Best’s Credit Rating Methodology Global Life and Non-Life Insurance Edition Global Life and Non-Life Insurance Edition Important Notice: Best's Credit Ratings A Best’s Financial Strength Rating is an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations It is based on a comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile The Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance policy and contract obligations The rating is not assigned to specific insurance policies or contracts and does not address any other risk, including, but not limited to, an insurer’s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder A Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser A Best's Debt/Issuer Credit Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security It is based on a comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile and, where appropriate, the specific nature and details of a rated debt security Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due These credit ratings not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor they address the suitability of any particular financial obligation for a specific purpose or purchaser In arriving at a rating decision, A.M Best relies on third-party audited financial data and/or other information provided to it While this information is believed to be reliable, A.M Best does not independently verify the accuracy or reliability of the information One of the primary sources for this information are a company’s annual and quarterly (if available) financial statements presented in accordance with statutory accounting requirements (U.S.) or in accordance with customs or regulatory requirements of the country of domicile (non-U.S.) Meetings between A.M Best senior personnel and company management also provide additional and valuable in-depth information on the company's current performance and future objectives For more information regarding specific data used in a typical rating evaluation, read Overview: Best’s Interactive Credit Rating Process, in this document Any and all ratings, opinions and information contained herein are provided "as is," without any express or implied warranty A rating may be changed, suspended or withdrawn at any time for any reason at the sole discretion of A.M Best A.M Best does not offer consulting or advisory services A.M Best is not an Investment Adviser and does not offer investment advice of any kind, nor does the company or its Rating Analysts offer any form of structuring or financial advice A.M Best does not sell securities A.M Best is compensated for its interactive rating services These rating fees can vary from US$ 5,000 to US$ 500,000 In addition, A.M Best may receive compensation from rated entities for non-rating related services or products offered For additional information on A.M Best’s fee policy, read Compensation Disclosure (www.ambest.com/nrsro/CompensationDisclosure.pdf) Best’s Credit Reports Best’s Credit Reports (www.ambest.com/sales/ambcreditreportsip/default.asp) are prepared solely for the confidential use of our subscribers Insurance Companies For most insurers domiciled in the United States, the data contained within these reports are based on each insurance company's sworn annual and quarterly (if available) financial statement as prescribed by the National Association of Insurance Commissioners (NAIC) and as filed with the Insurance Commissioners of the states in which the companies are licensed to business These official financial statements are presented in accordance with statutory accounting requirements Insurance-Linked Securities For these transactions, data and information is gathered from all structural, regulatory, legal and third-party related documentations Depending on the nature of the transaction, other types of information also are considered, including perils and geographic regions covered, peril modeling firm output, the output of scenarios run by actuarial organizations and related stress tests Non-U.S Data related to companies operating outside the United States are presented in accordance with customs or regulatory requirements of the country of domicile, and there may be significant variations in accounting standards or methods of reporting from one country to another These differences are imbedded in the accounting principles used, the valuation of assets and liabilities and the treatment of taxes Financial data usually are received in the currency of the country where the company is domiciled, and A.M Best’s reports generally are Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition presented in that currency and may be presented in U.S dollars as well A.M Best’s non-U.S reports represent a variety of reporting dates, as the fiscal years utilized by companies vary according to traditional reporting periods or regulatory requirements Within some of the Canadian insurance company presentations, portions of the data are provided by Beyond 20/20 Inc., Ottawa, Canada Supplemental Data In addition, our reports may include supplemental information obtained by us, such as: o Data supplied in response to our questionnaires o Data contained in state examination reports o Audit reports prepared by certified public accountants o Loss-reserve reports prepared by loss-reserve specialists o Annual reports to stockholders and policyholders o Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS) financial statements o Reports filed with the Securities and Exchange Commission (SEC) in the United States While the information obtained from these sources is believed to be reliable, its accuracy is not guaranteed A.M Best does not audit the company's financial records or statements and therefore cannot attest as to the accuracy of the information provided to us Consequently, no representations or warranties are made or given as to the accuracy or completeness of the information and no responsibility can be accepted for any error, omission or inaccuracy in our reports For additional details, see A.M Best’s Terms of Use (www.ambest.com/terms.html) For more information regarding A.M Best's rating process, including handling of confidential (non-public) information, independence, and avoidance of conflicts of interest, please read the A.M Best Code of Conduct (www.ambest.com/nrsro/code.pdf) Best's is a registered trademark of the A.M Best Company, Inc The rating symbols "A++,'' "A+," "A,'' "A-," "B++" and "B+'' are registered