparency, and policyholder security. While

some regulators are adapting Solvency II regulations to fit their

markets, others are looking to the International Association of

Insurance Supervisors (IAIS) and its insurance core principles.

Europe

As we approach the final few months before Solvency II goes

live, the European Insurance and Occupational Pensions

Authority (EIOPA) and the European Commission have been

busy preparing final versions of guidelines, approving various

Implementing Technical Standards, and making decisions

on equivalency status of several non-EU countries.

Equivalency status is of major importance to the large

internationally active insurance groups that have operations

in the EU. There are three areas in Solvency II where

equivalence status pertains: solvency calculation, group

supervision, and reinsurance.

Under solvency calculation, if a non-EU country (e.g., Brazil)

is deemed equivalent, an EU-based group’s subsidiary in

Brazil can use Brazil’s solvency calculation rules instead of

Solvency II rules. For group supervision, if a non-EU country

(e.g., Australia) is deemed equivalent, then a group based in

Australia with operations in Europe is exempt from some of the

group supervision rules in the Union. Reinsurance equivalence

applies when a reinsurer from a non-EU country enters into a

reinsurance agreement with EU company. If the third-country

is deemed equivalent, the Union has to treat a reinsurer from

that country the same as it would a reinsurer from the EU

and thus no collateral is required to be posted as part of the

transaction. The table below shows who benefits the most

from equivalence approvals under each of the three areas.

Exhibit 10: Solvency II three areas of equivalence

Equivalence Area Beneficiary

Solvency Calculation EU-domiciled companies

Group Supervision Non-EU domiciled groups having EU operations

Reinsurance Non-EU domiciled reinsurers reinsuring EU-domiciled companies

Source: EIOPA and Aon Benfield Analytics

14 Evolving Criteria

On June 5, the European Commission announced these equivalence decisions subject to a six-month review by the European Parliament:

Exhibit 11: Equivalence status by country

Country Solvency Calculation Group Supervision Reinsurance

Switzerland Full Full Full

US Provisional Not equivalent Not equivalent

Australia Provisional Not equivalent Not equivalent

Bermuda Provisional Not equivalent Not equivalent

Brazil Provisional Not equivalent Not equivalent

Canada Provisional Not equivalent Not equivalent

Mexico Provisional Not equivalent Not equivalent

Source: European Commission

Full equivalence is for an indefinite period of time whereas

provisional equivalence lasts for ten years and would need to

be re-evaluated again prior to its expiration. What this means

for groups domiciled in US, Australia, Bermuda, Brazil, Canada,

or Mexico is that if those groups want to operate in the EU,

the entire group is subject to Solvency II group supervision

requirements. Since 2013, the US has been in discussions with

the EU on a free-trade agreement called the Transatlantic

Trade and Investment Partnership. While an agreement is not

expected to be finalized before 2016, various insurance trade

organizations in the US are pushing for full equivalence.

Meanwhile, EU-domiciled companies subject to Solvency II

continue to spend a lot of time, effort, and money to meet

the various requirements, seek approvals, and participate

in various preparatory exercises taking place in order to be

ready by January 1, 2016. Hannover Re recently became

the first company to gain approval for the use of its internal

model to calculate regulatory capital, although operational

risk will still be calculated using standard formula. The

process for developing and testing the model took over six

years. Various other large groups such as Aviva, Lloyd’s, RSA,

Swiss Re, and Munich Re have applied to use their internal

models. Documentations that need to be supplied for

these models as part of the approval process can be in the

thousands of pages and so decisions are not expected until

early December. The use of an internal model could free up

capital compared to the standard model requirements.

United Arab Emirates

Earlier this year, the Insurance Authority issued new

regulations for insurance and takaful companies. The

regulations cover accounting and investment policies,

solvency capital requirements, reserving, and reporting.

The rules should lead to better security for policyholders,

improve risk management at the companies, and bring more

stability to the sector. Some of the new rules have a one

year transition period while others will have three years.

The new regulations call for the use of IFRS to bring the U.A.E.

in line with global accounting standards. Combined with

improved data reporting standards and a data reporting

tool, data quality and consistency should improve, giving the

regulator and the companies a better understanding of the

industry. Companies in U.A.E. generally take a very aggressive

approach with investments as the asset composition tends

to be weighted towards equities and real estate. The new

rules try to address this by limiting the exposure to high-risk

assets classes. However, the limits still allow an insurer to

allocate up to 80 percent of its investment portfolio to real

estate and equity securities. Solvency capital requirements

for these assets classes might mitigate some of this

aggressiveness. There is also a requirement for an independent

board-level investment committee that has to consider

liquidity requirements, counterparty limits, and investment

portfolio stress testing as part of its investment strategy.

Aon Benfield 15

Some of the other new rules include:

Actuaries must be involved in financial reporting,

pricing, reinsurance, and risk management

Transparency of financial results

Setting of reserves using standardized actuarial

practices, an annual actuarial review of gross and net

reserves, and a requirement for adequate reserving

Better reporting and communications

between company management, the board of

directors, and the Insurance Authority

Risk based solvency calculations with a new Solvency

Capital Requirement and a Minimum Guarantee Fund in

addition to the existing Minimum Capital Requirement

A risk management framework that addresses

strategy, policy, procedures, and risk assessment

including emerging risks and a risk appetite statement

to be determined by the board of directors

The changes have been viewed positively by the rating

agencies with A.M. Best noting that “the new rules are well

placed to address these issues [significant exposure to high-

risk assets, inadequate and varied treatment of accounting

principles, unsophisticated measurement of technical reserves

and weak ERM practice].” Moody’s finds the new regulations

to be a credit positive “because they will strengthen several

credit characteristics of insurers, including capital, asset

quality (by reducing risk-taking) and reserve adequacy.”

South Africa

Solvency Assessment and Management, which is based on

Europe’s Solvency II, becomes effective on January 1, 2016.

While the implementation is going as planned, the local

regulator, Financial Services Board (FSB), released a

consultation document in April, comment period closed on

June 1, 2015, where it plans to have lower capital requirements

for risks reinsured via a local reinsurer as opposed to a

foreign reinsurer. FSB would change the international

credit ratings of reinsurers, as shown in exhibit 12.

A Lloyd’s representative office and branches of foreign

reinsurers would be required to hold reserves within

South Africa in a trust. Reinsurance placed with a foreign

reinsurer can only be accounted for if the regulatory

framework of the reinsurer’s domicile is approved by FSB,

similar to equivalency provisions under Solvency II.

