ETHICS

 

 

 

INSURER SOLVENCY

 

 

 

  Many companies rate the financial strength of other companies.  Several rating services do so for insurance companies, but one of the best known among them is A.M. Best. They are not the only company that does so, but we will use them as our example here.

 

 

A.M. Best

 

  The following two paragraphs are taken directly from the A.M. Best website:

 

  The rating process used to develop a Best's Credit Rating opinion represents a comprehensive analysis consisting of a quantitative and qualitative evaluation of balance sheet strength, operating performance and business profile or, where appropriate, the specific nature and details of a security. The analysis may include comparisons to peers, industry standards and proprietary benchmarks as well as assessments of operating plans, philosophy, management, risk appetite and the implicit or explicit support of a parent or affiliate. The analysis is completed considering applicable BCRM criteria procedures or models.

 

  A.M. Best's Credit Rating Methodology (BCRM) is divided into two parts: 1) the Introduction contains a description of the rating process, information requirements, an overview of the credit rating evaluation, assumptions & economic factors, and key quantitative and qualitative rating factors and 2) the Insurance Criteria Procedure Reports describes the criteria employed.

 

 

 

RATING LEVELS AND CATEGORIES

 Level

A++, A+

A, A-

B++, B+

Category

Superior

Excellent

Very Good

Level

B, B

C++, C+-

C, C-

Category

Good

Fair

Marginal

Level

D

E

F

Category

Below Minimum Standards

Under State Supervision

In Liquidation

 

RATING MODIFIERS

 e = Parent Rating

 g = Group Rating

 s = Consolidated Rating

 p = Pooled Rating

 r = Reinsured Rating

 q = Qualified Rating

 x = Revised Rating

 w = Rating Watch List

 

RATING “NOT ASSIGNED” CATEGORIES

NA-1 Special Data Filing

NA-2 Less Than Minimum Size 

NA-3 Insufficient Operating Experience

NA-4 Rating Procedure Inapplicable

NA-5 Significant Change

NA-6  Reinsured by Unrated Insurer

NA-8  Incomplete Financial Information

NA-9  Company Request

NA-11 Rating Suspended

 

FINANCIAL PERFORMANCE INDEX (FPI)

  The Financial Performance Index (FPI) is assigned to companies with Rating “Not Assigned” categories of NA-2 and NA-3.  The FPI measures the financial strength of small or new companies and is based on the following numerical scale.

FPI

8 & 9

6 & 7

4 & 5

2 & 3

1

Description

Strong

Above Average

Average

Below Average

Not Assigned

 

 

FINANCIAL SIZE CATEGORIES

(In $000 of Reported Policyholders' Surplus Plus Conditional Reserve Funds)

   Class I

Up to

$1,000

   Class IX

$250,000 to

$500,000

   Class II

$1,000 to

$2,000

   Class X

$500,000 to

$750,000

   Class III

$2,000 to

$5,000

   Class XI

$750,000 to

$1,000,000

   Class IV

$5,000 to

$10,000

   Class XII

$1,000,000 to

$1,250,000

   Class V

$10,000 to

$25,000

   Class XIII

$1,250,000 to

$1,500,000

   Class VI

$25,000 to

$50,000

   Class XIV

$1,500,000 to

$2,000,000

   Class VII

$50,000 to

$100,000

   Class XV

$2,000,000 or

 more

   Class VIII

$100,000 to

$250,000

 

 

 

 

 

QUANTITATIVE EVALUATION FROM A.M. BEST

 

  The A.M. Best Company reports that they use an analysis of each company's financial performance for at least the past five years, utilizing over 100 key financial tests and supporting data.  The tests that they use measure each company's performance in three critical areas:

1.  Profitability,

2.  Leverage, and

3.  Liquidity.

 

  These standards are based on an evaluation of the performance of insurance companies for the past twenty years.  These standards are adjusted annually taking into account changes in underwriting, economic and regulatory conditions.

 

  The quantitative analysis is performed at two levels:

1) The first utilizes NAIC (National Association of Insurance Commissioners) statement data as submitted by the individual companies.  This data is used to calculate many of the resulting tests and ratios that appear in A.M. Best's published reports.

