General Insurance Rating Criteria

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Credit Rating Company Ltd. vis.com.pk 1 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 CRITERIA FOR GENERAL INSURANCE RATING VIS Credit Rating Company Limited.

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Credit Rating Company Ltd. vis.com.pk 2 VIS Credit Rating Company Limited General Insurance OCTOBER 2023
Table of Contents
SUMMARY OF CRITERIA CHANGES ..........................................................................................................................................3
SCOPE OF CRITERIA..........................................................................................................................................................................3
SUMMARY OF CRITERIA CHANGES ..........................................................................................................................................3
AN OVERVIEW OF RATINGS FRAMEWORK ..........................................................................................................................3
RATING METHODOLOGY...............................................................................................................................................................4
A. QUALITATIVE ELEMENTS .....................................................................................................................................................4
A. (I) Board And Management.................................................................................................................................................5
A. (Ii) Controls And Risk Management.................................................................................................................................5
B. QUANTITATIVE ELEMENTS..................................................................................................................................................6
B. (I) Capitalization......................................................................................................................................................................6
B. (Ii) Liquidity...............................................................................................................................................................................6
B. (Iii) Earnings And Franchise Value....................................................................................................................................7
B. (Iv) Reinsurance ......................................................................................................................................................................8
GENERAL INSURANCE RATIOS....................................................................................................................................................8
A. UNDERWRITING .......................................................................................................................................................................8
B. CAPITALIZATION......................................................................................................................................................................8
C. LIQUIDITY.....................................................................................................................................................................................8
D. PROFITABILITY..........................................................................................................................................................................9
RATING SCALE & DEFINITIONS ...................................................................................................................................................9

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Credit Rating Company Ltd. vis.com.pk 3 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 SUMMARY OF CRITERIA CHANGES In this updated methodology, environmental, social, and governance (ESG) considerations have been integrated to align with current assessment standards. SCOPE OF CRITERIA The criteria ‘Insurer Financial Strength (IFS) Rating Methodology’ applies to a range of entities operating in the insurance sector conducted by VIS Credit Rating Company Limited (VIS). An IFS rating is an assessment of an insurance company’s capacity to meet its contractual obligations that mainly constitutes of claims on insurance policies. However, timeliness of these payments is not commented on as is the case in conventional corporate credit ratings. The level of risk faced by an insurer is a function of the implicit and explicit risks associated with the business being underwritten. An IFS rating is defined as an evaluation of the company’s ability to bear the associated risks which are reflected in the strength of its cash flows, liquidity reserves, access to credit or capital and most importantly, strength of its reinsurance arrangements. As per VIS’ general insurance methodology, insurance industry is subdivided into three segments based on their Relative Market Shares (RMS); large, having RMS above 3.0x of 3-year trailing average industry premium, medium sized having a share between 0.75x and 3.0x and small, having RMS of below 0.75x. Each segment has well defined benchmarks, against which a company is analyzed. SUMMARY OF CRITERIA CHANGES This criteria is based on the fundamentals used in the last updated criteria documents. The fundamental criteria as outlined in ‘Rating Methodology – General Insurance’ dated November 2019 remains the same with no changes to the ratings framework itself. This document aims to lay out in more detail the key areas of assessment when reviewing IFS ratings and provides additional guidance on the relevant factors within the existing framework. In line with various changes in the local insurance industry over the past several years and the international guidelines, VIS has modified the Rating Scale for Insurer Financial Strength (IFS) Rating. The IFS rating scale is revised to create a clear distinction in symbols of IFS Ratings against Credit Ratings as well as to address any ambiguity with respect to rating category. For greater clarity, rating definitions have also been modified. AN OVERVIEW OF RATINGS FRAMEWORK The goal is to allow each stakeholder to know in detail, each of the major rating drivers and ultimately what factors may change the ratings in the future. VIS analyses both the intrinsic fundamental characteristics of the insurer along with the environment in which the company operates. The existing legal and regulatory environment, the number and size of the players operating in the market, extent of technological advancement and the entry and exit barriers in effect, have a bearing on the
opportunities that the company can capitalize upon, and also threats that it may encounter. Along with the macroeconomic view of the industry, company specific analysis based a combination of qualitative and quantitative factors is also conducted. Qualitative factors such as management expertise and internal controls are considered; as per methodology, these factors play a vital role in forming a healthy financial position. Furthermore, ownership structure, business and corporate strategies and vision that drives the institution, are important determinants of an entity’s prospects.