FSB’s rationale is to create a level-playing field for reinsurers and

better policyholder protection. FSB considers investment in

South African sovereign bonds as risk-free, unlike international

credit ratings agencies that include the sovereign rating caps in

their methodologies. Also, locally domiciled reinsurers would

offer better protection for policyholders as they are subject

to direct oversight by the FSB, unlike the foreign reinsurers.

Feedback on the issue has not yet been publicly released but

the rating changes will impact capital requirements via the

counterparty credit risk charges, if proposals are implemented.

Ghana and Oman

In Ghana, the regulator has raised the minimum paid up

capital to GHC 15 million, from GHC 5 million, and all insurers

and reinsurers will need to comply by end of 2015. The

move is seen as a way to stabilize the sector and strengthen

insurers’ ability to write larger risks. The regulator is also in

the midst of updating the existing Insurance Act from 2006.

The changes are expected to address governance and risk

management frameworks, as well as actuarial-based reserving.

The Sultanate of Oman has also increased the minimum

capital requirements for insurers to RO 10 million, from

RO 5 million. Companies will also need to make at least

40 percent of shares listed on the Muscat Stock Market and

separate legal entities must be created for life and non-life

business as composite companies will no longer be allowed.

The mandatory listing of the shares should bring additional

financial flexibility for companies and greater transparency for

the overall market. Companies have three years to comply.

Exhibit 12: Proposed reinsurer credit rating adjustments

Business ceded to Impact on reinsurer’s credit rating

Foreign reinsurer (including Lloyd’s) Downgrade by three notches

Foreign reinsurer with local branch Downgrade by two notches

Local Lloyd’s representative office Downgrade by one notch

Local reinsurers Upgrade by three notches or use parent company’s rating via a parental guarantee

Source: Financial Services Board

16 Evolving Criteria

Asia PacificThe global insurance industry is undergoing significant

regulatory changes, and Asia Pacific is no exception, where

a number of markets are reviewing and undergoing changes

in their approach to insurance regulation and holistic risk

management. Regulations that protect consumer data,

strengthen insurer capital, and address mergers and

acquisitions continue to emerge at local and international

levels in Asia Pacific. The regulatory agenda varies from

financial system liberalization in China to reforms in India.

Pressures to maintain domestic control of insurance and

reinsurance markets continue to exist across the region.

Cambodia

The new Insurance Law was enacted on August 4, 2014, and

became effective on February 4, 2015, superseding the previous

law of July 25, 2000. The law updates and amends a sub-decree

regulating the insurance sector. The sub-decree had 56 articles,

while the new law has 114 and involves the following changes:

a better protection for policyholders, an increased control

for the regulatory body, dispute resolution and insurance

companies’ liquidation and dissolution process, and a clearer

regulation for insurance companies to operate in Cambodia.

China

This year has been remarkable for China’s insurance regulatory

evolution. The China Insurance Regulatory Commission

(CIRC) finalized the China Risk Oriented Solvency System also

known as China’s “Solvency II” (C-ROSS), began building a

national earthquake scheme, liberalized motor pricing, and

strengthened management of reinsurance credit risk.

In February 2015, CIRC issued the final version of C-ROSS

rules and the transition period started right after. During the

transition period, insurers report solvency under both the

expiring scheme and C-ROSS, while supervision decisions are

still based on the expiring scheme. The three-pillar C-ROSS

aims to better align solvency capital requirement with the risks

insurers face. At the same time, risk management is emphasized

and the market discipline mechanism is implemented. The first

quarter of 2015 was the first period China insurers reported their

solvency under C-ROSS. According to CIRC’s announcement,

the average solvency ratio was at 264 percent for the whole

industry and 282 percent for property casualty insurers.

CIRC commented that the solvency level for the industry was

adequate, the risk indicators properly reflected the real risks

the industry faced, and C-ROSS guided the insurers to improve

their business model, marketing strategy, and risk management.

In March 2015, CIRC formally issued the Notice on

Implementing Reinsurance Registration System. Beginning

January 1, 2016, all reinsurers, including primary insurers writing

inward business, and reinsurance brokers must register on the

platform built and maintained by CIRC. Cedents must select

reinsurance counterparties from those valid in the registration

system. Treaty reinsurers must have secure rating (“A-” or

above for leaders and “BBB” or above for followers). Certain

exemptions may apply.

In April 2015, China’s Residential Earthquake Pool was

established in Beijing. According to a media report, in

July 2015, a consultation paper called China Residential EQ

Insurance (draft) was circulated among local insurers, with

rules proposed for catastrophe insurance at the national

level. At the provincial or municipal level, on August 20, CIRC

kicked off the pilot residential earthquake scheme in Da’li

prefecture of Yun’nan province. The residential earthquake

insurance pays for direct loss and rebuilding costs of rural

residential property, as well as death, caused by earthquakes

with a magnitude at or above 5.0. Payment for direct loss of

residential property is parametric based, ranging from CNY

28 million to CNY 420 million, depending on the earthquake

magnitude. Death payment is capped at CNY 100 thousand

per person, with aggregate limit at CNY 80 million per year.

Insurers form earthquake pool and utilize reinsurance. Insurers

need to accumulate cat reserve, as a percentage of premium

income and excessive underwriting profit.

In June 2015, an experiment of motor de-tariff began in six

provinces or cities. Each insurer in these experiment zones

needs to have its pricing formula reviewed and approved

by CIRC. The insurers can adjust the price within a range to

reflect their unique underwriting and distribution profile.

Hong Kong

In September 2014, the Insurance Authority of Hong Kong

published its first consultation paper on the development of a

new risk-based capital framework. The proposed framework

adopts a 3-pillar structure. Pillar 1 consists of the quantitative

requirements, including assessment of capital adequacy

and valuation. Pillar 2 sets out the qualitative requirements,

including corporate governance, enterprise risk management

Aon Benfield 17

and ORSA. Pillar 3 focuses on disclosures and enhancing

transparency of relevant information of insurers to the public.

More specific proposals and detailed specifications for

Quantitative Impact Study are expected to be covered in later

consultation. According to the accompanying FAQ issued by

Insurance Authority, the risk-based capital regime would be

developed in four phases:

Phase I—Development of the framework and key approaches

Phase II—Development of detailed rules and conducting

of a Quantitative Impact Study that should begin in 2015

or 2016, to be followed by another consultation exercise

Phase III—Amendment of legislation; at least two to three

years will be needed to complete all the preparatory tasks

including public consultations

Phase IV—Implementation phase

India

In March 2015, the Indian Parliament passed the Insurance

Laws (Amendment) Bill raising the ceiling for foreign

investment in the insurance sector. The enactment of the bill

will raise the foreign investment cap in the pension sector

as it was linked to the ceiling in the insurance sector.