certification marks of the A.M Best Company, Inc View our Legal and Licensing (www.ambest.com/about/legal.html) information for details on the use of A.M Best trademarks, logos and service marks For a complete list of Best’s Credit Rating Methodologies, including methodologies released subsequent to the publication of this document, visit A.M Best’s methodology Web page (www.ambest.com/ratings/methodology.asp) Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Table of Contents Introduction Purpose of Document Usage of Best's Ratings Overview: Best’s Credit Ratings .8 About A.M Best Best’s Credit Ratings Within the Insurance Segment Best’s Financial Strength Ratings Best’s Issuer Credit and Debt Ratings Ratings Initiation 10 Best’s Outlooks, Modifiers and Financial Size Categories 11 Overview: Best’s Interactive Credit Rating Process 12 Conducting a Rating Meeting 14 Property/Casualty Sample Meeting Agenda .15 Information Requirements 17 Requested Data Items – Property/Casualty & Life/Health Insurance Companies 17 Best’s Interactive Credit Rating Methodology 19 Overview of Best’s Credit Rating Evaluation 19 Best’s Credit Rating Approach: Top-Down and Bottom-Up 20 Key Components of Best’s Credit Rating Evaluation – Operating Company Analysis 22 Balance Sheet Strength 22 Operating Performance 33 Business Profile 36 Key Components of Best’s Credit Rating Evaluation – Holding Company Analysis .38 Corporate Capital Structure 38 Holding Company Methodology 39 Key Components of Best’s Credit Rating Evaluation – Assessing Non-Rated Affiliates 45 Enterprise Risk Management 45 Risk Management and the Rating Process 46 Enterprise Risk Management – Key Topics and Rating Meeting Agenda Items 47 Risk Management and Best’s Capital Adequacy Ratio (BCAR) 48 Group Rating Methodology .49 Country Risk Analysis .50 Application of Credit Rating Methodologies to Specific Types of Insurers 52 Rating Start-Ups and New Company Formations 52 Balance Sheet Strength 52 Sponsorship and Investors 53 Business Profile 53 Rating Captives 54 Balance Sheet Strength 55 Operating Performance 56 Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Business Profile 56 Rating Title Insurance Companies 57 Key Differences of Title Insurance From Property/Casualty Insurance 57 Rating Methodology for Title Insurance Companies 59 Rating Health Insurance Companies 61 Balance Sheet Strength 61 Operating Performance 62 Business Profile 63 Rating Takaful Insurance Companies 64 Main Characteristics of Takaful Companies 64 Two Separate Funds – a Two-Stage Risk-Based Capital Approach 65 Other Balance Sheet Issues 65 Operating Performance Issues in a Takaful Company 66 Insurance-Linked Securities 68 Rating Performance Statistics 69 Rating Distribution 69 Credit Rating Performance Statistics Through Year-End 2010 .71 Best’s Impairment Rate and Rating Transition Study – 1977 to 2010, published May 16, 2011 71 Appendices 73 Best’s Credit Rating Definitions 74 Financial Strength Ratings 74 Best’s Long-Term Issuer Credit Ratings and Long-Term Debt Ratings 75 Best’s Short-Term Issuer Credit Ratings and Short-Term Debt Ratings 76 Affiliation Codes and Rating Modifiers 77 Affiliation Codes 77 Rating Modifiers 78 Not Rated (NR) Category 79 Best's Analytical Reports – Quantitative Analysis Report (GAAP) 80 Organization Types 84 Insurance Licenses 85 Glossary 87 Balance Sheet Terms 87 Income Statement Terms 87 Criteria Reports 89 Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Introduction Purpose of Document Best’s Credit Rating Methodology provides a comprehensive explanation of Best’s rating process, including highlights of the rating criteria employed by A.M Best Company in determining Best’s Credit Ratings, which include Best’s Financial Strength, Issuer Credit and Debt Ratings within the insurance industry The report describes the rating process in detail, from the types of information typically gathered and reviewed, to the key financial metrics and qualitative factors considered in the analytical process, to the dissemination of public ratings The report summarizes A.M Best’s rating approach and the key components of our analytical framework, including risk management and other qualitative factors, for the evaluation of operating insurance companies, material non-insurance subsidiaries, holding companies, and groups, that are the core of our rating assessment Given its extensive knowledge of the insurance industry, A.M Best utilizes a broad and deep portfolio of both quantitative and qualitative measures to analyze the organizations we rate These measures and the rating processes are regularly reviewed and enhanced through a formalized, criteria review process Enhancements are then disseminated through criteria papers addressing specific issues or components of the rating process The most current rating criteria can be accessed through A.M Best’s website www.ambest.com/ratings/methodology The ongoing review and development of rating criteria is managed by A.M Best’s Corporate Rating Policy Committee (CRPC) The CRPC is responsible for ensuring that A.M Best continuously uses credit rating criteria and methodologies that are rigorous, systematic, and where possible, result in ratings that can be subject to some form of objective validation based on historical experience The CRPC is also responsible for the establishment and maintenance of all A.M Best policies and procedures related to the credit rating process Usage of Best's Ratings Best's Credit Ratings are proprietary and may not be reproduced without permission from A.M Best A company assigned a Best's Credit Rating should review the Guide to Proper Use, which outlines the acceptable parameters of the use of these ratings All queries regarding the use of proprietary information or to obtain a licensing agreement or a letter of consent should be directed to: A.M Best Company, Office of Intellectual Property, Ambest Road, Oldwick, New Jersey 08858 While Best's Credit Ratings reflect our opinion of a company's financial strength and relative ability to meet its ongoing senior obligations, they are not a warranty Best’s Credit Ratings, which include Best’s Financial Strength, Issuer Credit, and Debt Ratings, are not recommendations to purchase, hold or terminate any insurance policy, contract, instrument, or any other financial obligation issued by an insurer Nor they address the suitability of any particular policy, contract, instrument or any other financial