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Credit Rating Company Ltd. vis.com.pk 4 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 Finally, ratings take into account the external support available to the entity and may be enhanced on the basis of the extent of support from sponsors / shareholders, associated companies etc. and the relative standing of the supporting entity. Key factors that are considered in assessing financial strength of an insurance company include:
RATING METHODOLOGY
Our assessment model is based on some key factors, qualitative and quantitative, which may further be broken-down into sub-factors to comprehensively capture the rating drivers. A. QUALITATIVE ELEMENTS Industry Risk Profile Competitive Position Corporate Governance & Management Evaluation Financial Risk Profile Organizational Risk Management Liquidity Position BUSINESS RISK SUB-FACTORS Industry Risk Management & Organization Profile Operational Risk

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Credit Rating Company Ltd. vis.com.pk 5 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 Industry risk along with operational risk and management & organizational profile of a specific company determines mainly the business risk of an entity. The business risk of a company to a large extent is dependent on financial performance over the years and the premium pricing power the insurance company enjoys in the market. A. (i) Board and Management The strength of the sponsors and composition of the board and its committees are important features of a sound business. The profile of the board members and their experience in the insurance industry is of a considerable advantage, and may be gauged through their contribution to the company in terms of providing it with a vision and becoming the main source of business strategy. VIS also considers management quality and organizational structure as a key element in the rating process since it is critical to the overall performance of a company. The primary purpose of these factors is to understand how the board’s vision and strategy is translated into daily operations. Team experience and competence, corporate structure and decision-making hierarchy are also considered. A good management develops the company’s competitive position and manages resources in a prudent manner. Vision, objectives and strategies, are viewed in relation to the existing macro environment. Evaluation of the management’s strategies, operations, efficiencies and risk tolerance, as well as an insurer’s competitive advantage in the marketplace will influence our opinion of future financial performance. Our analysis also considers whether vision cascades down to lower management, ensuring a high level of commitment. Details regarding succession planning are also taken into account to evaluate the extent of stability in the management hierarchy. A. (ii) Controls and Risk Management Insurance companies are normally exposed to a large number of risks; the exact quantum of which is not known at the inception of a policy. As such, it is vital for these companies to develop strong risk management systems, which can help identify concentration levels and assist in mitigating the risk of extraordinary losses. Internal audit systems should be comprehensive and reliable. Risk management involves diversifying sector exposures, minimizing single event risks and identifying recurrent loss areas. Management Information System (MIS) needs to be robust enabling the company to undertake scenario testing. While evaluating MIS, the extent of networking between branches, which may enable ready and immediate access to branch data, and the level of data backup and security are also taken into consideration. Diversification of risks is considered to be a primary source of risk mitigation. Larger companies that demonstrate a spread of business in terms of business lines or geographic dispersion are less exposed to risks associated with particular
types of exposures. The company’s presence in different geographical areas, branch and agent network and its marketing strategy are also viewed to identify its growth potential. In captive insurance companies the evaluation of concentration related risks becomes even more important. In Pakistan, where not many large, diversified conglomerates are present; small companies are often exposed to greater sectoral concentration. Controls also involve the systems in place for managing the distribution channels. Quality of agreement with insurance agents, the checks and constraints imposed on the agents’ business and timely monitoring of the same are important. The general insurance sector, pivotal in providing protection against diverse risks, is seeing a growing emphasis on ESG integration. Environmentally, insurance companies are increasingly evaluating the sustainability practices of their policyholders, considering factors like environmental risk management and carbon footprints, especially when underwriting policies for businesses. Socially, insurers are becoming more attentive to the societal implications of their products, ensuring they promote fairness, inclusivity, and do not inadvertently support harmful practices. Governance, with its focus on transparency, ethical behavior, and stakeholder engagement, is taking center stage, ensuring that insurance companies maintain the