Increasing the foreign investment in insurance enhances

the industry prospects that struggle due to lack of capital.

It will increase infrastructure funding as only an insurance

entity can fund long-term public projects. The passing of the

bill will give more powers to the insurance regulator—the

Insurance Regulatory and Development Authority of India.

Key points of the bill:

The foreign direct investment cap in an Indian insurance

company will be increased from 26 percent to

49 percent but ownership and control of the insurance

company will remain with Indian residents.

The bill amends the definition of foreign company to include

a company or body established under a law of any country

outside India, and includes Lloyd’s of London, established

under the Lloyd’s Act, 1871, or any of its members.

Foreign reinsurers will be permitted to conduct reinsurance

business through setting up branch offices in India.

Insurance companies will be permitted to raise new

capital through instruments other than equity shares.

Insurance agents will be included in the definition of

insurance intermediaries and will be regulated, as will

key aspects of insurance company operations in areas like

solvency, investments, expenses, and commissions.

Indonesia

The Indonesian insurance industry is reshaping by changing

regulations and enforcing stricter capital requirements that

are aimed to introduce greater transparency and stability.

In this transformed regulatory landscape, there are more

new entrants to the market and greater opportunities for

mergers, acquisitions, and joint partnerships. Regulations

were introduced in 2008 that require insurance companies to

incrementally increase their minimum capital levels to IDR 100

billion by December 2014 and reinsurers are required to have

a minimum capitalization of IDR 200 billion by the same date.

The New Insurance Law, passed by Indonesia’s parliament

on September 23, 2014, effective a month later, sets out

a comprehensive regulatory framework for Indonesia’s

insurance sector. In broad terms, the new law updates the

1992 law in various significant areas and provides a stronger

consolidated legal foundation to the insurance sector,

covering all insurance business companies, whether they

are insurers, reinsurers, brokers, agents, or loss adjusters.

The summary below outlines the key changes introduced

by the New Insurance Law for insurance companies:

An existing joint venture insurance company whose

Indonesian shareholder is indirectly owned by foreign

parties must ensure that such Indonesian shareholder

transfers its shares to an Indonesian individual within a

period of five years from the promulgation of the New

Insurance Law. Alternatively, the joint venture company must

conduct an initial public offering within the same period.

The law is silent on foreign ownership limits, presumably

indicating that the existing 80 percent limit is still valid,

although this could be revised in future regulations.

Consideration must be given to the controlling party

concept and an assessment must be made as to whether

existing shareholders or parties may be classified as such

as a result of certain contractual or other arrangements.

18 Evolving Criteria

The New Insurance Law imposes single controlling

investment rule.

Sharia business units that form part of conventional

insurance companies must be segregated.

Additional parties or persons, the controlling party and

the internal auditor, are subject to the fit and proper test.

The Indonesian government is moving forward on an

earlier announced plan to merge state-owned reinsurers

PT Reasuransi Internasional Indonesia (Reindo) with PT Asei

Reasuransi Indonesia, to create Indonesia Re. PT Nasional

Reasuransi Indonesia also will be merged at a later date. This

will boost domestic reinsurance capacity, with plans to inject

an initial IDR 1.5 trillion in capital for the new company.

Japan

In June 2014, the Japan Financial Service Agency (JFSA)

announced the implementation of its second field tests with

the aim of introducing an economic value-based solvency

regime, and requested all insurance companies to implement

them, following the results of the first field tests which were

disclosed in 2011. The purpose of the tests is to grasp the

status of preparations of insurance companies as well as to

identify practical issues and problems that may arise in the

process by requesting all insurance companies calculate the

value of their insurance liabilities based on economic value.

JFSA disclosed the results in June 2015 noting that although

the field tests were more extensive and included more

calculation methods than the previous tests, all companies

involved provided the results of the requested calculations.

In addition, it was recognized that insurance companies’

interests in the economic value-based solvency regime and risk

management remain strong, and that they are making progress

in developing systems for such calculation. On the other hand,

the questionnaire results from individual companies suggested

that sufficient preparation time would be necessary before

the actual introduction of the regime, and that there are many

issues which need to be solved regarding system building

and burdens on practical operations. Furthermore, some

companies requested that a scheme be developed reflecting

the differences in the risk management systems and other

factors of each company, such as the use of internal models.

JFSA summarized the direction of future examinations noting

that a variety of issues and challenges were recognized in the

field tests, as in the previous tests. Based on the results, JFSA

needs to conduct further examination toward establishing

a specific framework. There are ongoing movements in the

economic value-based solvency regime and accounting

system, such as the IAIS’s Insurance Capital Standard field tests,

Solvency II in Europe and examination of IFRS 4 “Insurance

Contracts.” Under such circumstances, it is important to

establish a regulatory framework suitable to Japan, paying

attention to the nature of the Japanese insurance market.

Introducing the economic value-based solvency regime

requires some revisions to the business management and

risk management methods used by insurance companies.

Therefore, the JFSA will make steady efforts to establish

a new framework through dialogue with relevant parties

in various situations to ensure a smooth introduction.

Malaysia

Malaysia’s non-life sector is gearing up for the expected

removal of tariffs for motor and fire insurance by 2016. The

details of the de-tariff of the motor and fire insurance premiums

are still being finalized and would incorporate premium

bands to prevent the risk of under-pricing of premiums.

Industry players expect the de-tariff to be implemented

by the middle of next year. It is believed that the de-tariff

will be a partial and gradual one and there could be slight

margin erosion, although the risk of severe erosion in the

industry due to irrational competition has been eliminated.

Pakistan

In a circular dated March 13, 2015, The Securities and

Exchange Commission of Pakistan announced a planned

increase in the minimum paid-up capital requirements

for life insurance and non-life insurance companies. The

increases, which will take place incrementally in semiannual

intervals until December 2017, are aimed at strengthening

the insurance sector. For non-life insurers, the minimum

paid-up capital has to be PKR 300 million by December 31,

2015, increasing by PKR 50 million at semiannual intervals

until it reaches PKR 500 million by December 31, 2017.

Aon Benfield 19

Philippines

The Insurance Commission, the insurance regulator in

Philippines, has made amendments to the country’s Insurance

Code to provide for increased capital requirements for existing

insurers. The minimum paid-up capital for insurers will increase

to PHP 550 million by December 31, 2016; PHP 900 million by

December 31, 2019 and PHP 1.3 billion by December 31, 2022.