obligation issued for a specific purpose or purchaser Best’s Credit Ratings are not assigned to specific insurance policies or contracts and not address any other risk, including, but not limited to, an insurer's claims-payment policies or procedures; the ability of the insurer to dispute or deny Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder A Best's Issuer Credit or Debt Rating is an opinion regarding the relative future credit risk of an entity, a credit commitment or a debt or debt-like security Credit risk is the risk that an entity may not meet its contractual, financial obligations as they come due These credit ratings not address any other risk, including but not limited to liquidity risk, market value risk or price volatility of rated securities The rating is not a recommendation to buy, sell or hold any securities, insurance policies, contracts or any other financial obligations, nor does it address the suitability of any particular financial obligation for a specific purpose or purchaser A.M Best does not sell securities nor provide investment advice A.M Best is compensated for its interactive ratings from the entities/issuers that it rates Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Overview: Best’s Credit Ratings About A.M Best A.M Best Company is a global full-service credit rating agency dedicated to serving the financial and health-care services industries It began assigning credit ratings in 1906, making it the first of today's rating agencies to use symbols to differentiate the relative creditworthiness of companies Within the insurance segment, Best’s Ratings cover property/casualty, life, annuity, reinsurance, captive, title and health insurance companies and health maintenance organizations (HMOs) A.M Best provides the most comprehensive insurance ratings coverage of any rating agency, with reports and ratings maintained on over 10,000 insurance entities worldwide, in approximately 95 countries A.M Best is also a wellknown and highly regarded source of information and commentary on global insurance trends and issues through a host of other products and services In 1900, A.M Best first published what became known as Best’s Insurance Reports®— Property/Casualty Edition which reported on 850 property/casualty insurers operating in the United States This was soon followed by its companion volume, Best’s Insurance Reports®— Life/Health Edition, which was published in 1906 reporting on 95 legal reserve life insurers in the United States Over the better part of a century, these two annual publications have represented the most comprehensive source of financial information on domestic insurers The Property/Casualty and Life/Health Editions of Best’s Insurance Reports®—United States & Canada contain over 3,200 and 2,000 insurance companies, respectively, representing virtually all active insurers operating in the United States In addition, these editions contain Canadian and Caribbean property/casualty and life insurers and reports on United States, European, and Canadian branches In 1984, A.M Best embarked on completing global coverage of the insurance industry with the publication of Best’s Insurance Reports®—Non-US Edition, which currently reports, in CDROM format, on over 5,000 international property/casualty and life/health companies In 1999, A.M Best expanded its rating assignments to include debt and insurance-linked securities The issuance of securities ratings for insurers and insurance holding companies is a natural extension of our expertise in providing financial strength ratings and reports on insurance organizations to investors, analysts and policyholders This focus also serves as the foundation for which ratings are issued to other risk-bearing institutions and entities, including captive insurers and alternative risk transfer facilities Within the insurance segment, A.M Best assigns ratings to various instruments including debt, hybrid debt, surplus notes, preferred stock, commercial paper, collateralized debt obligations, insurance-based liability or asset-backed securitizations and monetizations, risklinked securities, closed block securities and institutional investment products Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Best’s Credit Ratings Within the Insurance Segment Best's Credit Ratings are independent opinions regarding the creditworthiness of insurance entities, issuers, and securities Best's Credit Ratings are based on a comprehensive quantitative and qualitative evaluation of a company's balance sheet strength, operating performance and business profile, and, where appropriate, the specific nature and details of a security A.M Best assigns various types of credit ratings within the insurance segment, including Financial Strength Ratings, Long-Term and Short-Term Issuer Credit Ratings, and Long-Term and Short-Term Debt Ratings on corporate securities and insurance-related securitizations Best’s Financial Strength Ratings The Best’s Financial Strength Rating (FSR) is an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations The FSR scale is comprised of 16 individual ratings grouped into 10 categories, consisting of three Secure categories of “Superior,” “Excellent” and “Good” and seven Vulnerable categories of “Fair,” “Marginal,” “Weak,” “Poor,” “Under Regulatory Supervision,” “In Liquidation” and “Suspended.” Rating Scale – FSR S ecure A++ and A+ Superior A and A- Excellent B++ and B+ V ulnerable Good B and B- Fair C++ and C+ Marginal C and C- Weak D Poor E Under Regulatory Su pervision F In Liquidation S Suspended Best’s Issuer Credit and Debt Ratings Long-Term Issuer Credit Ratings and Long-Term Debt Ratings Rating Scale – Long-Term ICR and Debt Investment Grade aaa Exceptional aa Very Strong a Strong bbb Adequate Non-Investment Grade bb Speculative b ccc, cc, c Very Specula tive Extremely Sp eculative d In Default Best's Long-Term Issuer Credit Rating (ICR) is an opinion of an issuer/entity's ability to meet its ongoing senior financial obligations Best's Long-Term Debt Rating is an independent opinion of an issuer/entity's ability to meet its ongoing financial obligations to security holders when due Best's rating scale used for Long-Term ICRs and Long-Term Debt Ratings is comprised of 22 individual ratings grouped into categories, consisting of four Investment Grade categories of "Exceptional," "Very Strong," "Strong", and "Adequate" and four Non-Investment Grade categories of "Speculative," "Very