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Credit Rating Company Ltd. vis.com.pk 6 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 trust of their policyholders. By seamlessly integrating these ESG factors into their methodologies, general insurers can better anticipate emerging risks, align with stakeholder expectations, and contribute to a more sustainable and resilient society. B. QUANTITATIVE ELEMENTS An insurance company’s ability to withstand shocks is usually affected by its market reach and the spread of business. Development of efficient internal systems and depth in management also requires an adequate resource base. Smaller companies are generally exposed to higher concentration risks emanating from a weak reinsurance arrangements and corresponding higher internal risk retention. These companies face greater competitive pressures and may not have easy access to external capital and liquidity support. These factors, if found to be present, will typically tend to constrain ratings. Individually, primary quantitative drivers of IFS ratings and key benchmarks for the same have been discussed below as part of this rating methodology. B. (i) Capitalization Strong capitalization enables an insurer to better withstand large underwriting losses and minimize impact of volatility in investment income while also allowing management to take advantage of growth opportunities in the market. While the Insurance Ordinance 2000 has set minimum capital requirements (MCR) for insurance companies, meeting the MCR alone does not necessarily imply sufficient capital. Adequacy of capital is evaluated in the context of the segment-wise exposures and the historical loss trends in these segments. Moreover, VIS analyses the strength of an insurer’s capital base through various leverage ratios measuring the level of business underwritten and technical reserves against the level of capitalization. The soundness of operating and financial leverage along with quantum of technical reserves and surplus are important rating factors. While determining the level of capitalization, hidden reserves and impairments are also taken into consideration. Furthermore, composition of technical reserves is evaluated to assess the extent to which these are held against payable claims or unearned premiums. The Insurance Ordinance prescribes creating an additional ‘premium deficiency reserve’ if a time series analysis shows technical reserves have been insufficient, on an average, to meet losses net of reinsurance recoveries. IFS rating may be enhanced on the basis of the extent of support from sponsors / shareholders, associated companies, etc. VIS takes into account how important the company is to the group, the relative financial health of the group and any explicit or implicit support to the company being rated. VIS seeks to analyze the particular instances in which assistance was required by the company being rated and the degree of support provided by the sponsors in the past. Evaluation of the financial
strength of the group then becomes important to give any benefit in IFS rating including its franchise value, access to funds and diversification element. B. (ii) Liquidity A general insurance company’s liabilities contain an additional uncertainty factor; both, the timing and the amount of the liability are uncertain imposing additional liquidity requirements. A high level of internal cash generation enables an insurer to meet its need for cash without sale of its investments. The primary source of liquidity is the operating cash flows, while liquidation of the investment portfolio is considered to be a secondary source, necessitated only in the event of extraordinary claims. VIS forms an opinion about the health of the invested asset portfolio in terms of liquidity, impairment if any, concentration of exposure and returns. Quality and liquidity of an insurer’s investment portfolio is