New insurance companies and branches of foreign companies

are required to have an initial minimum capital of PHP 1.0

billion to be allowed registration. Reinsurance companies,

on the other hand, must have a capitalization of at least PHP

3 billion paid in cash of which at least 50 percent is paid-up

and the remaining portion thereof is contributed surplus,

which in no case shall be less than PHP 400 million or such

capitalization as may be determined by the Secretary of Finance,

upon the recommendation of the Insurance Commission.

The increase in capitalization will boost the insurance industry

to better compete globally. It will also provide more cushion

against risks for the protection of the insured. This may

lead to the merger and consolidation of small players in the

industry to meet the minimum capitalization requirements.

Pursuant to Section 194 of the Amended lnsurance Code,

the Insurance Commission is conducting a review of the

current risk-based capital framework. Hence, all life and

non-life insurance and professional reinsurance companies

are required to participate in parallel runs for the risk-

based capital 2-Quantitative Impact Study starting with

financials as of December 31, 2014. This will allow the

Insurance Commission an opportunity to engage the

industry in a meaningful dialogue and obtain feedback

prior to the full implementation date on June 30, 2016.

Singapore

The risk-based capital framework for insurers was first

introduced in Singapore in 2004. While the risk-based capital

framework has served the Singapore insurance industry well,

the Monetary Authority of Singapore (MAS) has embarked

on a review of the framework (risk-based capital 2 review)

in light of evolving market practices and global regulatory

developments. The first industry consultation was conducted

in June 2012 in which the MAS proposed a number of changes

and an risk-based capital 2 roadmap for implementation. In

March 2014, MAS issued a consultation paper on the risk-

based capital framework, updating the earlier version from

June 2012. This second paper included the detailed technical

specifications required for insurers to conduct Quantitative

Impact Study. This will gather information and help evaluate the

full impact of the risk-based capital 2 proposals. MAS is finalizing

the risk calibration and features of the risk-based capital 2

framework, with implementation expected January 1, 2017.

Tier 1 insurers in Singapore were required to submit an

ORSA report to the MAS by December 31, 2014, while

non-tier-1 insurers have until December 31, 2015.

Sri Lanka

The minimum regulatory capital of insurance companies

has been increased to LKR 500 million from LKR 100 million

per class of insurance business. However, a newly formed

insurance company that complies with the segregation

process can maintain a capital of LKR 100 million at the time

of its segregation as an insurer. It must thereafter increase

the capital to LKR 500 million on or before February 2015.

The Insurance Board of Sri Lanka issued the final risk-based

capital framework for insurers in October 2013, following

a period of consultation and testing. This framework will

become effective in 2016 and replace the current solvency

margin requirements. Since the first quarter of 2014, all insurers

have been required to submit two sets of financial returns, in

accordance with the current and new risk-based capital regimes.

Composite insurers are required to split their business into

separate non-life and life companies by February 2015.

Some insurers have created new holding companies with

separate non-life and life subsidiaries, while others have

created new subsidiaries of their existing organizations.

The split of composites will, however, increase overall

costs and put pressure on smaller insurance companies.

All insurance companies must be listed on the Colombo

Stock Exchange by February 2016. This presents a big

challenge for small entities and foreign players that desire

exemption from mandatory listing, since it provides

greater transparency and promotes better governance,

thereby improving policyholder protection.

As a consequence, it is believed that some insurers will struggle

to maintain viability once the split of composite companies and

the new risk-based capital formula take effect, leading to merger

of smaller insurers to form larger and more stable companies.

20 Evolving Criteria

CaribbeanMost Regulators in the Caribbean have been moving towards

Solvency II Framework based regimes or alternatives such as:

Canadian minimum capital test or an equivalent risk based

model. The pace of the regulatory reforms is slower due to

political and economic influences.

At the same time, improving the level of capitalization coupled

with more stable earnings and the lack of hurricane activities

in the Caribbean has resulted in the upgrade of a number

of companies by A.M. Best. The most notable changes were

from “A-” to “A” ratings, as “A” companies are less common

in this market. However, economic conditions continue to be

challenging in this area and market conditions remain extremely

competitive. Companies continue to face difficulties with

growth and diversification. Even with the improving levels of

capitalization there continues to be reliance on proportional

reinsurance to provide capital support and risk mitigation.

This strategy is likely to continue going forward. Also, there

is continued expectation of merger and acquisition activities

should opportunities arise.

Latin America

Brazil

A key regulatory change was the introduction of Regulation

CNSP 322 with the intent to reduce the percentage of the

mandatory offer of reinsurance to the local market over a

five year period. To encourage greater capital efficiencies,

there will be an increase in the percentage allowed for inter-

company transactions using a phase-in approach.

In January of 2014, the Brazilian Regulator applied to the EIOPA

(European Insurance and Occupation Pension Authority) for

Solvency II equivalency. This was granted in June of 2015

for a 10-year period. This allows Brazil to maintain its own

solvency capital model with a similar Solvency II scale.

Chile

Regulators in the Chile insurance market intend to move

toward risk-based capital requirements and Solvency II with the

purpose of recognizing companies with strong risk management

and adjusting their capital requirements accordingly. Currently,

the Chilean Securities and Insurance Supervisory Authority’s

regulations require insurance companies to establish reserves

based on their aggregate exposure in their largest CRESTA

zone. This is calculated by applying a factor of 10 percent for

personal lines and of 15 percent for commercial lines, less

reinsurance plus a 10 percent safety margin. Regulators are

considering moving to a modeled PML based approach.

Colombia

Insurance regulation is laying the foundation for more

risk based solvency framework. It is possible that they will

consider following Chile’s lead on a modeled PML approach

for catastrophe exposure. Additionally, Colombia may be

moving toward a similar approach as Chile for homeowners

purchasing catastrophe insurance in conjunction with

individuals buying a home. These exposures would be

pooled and then insurance is purchased on the entire pool

with the costs being passed back to the individuals.

Mexico

On April 4, 2015, the Mexican regulators officially adopted

the new Insurance and Surety Institutions Law (Ley de

Instituciones de Seguros y Fianzas, or LISF). Under the new

law, regulation authority will be shifted from the Ministry

of Finance and Public Credit to the National Insurance and

Surety Commission, replacing the statutory examiner with an

audit committee. The LISF also creates opportunity for a new

surety insurance product, seguro de caución, or Insurance

Bond, to the Mexican market, enhancing it as a leader in surety

business, after the US and Italy. The LISF regulation paved the

way for the Unified Insurance and Surety Regulations (Circular

Unica de Seguros y Fianzas, or CUSF), which was adopted on

April 4, 2015 as well. The main objective of this regulation

is to incorporate the Solvency II framework throughout

the country. Both the LISF and CUSF set forth regulation

similar to Pillar 2 of Solvency II and ORSA requirements

with increased Board responsibilities and implementation

of risk management and internal control committees.