2) The second level of quantitative analysis uses NAIC statement data which is adjusted for two factors:

(a) Policyholders surplus which is a key denominator for many of the quantitative tests, and

(b) The company's affiliation with other insurers through investment, pooling, marketing or reinsurance agreements in order to perform the most appropriate quantitative evaluation.

 

  Company data must be adjusted to present affiliated insurance companies on a consolidated basis to evaluate the financial condition of an affiliated group of insurance companies on the same basis according to how the business is actually managed.

 

  There are several areas that must be looked at in order to understand a quantitative analysis of a company.

1.   Profitability: It should come as no surprise that profit is a measure of the ability, competence and skill of the company’s management.  This is certainly true of insurance companies as well.  Profit is the result of the management to provide viable insurance products at competitive prices, which maintains a financially healthy company. Operational profitability (underwriting and investment income) is the single most recurring and important source of surplus growth for an insurance company.  Surplus represents additional security for the policyholders.  It is protection against events that negatively affect the company.

2.   Leverage: A company typically has exposure to some risks.  Leverage measures the exposure of an insurance company's surplus to the various operating and financial practices.  A highly leveraged company can show a high return on their surplus, but may also be exposed to a high risk of instability.  A conservative level of leverage enables an insurer to better withstand adverse changes in such things as underwriting results, investment returns, regulatory, or economic conditions.  This is generally at the cost of lower returns on surplus.

 

  While leverage may be generated from several different sources, there tends to be four typical ones:

            1.   Current writings

            2.   Reinsurance

            3.   Policy or loss and loss adjustment expense reserves

            4.   Investments

 

  These types of leverage are reviewed by A.M. Best for a five year period to analyze changes in trends and magnitudes.  In order to measure each company's exposure to pricing errors in its book of business, they review the ratio of direct and net premiums written to surplus, gross and net of reinsurance.  To measure each company's exposure and dependence on reinsurance, they review the ratio of reinsurance premiums and reserves ceded and related reinsurance recoverables to surplus. To measure each company's exposure to unpaid obligations, unearned premiums and exposure to reserving errors, A.M. Best reports that they analyze the ratio of net liabilities to surplus.  There are adjustments made which take into consideration many factors that might affect analysis.  This would include such things as pyramiding, inadequacy or redundancy of policy or loss reserves, equity in unearned premiums, differences between statement and market value of assets and potential asset default risks.  This list is not inclusive and may also include other factors.

 

  It should be noted that leverage is a relative measure.  Each company may have unique features which affect the end result.  Some of these features may include such things as:

            1.   Spread of risk,

            2.   Soundness and appropriateness of the reinsurance program,

            3.   Quality and diversification of the assets, and

            4.   Adequacy of loss or policy reserves.

 

Liquidity: as insurance agents, we are all familiar with the term, liquidity.  Liquidity measures a company's ability to meet its anticipated short and long-term obligations, which includes policyholder claims.  Each company must have liquidity to some degree.  The level of a company's liquidity depends upon the degree by which it can satisfy its financial obligations by holding cash and other investments, which are sound, diversified and liquid.  If a company experiences unexpected obligations and does not have enough liquid assets on hand to meet those obligations, it might then be forced to sell other less liquid assets at a bad time which might result in investment losses.  The company might also be forced to borrow funds, or sell long-term investments too soon.  A high degree of liquidity enables the company to meet those unexpected obligations without adverse effects on their general investment portfolio.

 

 

QUALITATIVE EVALUATION BY A.M. BEST

 

  Besides the quantitative analysis of the company's financial performance, A.M. Best also performs a qualitative analysis.  This includes such things as the company's:

            1.   Spread of risk,

            2.   Quality and appropriateness of the reinsurance program,

            3.   Quality and diversification of assets,

            4.   Adequacy of policy or loss reserves,

            5.   Adequacy of surplus,

            6.   Capital structure,

            7.   Management's experience and objectives, and

            8.   Policyholders' confidence in the company.

 

  There may be additional elements studied if other factors seem to apply.

 

 

UNDERSTANDING THE RATING SYSTEM

 

  It should be pointed out that there are several companies that rate insurance companies.  We are not implying that A.M. Best is either the only company, nor necessarily the best company at rating insurers.  It is, however, one of the best known rating companies.  Even so, we recommend that all company rating services be looked at.  They may not necessarily give the same performance rating to the insurers so it does give the agent a better perspective if other rating firms are also considered.

