A.M. Best stress test may give companies more leeway in meeting capital requirements

A.M. Best has revised how it plans to apply its Natural Catastrophe Stress Test (NCST), potentially giving insurance companies leeway in meeting risk-adjusted capital requirements in the aftermath of a reasonably severe catastrophe.
The stress test considers a company’s balance sheet risks and the increased reinsurance recoverables and reserves associated with a natural catastrophe. The test is designed to reflect a company’s financial position shortly after a catastrophe event.
A.M. Best’s financial strength ratings are based on the ability of a company to maintain certain minimum capital levels, as measured by Best’s Capital Adequacy Ratio (BCAR).
“As the (NCST) stress test reflects the financial conditions following an event, A.M. Best may allow the stress-tested (BCAR) score to fall below the minimum required capital levels,” A.M. Best said in a press release.
Assuming the company can recover capital over the intermediate term, “the stress-tested BCAR score can fall to a maximum of 30 points below the minimum,” the release says.
For example, an insurance company could remain at a financial strength grade of A++ if its stress-tested BCAR score falls up to 30 points below the minimum level of 175 required to maintain the A++ grade.
But such flexibility is based on three considerations, A.M. Best adds.
•    The organization’s perceived financial flexibility: “Companies that are able and willing to replace lost capital immediately following an event will be afforded greater leeway with regard to the disparity in the standard BCAR and natural catastrophe stress test,” the ratings agency says.
•    The historical volatility of the company’s balance sheet and operating performance: “Companies with significant volatility in results will be afforded less tolerance in A.M. Best’s view, as replenishing capital through earnings could prove difficult.”
•    A company’s exposure to multiple events in a season: “Those with exposure to more frequent severe events will be afforded less tolerance in the application of the stress test.”