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Credit Rating Company Ltd. vis.com.pk 7 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 assessed to determine the level of coverage against its insurance related liabilities. Another key component of this analysis is the solvency margin; regulations have specified guidelines for the admissibility of assets to determine the solvency margin of a company. The solvency ratio is a key metric used to measure the insurer’s ability to meet its contractual obligations and it indicates whether a company’s cash flow is sufficient to meet its liabilities. The level of insurance debt is evaluated as an indicator of the insurer’s cash cycle and its relationship with, and dependence on its agents, co-insurers and re-insurers. Aging of insurance debt and its overall mix allows for an assessment of the quality and recoverability of these receivables. Lower levels of insurance debt as a proportion of gross premium are considered as indicators of adequate level of liquidity. Insolvency risk is defined as the risk of loss (or of adverse change) in the financial situation of a company which results from fluctuations in the credit standing of issuers of securities, counterparties and any debtors to which a solvency undertaking is exposed, in the form of counterparty default risk, spread risk, or market risk concentration. Insolvency risk of general insurance firms consist of three components. The first is the credit quality of their investment portfolio, whose performance we measure using investment returns. Investment portfolio of insurance companies also remains exposed to market risk. The second is the counterparty risk through reinsurance activity. A high reinsurance ratio increases the credit risk exposure of firms. The third is the direct default risk of insurers when their liabilities are greater than their assets and therefore, they might become insolvent. The financial health of firms is measured using the leverage, profitability, solvency and liquidity ratios. Size, growth and claims volatility are also taken into account. In the insurance sector, unlike the banking sector, there is no central bank that acts as the lender of last resort. In insolvency situations, there is lack of such liquidity support. In addition, limitations due to cross border transactions with respect to reinsurers together with inefficiencies in the judicial system related to claim processing may lead to liquidity concerns for the insurance companies. VIS believes that lack of depth in the capital markets also constraints timely access to liquidity. All these factors pose a limitation to higher ratings. B. (iii) Earnings and Franchise Value Profitability of an insurance company is a function of its underwriting and investment strategy. The choice of business segment, geographical outreach and diversification of underwritten risks are the key determinants of claim incidence operating expenditure as well as the company’s cash cycle. Large swings in business segments may
indicate a shift towards riskier business lines and may be impelled by liquidity or growth-related objectives. Conversely, a shift in focus may also be motivated by a need to minimize running costs or avoid excessive claim losses. Rapid premium growth, particularly for smaller, less diversified companies may indicate excessive risk undertaken. Sudden increments in premium written during any one year may be motivated by large losses from old policies and need to be monitored closely. A company’s pricing strategy and whether it is in consonance with risks underwritten is also an important element affecting performance over the longer run and in assessing sustainability in earnings. Trends on claims and expenses are also assessed. Segment-wise analysis of claims is carried out to determine each business line’s impact on overall profitability. To determine operating efficiency, business generation and operational costs are also evaluated in relation to the premium generated. Investment income serves to dampen the stress on underwriting streams. Well-diversified and mature insurance companies may sometimes also post underwriting losses, which are offset by returns on the investment portfolio. The

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Credit Rating Company Ltd. vis.com.pk 8 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 quality, diversity and returns of different segments of the investment portfolio are important determinants of investment support to underwriting risk. They are therefore an area of interest, while assigning ratings. B. (iv) Reinsurance Reinsurance arrangements are integral to the mitigation of insurance risks. An insurer’s relationship with its reinsures and the financial standing of reinsurance companies on its panel are an important consideration in assigning rating. Ratings of reinsurers assist in forming an opinion on their financial strength. Reinsurance treaty terms determine the capacity of an insurer to take risks and changes in terms often indicate an insurer’s track record of risk management. There are different kinds of covers provided by a reinsurer. Covers such as surplus, quota or excess of loss are most commonly used. These covers are negotiated for every business segment individually and are based on the company’s expectations for losses in these segments. Certain exposures, e.g., terrorism cover, are also being negotiated by the foreign reinsurers and local insurance companies. As a result, dependence on higher rated reinsurers is increasing as the capacity of these reinsurers to meet claims obligations becomes critical. The international ratings of the reinsurers and soundness of negotiated treaties with them have a bearing on assignment of IFS ratings to the local insurers. The reinsurers’ performance is also indicated by the quantum and aging of reinsurance receivables. The extent of impairment is also determined to evaluate stress on liquidity. Timely cash collection is important, especially for smaller insurance companies, which may not have readily available liquidity to meet large losses. An insurer’s retention ratio determines the proportion of risk retained by the company. Ideally, an insurer’s own retention should be between 40-60% of gross premium. Unusually high retention levels could signal inadequate reinsurance protection, while low retention could hamper profitability. In companies with excess of loss (XOL) coverage for a significant portion of their business, the retention ratio would tend to be high. The adequacy of this cover can be assessed through a comparison between the treaty’s protection level and average claim size over the period of assessment. GENERAL INSURANCE RATIOS A. UNDERWRITING

