A.M. Best Report: Understanding BCAR for Life and Health Insurers.

Business Editors

OLDWICK, N.J.--(BUSINESS WIRE)--Feb. 10, 2004

In determining a life/health insurer's ability to meet its current and ongoing obligations to policyholders, balance-sheet strength is one of the most important areas to evaluate, since it is the foundation for policyholder security. One of the key tools used in evaluating balance-sheet strength is A.M. Best Co.'s Capital Adequacy Ratio (BCAR), according to a rating methodology report released at A.M. Best's annual Review/Preview conference.

Balance-sheet strength measures the exposure of a company's surplus to its operating and financial practices. Business profile and operating performance then determine how that balance-sheet strength will be enhanced, maintained or eroded over time. The BCAR model provides a quantitative measure of the risks inherent in a company's investment and insurance profile relative to its statutory capital and surplus.

The objective of A.M. Best Co.'s financial strength rating system is to provide an opinion of an insurer's financial strength and ability to meet its ongoing obligations to policyholders. The assignment of an interactive rating is derived from an in-depth evaluation of a company's balance-sheet strength, operating performance and business profile, as compared with A.M. Best's quantitative and qualitative standards.

A.M. Best's life/health BCAR model is designed to capture major life and health insurance company risks and quantify the level of capital needed to support them. A.M. Best's capital formula computes required capital to support four broad risk categories: asset risk, insurance risk, interest-rate risk and business risk. The A.M. Best model also contains an adjustment for covariance, reflecting the statistical independence (mutually exclusive nature) of the individual components. A company's adjusted surplus is divided by its net required (risk-based) capital, after a covariance adjustment, to determine its BCAR score.

The BCAR model isn't a pass/fail test; rather, it is used to measure a company's capital position, relative to A.M. Best expectations, as an integral part of the determination of an ongoing concern's financial strength rating. The BCAR model also has a degree of flexibility, i.e., analysts can use discretion in making adjustments to the model based on their knowledge of the company, making the model an interactive tool. These adjustments within A.M. Best's capital model provide a more economic and comparable basis for evaluating capital adequacy.

The BCAR model, however, is only one tool used in the analysis of an insurer's statutory capital position. A.M. Best's analysis also encompasses a thorough review, using various financial tests and ratios, of historical trends over a five-year period of a company's:

-- Reported capital and surplus, including a comparison of the

growth rate of statutory capital to the growth rate in assets

and net premiums written;

-- Exposure to various types of leverage, such as operating

leverage (net premiums written to capital or capital to

liabilities), financial leverage (debt and debt-like

instruments to capital) and reinsurance leverage (reserves

ceded to capital);

-- Historical sources of growth in capital, such as operating

gains, capital gains and capital contributions; and

-- Quality and diversity of invested assets through a review of

trends in asset allocations, exposure to higher-risk assets,

and asset concentrations by class, issuer and industry.

A.M. Best's assessment of balance-sheet strength also includes an analysis of an organization's balance sheet under generally accepted accounting principles at both the operating insurance company and holding company levels. The analysis of an insurer's GAAP capital position is similar in many respects to the analysis done on the statutory balance sheet. The GAAP analysis of an operating company incorporates a review of trends in various financial tests and ratios aimed at measuring the relative risk to the entity's capital base generated by its own activities. Meanwhile, the holding company analysis provides valuable insight into how activities outside of the insurance operations potentially could affect the insurer's capital position--either as a source of added financial flexibility and long-term strength or as a potential drain on capital.

At a time when many companies in the industry face declining levels of capital relative to their current ratings, management of that capital is an important issue. Industry tools to improve capital allocation and understand capital strength continue to evolve. These tools often vary in theory, purpose and outcome. It is important to remember that while they can add significant value, they are only tools.

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

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.