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A.M. Best Co. is updating its methodology for alternative risk transfer vehicles, including captive insurers, in a criteria report supplementing the Rating Captives section of Best’s Credit Rating Methodology — Global Life and Non-Life Insurance Edition. The new methodology is likely to be finalized in 45 to 60 days.

Steven M. Chirico, assistant vice president at A.M. Best and co-author of the report, said there are a couple of new elements to the methodology, but no substantive changes. Two main disclosures have been added for ART vehicles.

One is a three-tier approach in the rating process for single-parent captives, Chirico said. The first tier includes an analysis based on the creditworthiness of the parent company in the marketplace. The second tier is a composite of other credit agencies’ credit ratings of the parent company. The third tier is A.M. Best’s own financial analysis of the parent, taking into account things like liquidity and the ability to sustain the parent company’s competitive niche.

“The rating of a single-parent captive is odd and different than almost all other kinds of ratings of any insurance company, whether captives, commercial or personal lines companies, in that you have a situation in which you have a captive that exists only to provide insurance to the parent. So basically we have come up with a stand-alone assessment, and then we will assess lift or drag depending upon the strengths and weaknesses of the parent company,” he said.

A.M. Best has also expanded its disclosure of how it incorporates what it calls “alternative capital,” which includes letters of credit, New York Regulation 114 trusts, “and how we derive capital credit for those types of instruments, and which types of instruments qualify for credit,” Chirico said.

The motivation to make methodology changes was based on questions A.M. Best analysts were receiving from captives, captive managers, actuaries, accounts and regulators, said Chirico.

Chirico said the rating process for ART vehicles is exactly the same as for commercial or personal lines carriers. What changes, however, are the facts, circumstances and information that analysts gather in order to come up with the rating. “Because ART companies are unique, there are things we can consider that would be outside consideration in the rating process of a commercial carrier,” he said.

A.M. Best has just begun the 30-day public comment period on the proposed new methodology, which will be followed by time for consideration of those comments and potential implementation, said Chirico.

According to criteria report, the ART marketplace was born out of insurance capacity shortages and price volatility of the commercial insurance market that historically have resulted from the vagaries of the underwriting cycle. ART vehicles therefore have the mission to provide consistent, tailored coverage at stable pricing to policyholder owners with a focus on capital preservation rather than on profit and return measures.

The report said most ART entities have a limited market share and therefore a limited market profile compared to many commercial insurers. While market profile is important in the rating process for any insurer, ART vehicles can be different in that they can have customized coverages, customer-specific claims and loss-control solutions, and board representation from owner insureds, the report said.

The updated ART criteria report is designed to delineate specific rating considerations that are intended to supplement the Rating Captives section of Best’s Credit Rating Methodology — Global Life and Non-Life Insurance Edition. The report breaks ART vehicles into the broad categories of single-parent (or pure) captives, non-risk retention group — group captives, risk retention groups and self-insurers funds. Protected cell corporations, or “cell captives,” are covered under a separate A.M. Best criteria report.

See a video interview with Chirico at http://bcove.me/yal6edob

(By Ron Panko, senior associate editor, Best’s Review: Ronald.Panko@ambest.com)

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