Speculative," "Extremely Speculative", and "In Default." While the above definitions apply to entities which not issue insurance obligations, A.M Best also assigns ICRs to all rated insurance companies In addition, it should also be noted that A.M Best assigns Issuer Credit Ratings to publicly traded holding companies, where a significant portion of cash flow is provided by insurance operations The definitions applied to insurance companies that are assigned an Issuer Credit Rating are as follows: (aaa) – Exceptional; (aa) – Superior; (a) – Excellent; (bbb) – Good; (bb) – Fair; (b) – Marginal; (ccc, cc) – Weak; (c) – Poor; (rs) – Regulatory Supervision/Liquidation Best’s Credit Rating Methodology _ Global Life and Non-Life Insurance Edition Short-Term Issuer Credit Ratings and Short-Term Debt Ratings Rating Scale – Short-Term ICR and Debt Investment Grade AMB-1+ Strongest AMB-1 AMB-2 Outstanding Satisfactory AMB-3 Adequate Non-Investment Grade AMB-4 Speculative D Best's Short-Term ICR and Short-Term Debt Ratings are an opinion of an issuer/entity’s ability to meet its senior financial obligations having original maturities of generally less than one year Best's Short-Term ICR and Debt Rating scale is comprised of individual ratings grouped into categories, consisting of four Investment Grade categories of "Strongest," "Outstanding," "Satisfactory", and "Adequate" and two Non-Investment Grade categories of "Speculative" and "In Default." In Default Rating Translation Table – FSRs and Long-Term ICRs As highlighted in the summary definition above, an FSR is an opinion of an insurer’s ability to meet its ongoing insurance policy and contract obligations The analysis required for this reflects various sources of risk, including non-insurance risks, to which the legal entity issuing the policies is exposed Since policyholders typically are among the senior-most creditors of an insurer, FSRs, in practice, have been the equivalent of the ICR for operating insurers See the translation table below Rating Translation Table FSR Long-Term ICR FSR Long-Term ICR With the growing interest by S ecure Investment Grade Vulnerable Non-Investment Grade non-policyholders in aaa bb+ A ++ B insurers’ creditworthiness, aa+ bb A.M Best draws a distinction aa BbbA+ between these two ratings aab+ C++ a+ b The FSR remains an opinion A a C+ bspecific to the insurer’s ability Aaccc+ to meet ongoing insurance C bbb+ ccc B ++ policy and contract bbb cccCobligations, while the ICR is B+ bbbcc an opinion as to the overall D c creditworthiness of an E and F rs insurer from the perspective of its senior creditors This distinction is important when considering ratings other than an FSR within an insurance organization, since ratings both of an organization’s debt issues and of related legal entities, such as holding companies, are tied to and based on the overall creditworthiness of the operating insurer Ratings Initiation A.M Best assigns long-term FSRs and ICRs on an interactive basis An entity is deemed to be an interactive participant in the rating process when it requests or otherwise subscribes to A.M Best’s credit rating services, such as, for example, an FSR Interactive participants and affiliated entities within the immediate organizational structure that expose the legal entity to risk are subject to the assignment of any type of interactive credit rating published by A.M Best that A.M Best believes is appropriate and that provides transparency to interested parties These entities expect, and in all cases are informed of, the ratings issued by A.M Best Such credit ratings may include FSRs, ICRs and debt ratings on entities, corporate securities and insurance-related securitizations Best’s Credit Rating Methodology 10 Global Life and Non-Life Insurance Edition d (In Default) Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed While the above definitions apply to entities which not issue insurance obligations, A.M Best also assigns Issuer Credit Ratings to all rated insurance companies In addition, it should also be noted that A.M Best assigns Issuer Credit Ratings to publicly traded holding companies, where a significant portion of cash flow is provided by insurance operations The definitions applied to insurance companies that are assigned an Issuer Credit Rating are as follows: (aaa) – Exceptional; (aa) – Superior; (a) – Excellent; (bbb) – Good; (bb) – Fair; (b) – Marginal; (ccc, cc) – Weak; (c) – Poor; (rs) – Regulatory Supervision/Liquidation Best’s Short-Term Issuer Credit Ratings and Short-Term Debt Ratings Investment Grade AMB-1+ (Strongest) Assigned to issues where, in our opinion, the issuer has the strongest ability to repay shortterm debt obligations AMB-1 (Outstanding) Assigned to issues where, in our opinion, the issuer has an outstanding ability to repay shortterm debt obligations AMB-2 (Satisfactory) Assigned to issues where, in our opinion, the issuer has a satisfactory ability to repay shortterm debt obligations AMB-3 (Adequate) Assigned to issues where, in our opinion, the issuer has an adequate ability to repay shortterm debt obligations; however, adverse economic conditions will likely reduce the issuer's capacity to meet its financial commitments Non-Investment Grade AMB-4 (Speculative) Assigned to issues where, in our opinion, the issuer has speculative credit characteristics and is vulnerable to adverse economic or other external changes, which could have a marked impact on the company's ability to meet its financial commitments d (In Default) Assigned to issues in default on payment of principal, interest or other terms and conditions, or when a bankruptcy petition or similar action has been filed With the growing interest by non-policyholders in insurers' creditworthiness, A.M Best draws a distinction between the Financial Strength and Issuer Credit ratings The FSR remains an opinion specific to the insurer's ability to meet ongoing insurance obligations, while the ICR is an opinion as to the overall creditworthiness of an insurer from the perspective of its senior creditors This distinction is important when considering ratings other than an FSR within an Best’s Credit Rating Methodology 76 Global Life and Non-Life Insurance Edition insurance organization, since ratings both of an organization's debt issues and of related legal entities, such as holding companies, are tied to and based on the overall creditworthiness of the operating insurer Affiliation