A.M. Best Methodology: Review of BCAR Treatment for XXX Captives.

OLDWICK, N.J. -- In its methodology "Review of BCAR Treatment for XXX Captives," A.M. Best Co. discusses its review process and view of risk-adjusted capitalization with respect to certain life insurance captives. Over the past several years, direct writers have been searching for effective capital solutions to fund reserves for level premium term products subject to the reserve requirements of the Valuation of Life Insurance Policies Model Regulation, more commonly known as Regulation XXX. Since the change in reserving methodologies became effective in 2000, insurers have been struggling with the additional capital requirements, especially since most companies believe that a part of the reserves required under Regulation XXX is redundant.

The change has impacted both direct writers and reinsurers. Term insurance products remain popular, and direct writers are looking to maintain a pricing edge in a highly competitive market, while reinsurers need means to continue to provide coverage while not straining their own capital positions. Whereas reinsurance had been the most common means of providing direct writers capital relief, rising reinsurance rates and capacity issues have led insurers to search for alternative means of funding their growth.

Insurers have developed structures that access the capital markets to provide a XXX solution by funding perceived statutory reserve redundancies through securitization. The amount funded is the excess over what the insurer and investors believe is the true economic reserve required to support the business. A.M. Best believes that securitization of XXX reserves will continue to be utilized as an effective funding vehicle by insurance companies for long-term, guaranteed, preferred risk term insurance products.

A.M. Best has been monitoring the evolution of XXX solutions and its impact on direct writers' capital strength (in terms of operating leverage, etc.). As part of A.M. Best's standard review of an entity's financial strength, an important tool is Best's Capital Adequacy Ratio (BCAR), which along with other capital ratios is impacted directly by a XXX securitization transaction.

In order for A.M. Best to properly review the relationship between a XXX captive and the direct writer, and to provide appropriate credit in the BCAR model, A.M. Best has developed a list of items necessary to complete its analysis. The analysis would be the same if the securitization was company specific or if a company was a participant in a XXX-pooled securitization.

Assuming A.M. Best is comfortable with the stress testing, the structure and the assumptions used in the transaction, and with the stand-alone BCAR of the captive, no additional charges will be made to the ceding company's published BCAR. A consolidated BCAR, which would be used for internal analytical purposes, also will be reviewed and will factor in the captive's results in the consolidation. This allows A.M. Best to view the consolidated entity's risk-adjusted capital position, assuming no securitization had been completed.

A.M. Best will view companies that have effective asset/liability matching, conservative reserving and demonstrated underwriting acumen most positively. In addition, while not considered financial leverage, an excessive use of debt-funded securitization transactions as a capital-management tool would be considered a negative rating factor.

For more information on A.M. Best's rating methodologies or to download a copy of this methodology report, visit http://www.ambest.com/ratings/methodology.asp.

A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at www.ambest.com.