Argentina

The Argentine Superintendence of Insurance adopted

antifraud regulations that will require insurers and reinsurers

to establish anti-fraud governance policies and guidelines.

Such policies and guidelines must be approved by insurance

entities’ board of directors. In 2014, Argentina Federal

Congress passed a new unified civil and commercial

code, which includes provisions to increase protections

to consumers, and will obviously have significant impact

on the insurance activity conducted in the country.

Aon Benfield 21

International Accounting StandardsIt has been anticipated that the International Accounting

Standards Board (IASB) would issue the finalized IFRS 4

“Insurance Contracts” this year with the standard becoming

effective in 2019. Last year, the Board finalized IFRS 9 “Financial

Instruments” and set its effective date at January 1, 2018, raising

concerns from insurers. Both standards impact insurers, so the

IASB has spent a considerable time this year addressing concerns

about temporary accounting mismatches and volatility in profit

or loss due to the differing effective dates of the two standards.

Although the impact would be limited to only a select group of

companies, the IASB is considering various optional solutions.

These include amending the existing IFRS 4 or deferral of

IFRS 9 for insurers until the effective date of the new IFRS 4.

Amending the existing IFRS 4 means the IASB will need

to go through its due process, including the issuance

of an exposure draft, allow for a comment period and

then finalize changes based on the comments. This

will not impact the finalization of the new IFRS 4.

The rating agencies continue to follow the development of

the new standard as it will significantly change the way the

insurers will report their financials. Income statements will

be vastly different with short and long duration contracts

being split and shown differently. A.M. Best expects the new

IFRS 4 to impact the data they use to analyze the companies

in the non-US insurance sector. Standard & Poor’s sees a

reduction in net income volatility. Fitch thinks comparability

may be hampered due to different methodologies companies

are allowed to use, like in the discount rate a company can

pick, and so expect disclosures to be critical. All three of

the rating agencies do not expect any rating actions as a

result of the new standard but do expect discussions in

their rating meetings and some impact on their analysis.

Development of global Insurance Capital StandardWhile the banking industry is seen as the predominant source

of the 2008 financial crisis, there is a growing concern that there

are risks in the insurance industry that could lead to a crisis of

similar proportions. As in banking, there are key institutions

(referred by IAIS as Global Systemically Important Insurers or

G-SIIs) that play a significant role in the global economy.

To reduce the risk of their failure and thus trigger another

crisis, the IAIS took on the task of developing a global

capital and supervisory framework known as the Common

Framework, ComFrame, for the supervision of Internationally

Active Insurance Groups. They are defined as groups with:

Premiums written in less than three jurisdictions,

and percentage of gross premiums written outside

the home jurisdiction is at least 10 percent of the

group’s total gross written premium; and

Total assets of at least USD 50 billion, or gross

written premiums of not less than USD 10 billion

(based on a rolling three-year average)

The quantitative portion of the ComFrame is the risk-

based global Insurance Capital Standard (ICS). With

hopes of implementing ICS by 2019, the IAIS released a

consultation paper in December 2014 seeking feedback

on the use of valuation method of balance sheet

items, methodology of determining the ICS capital

requirement, and qualifying resources of capital.

The feedback was overwhelming—1,321 pages—and has

forced the IAIS to reconsider their aggressive timeline

for the ICS. As a result, the IAIS announced in June that

it would push back the first and second version of the

rules by about a year to 2017 and 2019, respectively.

The IAIS is also working on developing standards for an

additional buffer of capital called Higher Loss Absorbency

which will impact only the G-SIIs, currently nine insurance

groups. A consultation paper issued by the IAIS suggests

that capital requirements could be 20 percent higher for

a G-SII. Fitch commented that the average 20 percent

increase in minimum capital proposed by the IAIS is unlikely

to result in any G-SIIs needing to raise additional capital.

Accounting Developments

22 Evolving Criteria

M&A activity in the industry remains in the spotlight as there has been several deals involving large market players that are changing the industry landscape. As companies have record capital levels and are looking for ways to grow, acquisitions are offering opportunities for companies to achieve geographic expansion, product diversification, cost efficiencies from scale, and profitable growth.

Below is a summary of recent large acquisitions and the primary

rationale for the acquiring entity. Several of the deals are

focused on expansion of the acquirer’s Lloyd’s platform that

provides access to the global market with a relatively efficient

capital structure. Both the Fosun and Ironshore, and EXOR and

Partner Re deals stem from multi-industry companies looking

to enter or grow their insurance platforms in the hopes of

modeling the Berkshire Hathaway structure.

The reinsurance market has gone through a period of

unprecedented change over the past three years. The

pressure on rates, terms, and conditions due to alternative

market capital and low catastrophe losses in recent years

has squeezed margins. These challenges do not appear to

be short-term but rather will be issues for the foreseeable

future. There are very few “pure” reinsurance companies

left as most are now part of larger insurance and reinsurance

organizations. Monoline writers, or companies focused only

on reinsurance or property catastrophe insurers only, are

likely a thing of the past and face the most pressure. Some of

the third party capital may elect to enter the market through

the acquisition of insurance and reinsurance groups.

Exhibit 13: Notable M&A in the industry

Acquirer Target Company Primary Rationale

ACE Group Fireman’s Fund

Chubb

Acquiring Fireman’s Fund’s personal lines insurance

Global scale and distribution / market clout

EXOR Partner Re Diversify holdings / enter insurance sector

Endurance Montpelier Access to Lloyd’s and third party capital management

Fairfax Brit

American Safety

Various QBE European operations

Secure a top five position in the Lloyd’s market

Growth in environmental casualty, E&S, and property lines

Expansion in Czech Republic, Hungary, and Slovakia

Fosun Ironshore Growing insurance platform outside the Asian region

Hamilton Re Sportscover U/W Ltd (manages Syndicate 3334)

Valiant

Entry into the Lloyd’s market

Entry into US specialty insurance on admitted and E&S basis

Enstar Torus Expansion into active underwriting (prior focus was run-off)

Renaissance Re Platinum Underwriters Accelerate US casualty platform

Sompo Canopius Geographic expansion in specialty lines via this Top 10 Lloyd’s insurer

Tokio Marine Houston Casualty Further penetration into the US property casualty market

Validus Western World Entry into US commercial insurance on an E&S basis

XL Catlin Global expansion via Catlin’s significant Lloyd’s presence

Source: Aon Benfield Analytics

Mergers & Acquisitions

Aon Benfield 23

All these changes will likely mean that there is significant

pressure on the smaller reinsurers as:

They will not have the economies of scale of larger

organizations

They may have a more limited product offering and

less expertise in local markets and emerging risks

They may not be able to make the same investments

in technology

Potential increased regulations may raise operating

costs and contribute to their inability to compete

More limited ability to adapt to changing market conditions

Some of these smaller reinsurers may become acquisition targets.