Codes and Rating Modifiers Affiliation Codes and Rating Modifiers are added to Best’s Financial Strength Ratings to identify companies whose assigned rating is based on a Group (g), Pooled (p), or Reinsured (r) affiliation with other insurers In addition, a company’s rating may be placed Under Review and be subject to a near-term change, as indicated by the “u” rating modifier The “s” rating modifier is assigned to syndicates operating at Lloyd’s that have subscribed to our interactive rating process These affiliation codes or modifiers appear as a lowercase suffix to the rating (i.e., A g, A u, etc.) Insurers with affiliation codes (g, p, r) indicate that their rating is based on the consolidated performance of the company and its affiliation with one or more insurers, which collectively operate, in Best’s opinion, as one coordinated insurance group and meets our criteria for the same rating Accordingly, the Financial Size Category of these member companies usually equals that of the group Affiliation Codes "g" Group Rating: Assigned to the parent company of a group and is based on the consolidation of the parent company and its insurance subsidiaries where ownership or board control exceeds 50% The group rating is also assigned to subsidiaries deemed to be integral to the group, which generally operate under common management and/or ownership Group rated subsidiaries typically demonstrate a combination of the following characteristics They are critical to the group's strategy and ongoing success; fully integrated into the group's strategic plan; carry the group name or are easily identified with the group; are material to the business profile of the group; are significant contributors to the group's earnings; currently benefit from some form of explicit parental support and have a history of receiving explicit support when needed In certain cases, group ratings are also assigned to sister companies owned by a common holding company A stand-alone analysis is conducted on all insurance subsidiaries to assess each legal entity's stand-alone operating performance and capitalization, before consideration is given to any group rating enhancement "p" Pooled Rating: Assigned to a group whose member companies pool assets, liabilities and operating results and maintain, in theory, the same operating performance and balance sheet strength as other companies within the pool Pooling is viewed as explicit financial support The assets of each pool participant are available for the protection of all pool members' policyholders In many cases, pooled affiliates market under a common brand name and generally operate under common management and/or ownership The pooled (p) affiliation code is typically assigned if the pooling agreement is joint and several; pure/net; stand-alone capitalization supports the assigned rating after the pool is considered; includes coverage for any prior year loss reserve development, and the run-off of Best’s Credit Rating Methodology 77 Global Life and Non-Life Insurance Edition all liabilities incurred on policies incepted prior to termination; ownership or board control exceeds 50% and includes a 12-month notice of termination "r" Reinsured Rating: Assigned to a company with 100% quota share of all gross premiums, losses and expenses (unless regulatory restrictions apply) Reinsurance is viewed as explicit financial support In many cases, reinsured affiliates market under a common brand name and generally operate under common management and/or ownership The reinsured (r) affiliation code is typically assigned if stand-alone capitalization supports the assigned rating after the reinsurance is considered; the contract contains no loss caps or loss corridors; includes coverage for any prior year loss reserve development, and the run-off of all liabilities incurred on policies incepted prior to termination; ownership or board control exceeds 50% and includes a 12-month notice of termination Rating Modifiers “u” Under Review: Assigned to companies with potential near-term rating changes (typically within six months) due to a recent event or abrupt change in their financial condition, which may have positive, developing, or negative rating implications A rating placed under review with positive implications indicates that, based on information currently available, there is a reasonable likelihood the company's rating will be raised as a result of A.M Best's analysis of the recent event Conversely, a rating placed under review with negative implications indicates that, based on information currently available, there is a reasonable likelihood the company's rating will be lowered as a result of A.M Best's analysis of the recent event A rating placed under review with developing implications indicates that, based on information currently available, there is uncertainty as to the final rating outcome, but there is a reasonable likelihood the company's rating will change as a result of A.M Best's analysis of the recent event A company's rating remains under review until A.M Best is able to fully determine the rating implications of the event before affirming, upgrading or downgrading the rating Generally, a company's rating is placed under review for less than six months “pd” Public Data Rating: Indicates rating assigned to insurer that chose not to participate in A.M Best’s interactive rating process (Discontinued in 2010) “s” Syndicate Rating: Assigned to syndicates operating at Lloyd’s that meet our minimum size and operating experience requirements for a Best’s Credit Rating and subscribe to our interactive rating process Best’s Credit Rating Methodology 78 Global Life and Non-Life Insurance Edition Not Rated (NR) Category This designation is assigned to companies that are not rated by A.M Best Best’s Credit Rating Methodology 79 Global Life and Non-Life Insurance Edition Best's Analytical Reports – Quantitative Analysis Report (GAAP) Sample Company Best's GAAP Summary Financial Information ($000) Selected Consolidated Balance Sheet Items 2008 2007 2006 2005 2004 Total Cash and Investments Reinsurance Recoverables Deferred Policy Acquisition Costs Value of Insurance Acquired Goodwill All Other Assets Separate Account Assets Total Assets Total P/C Reserves Claims Payable Total L/H Reserves Total Debt & Notes Payable Separate Account Liabilities All Other Liabilities Total Liabilities Capitalization Table Short-term Debt Long-term Debt Current Maturities