Gross Claims Ratio: Claims Expense / Premium Earned
Net Claims Ratio: Net Claims Expense / Net Premium Revenue
Cession: Reinsurance Ceded / Premium written
B. CAPITALIZATION
Gross Financial Leverage: Gross Technical Reserves1 / Adjusted Shareholder’s Equity2
Net Financial Leverage: Net Technical Reserves3 / Adjusted Shareholder’s Equity
Operating Leverage: Net Premium Revenue / Adjusted Shareholder’s Equity
C. LIQUIDITY
Insurance Debt to Gross Premium: Insurance Debt4 / Premium Written
Liquid Assets to Technical Reserves: High Quality Liquid Assets / Net Technical Reserves

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Credit Rating Company Ltd. vis.com.pk 9 VIS Credit Rating Company Limited General Insurance OCTOBER 2023

Liquid Assets to Gross Claims Outstanding: High Quality Liquid Assets / Provision for Outstanding Claims
Net Operating Cash Flow: Cash Flow from Operations + Dividend Income + Rental Income + Recurring Investment
Income
Cash Premium Written: Premium Written – Reinsurance Ceded + Change in Outstanding Premium
D. PROFITABILITY
Underwriting Profit: Net Premium Revenue – Net Claims – Operating (Management) Expenses (+) /- Net
Commission - General and Admin Expenses
Underwriting Expense Ratio: [Management Expense (+)/- Net Commission + General & Admin Expenses] / Net
Premium Revenue
Combined Ratio: Net Claims Ratio + Underwriting Expense Ratio
Net Operating Ratio: Combined Ratio - [Recurring Investment Income / Net Premium Revenue]

Provision for Outstanding Claims + Provision for Unearned Income + Commission Income Unearned
Equity + [unrealized surplus on all investments]
Gross Technical Reserves - Prepaid Reinsurance Ceded
Premiums due but unpaid + Amount due from other insurers and reinsurers
RATING SCALE & DEFINITIONS
Rating scale and Definitions may be accessed at (https://docs.vis.com.pk/docs/VISRatingScales.pdf)

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Credit Rating Company Ltd. vis.com.pk 10 VIS Credit Rating Company Limited General Insurance OCTOBER 2023

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Credit Rating Company Ltd. vis.com.pk 11 VIS Credit Rating Company Limited General Insurance OCTOBER 2023 Information herein was obtained from sources believed to be accurate and reliable; however, VIS does not guarantee the accuracy, adequacy or completeness of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. Rating is an opinion on credit quality only and is not a recommendation to buy or sell any securities. Copyright VIS Credit Rating Company Limited. All rights reserved. Contents may be used by news media with credit to VIS. Islamic International Rating Agency – Bahrain – iira.com Credit Rating Information & Services Ltd. – Bangladesh – crislbd.com Japan Credit Rating Agency, Ltd. - Japan China Chengxin International Credit Rating Company Limited - China 128/C, 25th Lane off Khayaban-e-Ittehad, Phase VII, DHA, Karachi Tel: (92-21) 35311861-64 431, Block-Q, Commercial Area, Phase-II, D.H.A. Lahore - Cantt. Tel: (92-42) 35723411-13 www.vis.com.pk info@vis.com.pk VIS Credit Rating Company Ltd. DISCLAIMER