Primary companies are also well capitalized and are retaining

more risk now than in recent years. As interest rates remain

low and provide cheap financing for deals, companies are

looking for targets that will offer growth, entrance into new

markets, cost savings and diversified product lines, and

distribution channels. The illustration highlights key reasons that

companies are interested in merger and acquisition activity.

The implications of the insurance entity’s and the group’s

ratings are an important factor as well. When an acquisition

is announced, the target is generally placed ‘under review’

with positive, negative, or developing (neutral) implications

based on the rating agency’s view of the likely outcome at

the conclusion of the deal. It is critical to understand the

lift or drag implications of each rating agencies’ notching

criteria relative to the holding company’s ratings and the

impact to the insurance entity’s business profile. Rating

agencies recognize the possible benefits of cost savings and

enhanced competitive position but also note the challenges

surrounding execution risk, legacy reserve exposures, impact

to capital position and financial flexibility, and enterprise risk

management. From an ERM standpoint, acquirer’s should

be prepared to discuss how the new parent is prepared for

taking on the risks of the target, commitment level to support

insurance entity, and how their interests are aligned.

As we continue to see the industry consolidate, it will mean fewer

choices for buyers, but more solid balance sheets.

Earnings Drivers

M&A Influences

Scale

Diversification

Changing Buying Habits

Underwriting margins are being eroded by increased competition

Investment returns continue to decline

Benign catastrophe activity is unlikely to continue

Reserve redundancies may not be sustainable

More efficient operations

Reduces retro purchases (relative basis)

Greater ability to influence pricing, terms and conditions

Increased ability to provide UW expertise—Resources needed to exploit emerging risks

Accelerates growth into Lloyd’s, other lines of business such as insurance, A&H, life, crop as well as other territories

Better ability to manage earnings volatility and the underwriting cycle

Lowers capital requirements

May provide local expertise

Some ceding insurers are favoring a smaller panel of stronger reinsurers

Some ceding insurers are seeking multi-line covers, multi-year deals

Both traditional and alternative platforms are needed for some buyers

24 Evolving Criteria

Operating performanceDespite increased catastrophe losses and reduced benefit from

prior year reserve releases, the US property casualty industry is

expected to post a third consecutive year of underwriting profit.

A.M. Best believes 2015 will be a profitable year for the industry

as well, with a 99.1 percent expected industry combined ratio,

which includes 4.9 points for catastrophe losses. A.M. Best

notes continued concerns over loss reserve adequacy citing

declines in the level of favorable reserve development in

calendar year results: from USD 13.3 billion in 2013 to

USD 9.3 billion in 2014 and an expected USD 5 billion in 2015.

Exhibit 14: A.M. Best’s combined ratio comparison by segment

Combined Ratio (Reported)

Industry SectorOutlook

2013 Actual

2014 Estimated

2015 Projected

Commercial Negative 96.7% 97.7% 99.8%

Personal Stable 97.5% 98.4% 99.4%

Reinsurance* Negative 83.9% 88.0% 93.2%

*US and Bermuda, GAAP Basis Source: A.M. Best

For 2014, the US personal lines segment had the highest

estimated combined ratio, with higher catastrophe losses than

the other segments and a 2.8 percent decrease in net premiums

written. In commercial lines, rating agencies are anticipating the

contribution of prior year reserve releases to decrease as they

expect that the segment will soon reach a point where further

releases cannot be actuarially justified. A.M. Best is projecting

only 0.2 percent benefit to the 2015 combined ratio for reserve

releases, versus 2.2 percent and 4.2 percent in the prior two

years. The reinsurance segment continues to be very profitable

with an estimated 88 percent combined ratio for 2014 and 93.2

percent projected for 2015 (93.2 percent is the five-year average

for the US and Bermuda reinsurance segment). Despite rate

pressures, a lack of significant catastrophe activity and favorable

reserve releases have aided in the continued underwriting

profitability. Favorable reserve development has decreased this

combined ratio on average 6.1 points over the past five years.

Capital adequacy continues to growCapitalization continues to be very strong. As a benchmark,

we estimate the US Industry aggregate capital position as

redundant at the ‘AA’ level per Standard & Poor’s Capital

model and supportive of ‘A++’ capital per A.M. Best’s BCAR

model. From 2013, capital adequacy improved USD 11 billion

as measured by Standard & Poor’s Capital and USD 23 billion

per BCAR.

Exhibit 15 provides a distribution of Standard & Poor’s Capital

levels for 50 rated companies in the US and Bermuda. Thirty-

six percent of companies’ capital adequacy is considered

‘Extremely Strong’, indicating redundant capital at the

‘AAA’ level. Another 42 percent have ‘Very Strong’ capital

adequacy, representing redundant capital at the ‘AA’ level.

In addition, A.M. Best’s published BCAR scores continue to

increase for most rating levels (ironically, the highest two levels

of A+ and A++ show slight decreases from 2013 to 2014 but also

have the fewest data points per category). Median BCAR results

by rating category are roughly double published minimum

standards. In addition, results at the 25th percentile are on

average 76 points higher than the respective minimums, which

is equivalent to four rating levels (each rating level = 15 BCAR

points). The following charts show these medians can vary

significantly when broken down by surplus size and segment.

Exhibit 15: Distribution of Standard & Poor’s capital adequacy

Source: Standard & Poor’s

Extremely Strong36%

Very Strong42%

Strong11%

Moderately Strong7%

Upper Adequate2% Lower Adequate

2%

Financial Trends

Aon Benfield 25

Exhibit 16: BCAR medians

FSRPublished Minimum

25th Percentile Median

75th Percentile

A++ 175 251 283 374

A+ 160 207 312 399

A 145 254 315 446

A- 130 225 300 465

B++ 115 188 229 293

B+ 100 158 199 284

Sources: A.M. Best, Aon Benfield Analytics. Data as of June 15, 2015

Exploring the ‘A’ rating level deeper, shown above with a 315

percent median BCAR, the chart below shows that the median

of ‘A’ rated companies below USD 100 million of surplus is 76

points higher at 391 percent. Companies at this rating level

with greater than USD 1 billion of surplus have a median BCAR

of 272 percent, or 43 points less than the overall group. Larger

companies tend to have superior business profile attributes like

geographic or product line diversification, scale of operations

and financial flexibility/access to capital and are therefore rated

as highly as a smaller company with a higher capital score.