of Long-term Debt Finance Company Debt & Other Notes Payable Redeemable Preferred Stock (Non-equity) Minority Interest and Other Convertible Preferred Equity Non-Convertible Preferred Equity Common Equity Total Equity Total Capital Accumulated Other Comprehensive Income Total Adjusted Shareholders' Equity Total Adjusted Capital Tangible Equity Tangible Capital Selected Income Statement Data Premiums Earned Net Investment Income Best’s Credit Rating Methodology 80 Global Life and Non-Life Insurance Edition Summary Financial Information (Continued) 2008 2007 2006 2005 2004 2007 2006 2005 2004 Net Realized Gains/(Losses) Total Fee Income Other Revenues Total Revenues Benefits, Losses & Expenses Interest Expense Preferred Dividends (Non-equity) Minority Interest Operating Earning Before Interest and Taxes (EBIT) Pretax Operating Income Net Income Preferred Stock Dividends Paid Common Stock Dividends Paid Selected Cash Flow Statement Items Operating Activities Investing Activities Financing Activities Net Change in Cash and Equivalents Holding Company (Parent Company Only) and Statutory Information Dividends from Subsidiaries Other Holding Company Revenues Cash and Invested Assets at Parent Holding Company Investment in Subsidiaries Maximum Statutory Dividends Available to Parent Consolidated Statutory Surplus Consolidated Statutory Net Income Net Premiums Written (P/C Only) Select Financial Ratios and Measures Leverage (%) 2008 Long-term Debt / Total Adjusted Capital Long-term Debt / Total Capital Short-Term + Long-term Debt / Total Adjusted Capital Short-Term + Long-term Debt / Total Capital Total Debt / Total Adjusted Capital Total Debt / Total Capital Long-term Debt / Total Adjusted Equity Long-term Debt / Total Equity Best’s Credit Rating Methodology 81 Global Life and Non-Life Insurance Edition Select Financial Ratios and Measures (Continued) 2008 2007 2006 2005 2004 Short-Term + Long-term Debt / Total Adjusted Equity Short-Term + Long-term Debt / Total Equity Total Debt / Total Adjusted Equity Total Debt / Total Equity ( Total Debt + Preferred Stock ) / Total Adjusted Capital ( Total Debt + Preferred Stock ) / Total Capital ( Total Debt + Preferred Stock ) / Total Adjusted Equity ( Total Debt + Preferred Stock ) / Total Equity ( Total Debt + Preferred Stock ) / Tangible Capital Long-term Debt / Tangible Equity Long-term Debt / Tangible Capital Total Debt / Tangible Capital Premium Revenue / Average Adjusted Equity Premium Revenue / Average Equity Premium Revenue / Average Tangible Equity Double Leverage NPW to Equity (Non-Life Only) GPW to Equity (Non-Life Only) GPW to Equity NPW to Equity Net PC Reserves to Equity Ceded Reinsurance Recoverable to Equity Loss Reserves to Net Premiums Earned Unearned Premiums to Equity Deferred Acquisition Cost to Equity Goodwill to Equity Other Intangibles to Equity Equity Investments to Equity Affiliated Investments to Equity Real Estate Investments to Equity Cash and Equivalents to Equity Coverage and Liquidity (x) Operating EBIT / ( Interest Expense + Preferred Stock Non-Equity ) Operating EBIT / Fixed Expenses Operating EBIT / Adjusted Fixed Charges Operating EBIT / ( Total Debt + Preferred Stock ) Maximum Dividend / ( Interest Expense + Preferred Stock Non-Equity ) Maximum Dividend / Fixed Expenses Maximum Dividend / Adjusted Fixed Charges Best’s Credit Rating Methodology 82 Global Life and Non-Life Insurance Edition Select Financial Ratios and Measures (Continued) 2008 2007 2006 2005 2004 Maximum Dividend / ( Total Debt + Preferred Stock ) Holding Company Cash Available / ( Total Debt + Preferred Stock) Unrealized Gain (Loss) on Securities/Equity (%) Dividend Payout Ratio (%) Operating Cash Flow / Total Operating Revenues Operating Cash Flow / Total Debt Operating Cash Flow Interest Coverage Quick Liquidity Current Liquidity Bonds to Total Reserves Total Investments to Total Reserves Total Investments to Total Liabilities Cash to Fixed Charges Profitability (%) Operating Return on Adjusted Equity Operating Return on Adjusted Capital Operating Return on Revenues Operating Return on Assets Operating Return on Adjusted Assets EBIT Margin Net Return on Revenue Net Return on Equity Net Return on Capital Invested Income/Invested Assets Pre-tax net investment yield (inc gains) Health Care Loss Ratio Expense Ratio Loss & LAE ratio Expense Ratio (SI) Combined Ratio Asset Quality (%) DAC and Value of Insurance Acquired/Total Adjusted Equity Goodwill/Total Adjusted Equity Cash & Short-term Investments/Total Cash and Investments Fixed Maturities/Total Cash and Investments Equity Securities/Total Cash and Investments High Risk Assets/Total Adjusted Equity Best’s Credit Rating Methodology 83 Global Life and Non-Life Insurance Edition Organization Types Insurance transactions are conducted primarily through seven types of organizations—stock companies, mutual companies, fraternal societies, non-profit organizations, U.S Lloyds Organizations, reciprocal exchanges, and risk retention groups A brief description of the legal structure and function of each is as follows: ● ● ● ● ● ● ● Stock Companies: Stock companies are corporations, the financial ownership of which is comprised of capital stock which is divided into shares Ultimate control of stock insurance companies is vested in the shareholders Mutual Companies: Mutual companies are corporations without capital stock Ultimate control of mutual insurance companies is vested in the policyholders Fraternal Societies: Fraternal life insurance societies are purely mutual organizations and the major fraternal societies furnish life insurance benefits to their members on a basis essentially the same as that utilized by legal reserve life insurance companies The fraternal life insurance society is characterized by its lodge system, a representative form of government and its fraternal or benevolent activities Non-Profit Organizations: Insurance companies that have no individuals/organizations with an ownership interest Control of these companies rests with the board of directors Non-profit companies reported on by Best are typically health or dental insurers U.S Lloyds Organizations: These organizations are voluntary unincorporated associations of individuals Each individual assumes a specified portion of the liability under each policy issued The organizations operate through a common attorney-in-fact appointed for this purpose by the underwriters Reciprocal Exchanges: These organizations are