Fitch Sets New Capital Model

NU Online News Service

Fitch introduced its new economic capital model yesterday, asserting it was the most significant event in this area since the introduction nearly 20 years ago of risk-based capital measurements.

Fitch analyst James Auden said the model called Prism advances the game by taking a factor-based platform such as RBC to a full stochastic platform with random variables.

"This allows all risks within a business to be modeled simultaneously and interactively, unlike factor models that look at each risk in isolation," he said.

In that regard, Prism strongly aligns the goals of enterprise risk management with prospective analysis focusing on risk drivers, correlation and diversification among various risk exposures.

Fitch yesterday presented the results of beta testing conducted using 2005 year-end data for U.S. property-casualty insurers.

Among the observations of how Prism differs significantly from traditional factor-based models and traditional leverage ratio analysis:

o Prism indicates an increase in required capital on every new dollar of written premium due to Fitch's forecast of softening market conditions in most lines.

o As a group, auto insurers performed the strongest of any non-life sector under Prism in 2005, reflecting the group's lack of catastrophic risk and high levels of stability in both underwriting and reserving.

o Interest rate risk in p-c carriers is significant, and for most insurers its related capital requirements are greater than both credit and equity risk related capital requirements. Current factor-based models overlook this exposure to interest rate risk.

o For insurers heavily exposed to concentrated catastrophic risk, Prism indicates that required capital can materially exceed the 100-year probably maximum loss and 250-year PML thresholds used in certain factor-based models. On the other hand, when catastrophe risk is moderate and part of a diversified portfolio, required capital contributed from catastrophic risk can be less than a 100-year PML.