Exhibit 17: ‘A’ rated entities: BCAR median by size

Size Median Diff. From Total Count

< USD100 M 391 76 69

UDS100 M - USD500 M 310 -5 97

USD500 M - USD1 B 304 -11 32

>USD1 B 272 -43 30

All 315 228

Sources: A.M. Best, Aon Benfield Analytics. Data as of June 15, 2015

Additionally, we look at the ‘A’ rated composite broken down

into segment. The personal property composite is well over

the median BCAR likely due to additional capital requirements

in the A.M. Best stress test that are not captured in the

published score. Medical professional insurers have had several

years of excellent operating performance reflected in their

scores. However, the medical liability composite has also seen

shrinking premium volume due to consolidation in the health

care industry. While not good for the segment, mechanically

in the BCAR model the scores increase as companies write less

premium. The workers’ compensation segment is the only

group materially lower than the overall median due to reserve

adequacy and the recent poor operating results.

Exhibit 18: ‘A’ rated entities: BCAR median by industry composite

268

307

310

314

315

342

455Personal Property (26)

Medical Prof Liability (23)

Commercial Property (17)

Priv Pass Auto & HO (41)

Private Pass Auto (9)

Commercial Casualty (51)

Workers' Compensation (19)

Median BCAR = 315

Source: A.M. Best, Aon Benfield Analytics

Public company benchmarksThe median scores of ‘A’ rated publically traded P&C companies

in the US is 223 percent, 92 percentage points lower than the

median of all ‘A’ rated US property casualty companies. We

believe this is mainly driven by the publicly traded population’s

typical characteristics: larger size, strongly developed enterprise

risk management capabilities, and proven financial flexibility.

Exhibit 19: BCAR and financial leverage metrics for ‘A’ rating publicly traded companies

Guideline25th

Percentile Median75th

Percentile

BCAR (%) 315* 202 223 274

Debt to Capital (%) <45 14.2 17.5 22.7

Interest Coverage >3x 5.9x 8.9x 14.4x

* Guideline for BCAR refers to 2015 Industry Median Source: Aon Benfield Analytics

The above analysis involves 21 public holding companies.

The holding company normally is assigned a lower issuer

credit rating than the operating company due to the

greater degree of risk taken by senior unsecured creditors

relative to that of the operating company. Financial

strength ratings of the operating company is mapped to

the issuer credit rating of holding company guidelines.

26 Evolving Criteria

Enterprise Risk Management is an area that has evolved significantly for many insurance companies in recent years. Rating agencies and regulatory authorities continue to stress the importance of management identifying and evaluating risks throughout the organization.

Risk tolerance statementsOne of the first steps to establish a robust ERM practice is

identifying a risk tolerance statement that defines an amount that

management is willing to risk over typical business operations.

Although rating agencies prefer these to be quantitative, a risk

tolerance statement can be qualitative in nature. A.M. Best in

particular outlined the importance of a stated risk tolerance

statement by requiring a disclosure on the first page of the

2014 updated Supplemental Rating Questionnaire. This request

was originally included in the 2010 through 2012 SRQ, but was

removed for the 2013 version.

Catastrophe Risk Tolerance StudyMany public companies disclose some type of risk tolerance

specifically around catastrophe exposure. This type of risk

is easily quantifiable due to computer models and vast data

availability. The disclosures are typically presented as a

percentage of equity given a stated return period. Aon Benfield

has been tracking these disclosures since 2007, and aggregates

the results annually in the Catastrophe Risk Tolerance Study. The

most recent version of the study features 102 global insurers

and reinsurers. Eighty-four percent of these companies report

some type of catastrophe risk exposure through 10K, annual

statements, investor presentations, etc. Of the 102 companies,

nearly half or 46 percent state their risk tolerance as a net

PML figure. Exhibit 20 shows reinsurers tend to have higher

catastrophe exposure relative to equity.

Companies are more mindful of how peer companies disclose

their risk tolerances and ensure they fall in line. Comparing peers

against a set metric, such as net PML to equity, can help reduce

the inconsistencies found in public risk tolerance disclosures.

Stress scenariosThrough the ERM process, companies should have the

ability to quantify how adverse events impact results. Rating

agencies and regulators perform stress scenarios when

evaluating companies and may run in-house modeling to

share impacted financials from various stress scenarios.

Companies must identify major risks before determining the

best stress scenarios to use. Exhibit 21 can provide insight

into major risk categories and what metrics, including

stress testing, may be useful to help measure impact.

ORSA has currently been adopted by 35 states, with three

under consideration. As one component of the ERM process,

ORSA provides a framework for companies to quantify stress

scenarios. ORSA requirements highlight how ERM has evolved

from a list of operational and financial controls, to a process of

analyzing stress scenarios and impact to capital adequacy.

A.M. Best removed all ERM information from their SRQ for

the 2013 year, as many ERM conversations are discussed in

companies’ annual ratings meetings.

Enterprise Risk Management Trends

Exhibit 20: Catastrophe risk tolerance diclosure analysis

0%

5%

10%

15%

20%

25%

30%

HighMean

5%

14%17%

18%

8%

16%

26%25%

Insurers Reinsurers

1:100 after tax net PML as a percent of equity 1:250 after tax net PML as a percent of equity

0%

5%

10%

15%

20%

25%

30%

HighMean

Source: Company filings, Aon Benfield Analytics

Aon Benfield 27

Exhibit 21: Risk identification and prioritization

Underwriting Reserve Market Credit Operational

Risk elements

Pricing risk

Parameter risk

Loss process risk

Catastrophe risk

Product design risk

Long-tailed lines

Latent risks (A&E)

Equity

Interest rate (GAAP)

Currency

Reinsurance recoverables

Receivables

Bond defaults

Downgrade migration

Basel II banking definition:“the risk of loss resulting from inadequate or failed internal processes, people, or systems, or from external events

Excludes strategic risk and reputational risk

Metrics Risk adjusted target combined ratios

Catastrophe risk PML target

Exposure capacity guidelines

Scenario stress tests

Conservative reserving

Reserve risk quantification

Reserve process validation

Mix and asset concentration limits

Equity and interest rate risk quantification

Scenario stress tests

Detailed exposure monitoriing

Rating migration impact quantification

Scenario stress tests

Disaster recovery plans

IT robustness testing

Compliance monitoring

Source: Aon Benfield Analytics

For the most recent 2014 SRQ, A.M. Best added back one

related question regarding risk tolerance statements. ERM

continues to be an important aspect of an A.M. Best rating.