composed of a group of persons, firms or corporations commonly termed "Subscribers'' who exchange contracts of insurance on a Reciprocal or Inter-Insurance plan through the medium of an attorney-in-fact Under this plan, each Subscriber executes an agreement identical with that executed by every other Subscriber, empowering the attorney-in-fact to assume on his behalf an underwriting liability on policies issued by the Exchange covering the risks of the other Subscribers Customarily, the attorney-in-fact is compensated by payment of a percentage of premium income, out of which most operating expenses are paid Risk Retention Groups (RRG): These entities, formed under the federal Liability Risk Retention Act of 1986 of the United States, enable businesses or professionals with similar risks to band together to provide needed liability coverages for each other Under statute, RRGs are precluded from writing certain coverages, most notably property lines and workers' compensation RRGs predominantly write medical malpractice, general liability, professional liability, product liability and excess liability coverages An RRG can be formed as a mutual or stock company or a reciprocal Best’s Credit Rating Methodology 84 Global Life and Non-Life Insurance Edition Insurance Licenses States have the authority to regulate insurance companies and have controlled insurance mainly through the licensing power The license is a document that indicates an insurer has met the minimum requirements established by state statute and is authorized to engage in the lines of business for which it has applied The importance of a company being licensed in a particular domicile also determines not only the protection to the insured provided by the regulatory authorities to assist if a problem arises, but also the protection afforded the insured by guaranty fund laws, which generally apply only to licensed insurers Each jurisdiction has its own statutes and there are a number of different licensing requirements In addition to licensed insurers, there are other specialty types of companies that exist in the field of insurance such as reinsurers, non-admitted surplus lines carriers and risk retention groups A reinsurer is a company that agrees to indemnify, for consideration, the ceding company against all or part of a loss that the latter may sustain under policies that it has issued Reinsurers not always have to be licensed and may operate on an approved basis in some states A surplus lines insurer is a company that underwrites risks for which insurance coverage generally is not available through a company licensed in the insured's state (an admitted insurer) This business, therefore, is placed with a non-admitted insurer (a company not licensed in the state) in accordance with excess or surplus lines provisions of state insurance laws A risk retention group is an insurer that generally is not licensed in a state but operates under the authority of the federal Liability Risk Retention Act of 1986 Since there are a number of different licensing requirements, we have used seven descriptions to signify the general status of a company in a particular jurisdiction ● ● ● ● ● State of Domicile: The state in which the company is incorporated or chartered The company is also licensed (admitted) under the state's insurance statutes for those lines of business for which it qualifies Licensed: Indicates the company is incorporated (or chartered) in another state but is a licensed (admitted or chartered) insurer for this state to write specific lines of business for which it qualifies Licensed for Reinsurance Only: Indicates the company is licensed (admitted) to write reinsurance on risks in this state Indicates the company is incorporated (or chartered) in another state but is a licensed (admitted) reinsurer for this state Approved for Reinsurance: Indicates the company is approved (or authorized) to write reinsurance on risks in this state A license to write reinsurance may not be required in these states Indicates that the company is accredited or credit is allowed for reinsurers domiciled and licensed in another state These reinsurers meet size and regulatory filing requirements that were included as part of the Model Law on Credit for Reinsurance Credit for Reinsurance (Other): Indicates that the company meets state requirements other than licensing or accreditation Included are reinsurers that maintain trust funds, reinsurance arrangements that are required by law (pools, joint underwriting associations, state-owned or controlled companies) and qualified trust agreements and letters of credit arrangements These requirements were also specified under the Model Law Best’s Credit Rating Methodology 85 Global Life and Non-Life Insurance Edition ● ● Approved or not Disapproved for Surplus Lines: Indicates the company is approved (or not disapproved) to write excess or surplus lines in this state Authorized under federal Liability Risk Retention Acts (Risk Retention Groups): Indicates companies operating under the federal Products Liability Risk Retention Act of 1981 and the Liability Risk Retention Act of 1986 Indicates states in which the company operates for "members whose business or activities are similar or related with respect to the liability to which members are exposed by virtue of any related, similar, or common business, trade, product, services, premises, or operations." Companies are licensed in the state of domicile only Best’s Credit Rating Methodology 86 Global Life and Non-Life Insurance Edition Glossary Balance Sheet Terms ● ● ● ● ● ● ● ● Unaffiliated Investments: Represents cash, bonds, stocks, mortgages, real estate and accrued interest, excluding investments in affiliates and real estate properties occupied by the company Investments in Affiliates: Bonds, stocks, collateral loans, short-term investments in affiliates, and real estate properties occupied by the company Premium Balances: Premiums and agents' balances in course of collection; premiums, agents' balances and installments booked but deferred and not yet due; bills receivable, taken for premiums and accrued retrospective premiums Total Admitted Assets: This item is the sum of all admitted assets These assets are valued in accordance with state laws and regulations, as reported by the company in its financial statements filed with state insurance regulatory authorities Losses and Loss Adjustment Expenses: This item represents the total reserves for unpaid losses and loss adjustment expenses, including reserves for incurred but not reported losses (IBNR), if any, and supplemental reserves established by the company Unearned Premiums: The calculated aggregate net amount, after deducting reinsurance credits, which an insurance company would be obliged to tender to its policyholders as return premiums for the unexpired terms, should it cancel every policy in force Conditional Reserves: This item represents the aggregate of various reserves which, for technical reasons, are treated by companies as liabilities Such reserves, which are similar to free resources or surplus, include unauthorized reinsurance, dividends to policyholders undeclared and other similar reserves established voluntarily or in compliance with statutory regulations Policyholders' Surplus: This item is the sum of paid-in capital, paid-in and contributed surplus, and net earned surplus, including voluntary contingency reserves Income Statement Terms ● ● ● ● ● Direct Premiums Written: This item represents the aggregate amount of recorded originated premiums, other than reinsurance, written during the year whether collected or not at the close of the year (plus retrospective audit premium collections), after deducting all return premiums Reinsurance Assumed: Premiums assumed from other affiliated and non-affiliated insurance companies for reinsurance Reinsurance Ceded: Premiums ceded to other affiliated and non-affiliated insurance companies Net Premiums Written: This item represents gross premium written, direct and reinsurance assumed, less reinsurance ceded Net Premiums Earned: This item represents the adjustment of the net premiums written for the increase or decrease during the year of the liability of the company for unearned premiums Best’s Credit Rating Methodology 87 Global Life and Non-Life Insurance Edition ● ● ● ● ● ● ● ● ● ● ● Business Net Retention: The percentage of a company's gross writings that are retained for its own account Gross writings are the sum of direct writings and assumed writings Losses Incurred (Pure Losses): Net paid losses during the current year plus (minus) the change in loss reserves since the prior year-end Loss Adjustment Expenses: Expenses incurred to investigate and settle losses Underwriting Expenses Incurred: Expenses, including net commissions, salaries and advertising costs, which are attributable to the production of net premiums written Net Underwriting Income: Net premiums earned less incurred losses, loss adjustment expenses, underwriting expenses incurred, and dividends to policyholders Other Income/Expenses: Miscellaneous sources of operating income or expense that principally relate to premium finance income or charges for uncollectible premium and reinsurance balances Net Investment Income: Investment income earned during the year less investment expenses and depreciation on real estate Pre tax Operating Income: Pretax operating earnings, before any capital gains, generated from underwriting, investment and other miscellaneous operating sources Income Taxes: Incurred income taxes (including income taxes on capital gains) reported in each annual statement for that year Net Income: Total after-tax earnings generated from operations and realized capital gains Change in Policyholders' Surplus: The annual change in a company's policyholders' surplus derived from operating earnings, investment gains, net contributed capital and other miscellaneous sources Best’s Credit Rating Methodology 88 Global Life and Non-Life Insurance Edition Criteria Reports Methodologies published by A.M Best listed below are accessible through our website www.ambest.com/ratings/methodology They are listed in alphabetical order ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● ● A.M Best's Liquidity Model for U.S Life Insurers A.M Best's Perspective on Operating Leverage A.M Best's Rating Methodology for Captive Insurance Companies A.M Best's Ratings & the Treatment of Debt A.M Best's Title Insurance Rating Methodology Analyzing Commercial Banking Operations Analyzing Contingent Capital Facilities Analyzing Finance Companies Analyzing Securities Issued Under the U.S Treasury's Capital Purchase Program Assessing Country Risk Assessing the "Tail Risk" of Sidecars BCAR for Life and Health Insurers - Model Update 2006 BCAR For Title Insurance Companies Best's Idealized Default Matrix Catastrophe Analysis in A.M Best Ratings Catastrophe Risk Management Incorporated Within Rating Analysis Commercial Paper Methodology Equity Credit for Hybrid Securities Evaluating Health-Care Systems Gauging the Basis Risk of Catastrophe Bonds Life Settlement Securitization Measuring Transfer and Convertibility Risk Natural Catastrophe Stress Test Methodology Rating Closed-Block Monetizations Rating European Mutual Insurers Rating Funding Agreement-Backed Securities Rating Health Insurance Companies Rating Life-Related Premium Financing Loan Securitizations Rating Lloyd's Syndicates Rating Members of Insurance Groups Rating Natural Catastrophe Bonds Rating New Company Formations Rating Protected Cell Companies Rating Sidecars Rating Surplus Note And Insurance Trust Best’s Credit Rating Methodology 89 Global Life and Non-Life Insurance Edition ● ● ● ● ● ● ● ● ● ● ● ● ● Review of BCAR Treatment for XXX Captives Risk Management and the Rating Process for Insurance Companies Securitization of Annuities Securitization of Period-Certain and Life-Contingent Structured Settlements Securitization of Reinsurance Recoverables Tail Risk and the BCAR Takaful (Shari'a Compliant) Insurance Companies The Treatment of Terrorism Risk in the Rating Evaluation Understanding BCAR for Canadian Property/Casualty Insurers Understanding BCAR for Life/Health Understanding BCAR for Property/Casualty Insurers Understanding Universal BCAR Update to BCAR for Life & Health Insurers Best’s Credit Rating Methodology 90 ... Best’s Credit Rating Process – Holding Company Analysis Best’s Credit Rating Methodology 21 Global Life and Non -Life Insurance Edition Key Components of Best’s Credit Rating. .. Supervision/Liquidation Best’s Credit Rating Methodology _ Global Life and Non -Life Insurance Edition Short-Term Issuer Credit Ratings and Short-Term Debt Ratings Rating Scale –... interactive ratings from the entities/issuers that it rates Best’s Credit Rating Methodology _ Global Life and Non -Life Insurance Edition Overview: Best’s Credit Ratings About