During the 2015 Review & Preview conference, A.M. Best

discussed emerging risks that they believe companies’

should be considering through their ERM process:

Mergers and acquisitions—Key issues and related risks

Alternative capital—Use and permanence

Regulation—Ability to respond to

increasing regulatory demands

Meta data—Use of technology in making ERM decisions

Cyber risks—There are various unique exposures

and levels are quickly increasing

Alternative investments—Considering hedge funds or

private equity investments to improve returns still has risk

Standard & Poor’s has released an updated ERM report in

June 2015. The report continues to provide commentary

on how Standard & Poor’s views ERM and trends seen in

the industry. Standard & Poor’s highlights that ERM should

not be a check the box exercise, and that every company is

different. Companies are expected to focus on the following

areas during ERM assessment; risk management culture, risk

models, strategic risk management, risk controls, emerging risk

management. Overall, there has been modest improvement in

the ERM scores of Standard & Poor’s rated companies. As the

graph below highlights, the percentage of Weak ERM scores

have decreased while Strong scores have increased with three

companies upgraded to Strong over the year. Both Very Strong

and Adequate ERMS scores have remained stagnant from 2013.

Standard & Poor attributes the modest uplift in part to newly

adopted ORSA requirements for the large companies that

comprise the majority of Standard & Poor’s portfolio.

Exhibit 22: Standard & Poor’s May 2015 enterprise risk management report

*Note: YTD 2015 as of May 15, 2015 Source: S&P

In June 2014, Standard & Poor’s received a comprehensive

ERM survey they had sent to US and Bermudan companies.

The survey asked both qualitative and quantitative questions

around risk culture, risk controls, risk models, emerging risk,

and strategic risk. In September 2014, Standard & Poor’s

summarized the findings from the surveys and found that many

companies had more work to do in order to prepare for the

2015 ORSA requirements, with higher ERM rated companies

being more prepared than their lower ERM rated counterparts.

201120102009 2012 2013 2014

0%

25%

50%

75%

100%

WeakAdequateStrongVery Strong

28 Evolving Criteria

As companies continue to operate within a very competitive market, there will be a number of key rating agency and regulatory themes when looking forward into 2016:

New stochastic-based BCAR: With an expected release

of draft in October of 2015 and implementation in mid-

2016, both life and non-life companies globally will be

evaluated under a new capital model. We expect it will

be an adjustment for those familiar with BCAR to calibrate

companies’ scores under the new model. As the new

model is released, there will be a flurry of activity as

companies try to understand not only their own BCAR,

but also how it relates to the industry as a whole.

Reinsurance segment pressures: Between the new

alternative capital entrants and low catastrophe activity,

capital in the reinsurance market is at a high and is squeezing

margins. All four rating agencies have negative outlooks on

this sector as they are concerned about pricing trends.

Further emphasis on ERM and capital models: With

continued requests from both regulators and rating

agencies, companies continue to work towards defining risk

tolerance statements, implementing and documenting risk

management practices and using internal capital models.

Mergers and acquisitions: M&A activity in the industry

is expected to continue in the next year as companies

have record capital levels and looking for ways to grow.

Acquisitions are offering opportunities for companies to

achieve geographic expansion, product diversification,

cost efficiencies from scale and profitable growth.

Increasing global regulation. Regulators around

the world continue to evolve their criteria, including

increasing capital requirements, catastrophe exposure

thresholds and evaluations under updated risk-based

capital models. Additionally, regulation is becoming more

global in nature with the rules in some regions impacting

other countries that want to do business there.

Looking Forward: Key Topics for 2015 and 2016

Aon Benfield, a division of Aon plc (NYSE: AON), is the world‘s

leading reinsurance intermediary and full-service capital

advisor. We empower our clients to better understand,

manage and transfer risk through innovative solutions and

personalized access to all forms of global reinsurance capital

across treaty, facultative and capital markets. As a trusted

advocate, we deliver local reach to the world‘s markets, an

unparalleled investment in innovative analytics, including

catastrophe management, actuarial and rating agency

advisory. Through our professionals’ expertise and experience,

we advise clients in making optimal capital choices that will

empower results and improve operational effectiveness for

their business. With more than 80 offices in 50 countries, our

worldwide client base has access to the broadest portfolio of

integrated capital solutions and services. To learn how Aon

Benfield helps empower results, please visit aonbenfield.com.

About Aon Benfield

© Aon Benfield Inc. 2015.All rights reserved. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. This analysis is based upon information from sources we consider to be reliable, however Aon Benfield Inc. does not warrant the accuracy of the data or calculations herein. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Benfield Inc. disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Members of Aon Benfield Analytics will be pleased to consult on any specific situations and to provide further information regarding the matters.

ContactsGlobal

Greg HeerdeHead of Analytics & Inpoint, AmericasAon Benfield+1 312 381 5364greg.heerde@aonbenfield.com

Patrick MatthewsHead of Global Rating Agency AdvisoryAon Benfield +1 215 751 1591 patrick.matthews@aonbenfield.com

Americas

Kathleen ArmstrongDirector, US Rating Agency AdvisoryAon Benfield+1 513 562 4508kathleen.armstrong@aonbenfield.com

EMEA

Ankit DesaiHead of Rating Agency Advisory, EMEAAon Benfield+44 207 522 8268ankit.desai@aonbenfield.com

APAC

Sifang ZhangDirector, Head of Rating Agency Advisory, APACAon Benfield+852 2861 6493sifang.zhang@aonbenfield.com

Canada and Caribbean

Raymond LuiSenior Vice PresidentAon Benfield+1 416 598 7320raymond.lui@aonbenfield.com

About Aon Aon plc (NYSE:AON) is a leading global provider of risk management, insurance brokerage and reinsurance brokerage, and human resources solutions and outsourcing services. Through its more than 69,000 colleagues worldwide, Aon unites to empower results for clients in over 120 countries via innovative risk and people solutions. For further information on our capabilities and to learn how we empower results for clients, please visit: http://aon.mediaroom.com.

© Aon plc 2015. All rights reserved.The information contained herein and the statements expressed are of a general nature and are not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information and use sources we consider reliable, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate profes-sional advice after a thorough examination of the particular situation.

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