 

  For our purposes we are going to examine how A.M. Best rates insurers.  If an agent does not understand the rating procedures, he or she is at a disadvantage when selecting which insurance carriers they wish to represent.

 

  The annual and first quarter review and assignment of Best's Ratings begin in the spring of each year.  That is after the receipt of the annual NAIC statement, which is due on March first.  It is also after the first quarter statements are due on April fifteenth.  Official notification of the assigned rating is sent to the chief executive officer of each insurance company for acknowledgment before its release for publication.  Beginning in April, ratings are released on a weekly basis as they are assigned. 

 

  Ratings are subsequently reviewed based on a company's six and nine month quarterly financial results.  Sometimes, these ratings may be released more frequently if there seems to be a situation that warrants it.  The ratings are released to subscribers of A.M. Best in the September and December issue of Best's Rating Monitor and are updated on BestLink and BestLine publications.  Interim rating changes are released immediately in Best's Insurance Management Reports publication. 

 

  It should be noted that A.M. Best revised their rating structure in 1992 to add finer distinctions among the letter ratings used.  Three rating levels were added:  A++, B++ and C++.  In addition, there are three new rating categories that will simplify and complete the structure.  The new categories are D, E and F.

 

 

A++ and A+ (Superior)

 

  These letter and symbol ratings are assigned to companies, which, in the opinion of A.M. Best, have achieved superior overall performance when compared to the standards established by A.M. Best.  The companies in this rating category have a very strong ability to meet their obligations to the policyholders over a long period of time.

 

 

A and A- (Excellent)

 

  This rating is assigned to companies, which in the opinion of A.M. Best, have achieved excellent overall performance when to the standards established by A.M. Best. A and A- insurance companies have a strong ability to meet their obligations to their policyholders over a long period of time.

 

 

B++ and B+ (Very Good)

 

  These two ratings are assigned to insurance companies which, in the opinion of A.M. Best, have achieved very good overall performance when compared to the standards established by the the A.M. Best company.  These companies have a strong ability to meet their obligations to their policyholders, but their financial strength may be susceptible to unfavorable changes in underwriting or economic conditions.

 

 

B and B- (Good)

 

  Assigned to companies, which in the opinion of A.M. Best, have achieved good overall performance when compared to the standards A.M. Best has established.  Companies with these two ratings generally have an adequate ability to meet their obligations to their policyholders, but their financial strength is susceptible to unfavorable changes in underwriting or economic conditions.

 

 

C++ and C+ (Fair)

 

  C++ and C+ are assigned to insurance companies which, in the opinion of A.M. Best, have achieved fair overall performance when compared to the standards established by the A.M. Best Company.  These companies generally have a reasonable ability to meet their obligations to policyholders, but their financial strength is vulnerable to unfavorable changes in underwriting and/or economic conditions.

 

 

C and C- (Marginal)

 

  Marginal ratings are assigned to companies, which in the opinion of A.M. Best, have achieved marginal overall performance when compared to the standards established by the A.M. Best company.  These companies have a current ability to meet their obligations to policyholders, but their financial strength is very vulnerable to unfavorable changes in underwriting and/or economic conditions.

 

 

D (Below Minimum Standards)

 

  This rating is assigned to companies which, in the opinion of A.M. Best company, meet their minimum size and experience requirements, but do not meet the minimum standards established by the A.M. Best company for a C- rating.  This rating category was formerly called the NA-7 Rating "Not Assigned" category.

 

 

E (Under State Supervision)

 

  This rating is assigned to companies which are placed by a state insurance regulatory authority under any form of supervision, control or restraint.  This would include conservatorship or rehabilitation.  It would NOT include liquidation.  This rating could be assigned to a company under a cease and desist order issued by a regulator from a state other than its state of domicile.  This rating category was formerly the NA-10 Rating "Not Assigned" category.

 

 

F (In Liquidation)

 

  Assigned to companies which have been placed under an order of liquidation or have voluntarily agreed to liquidate.  This is a new rating category for A.M. Best which was created in 1992 to distinguish between companies under state regulatory supervision (E) and those in the process of liquidation (F).

 

 

RATING MODIFIERS:

 

  A.M. Best adds a Rating Modifier to the ratings A++ through F to identify a company whose assigned rating has been modified because of performance, affiliation or contractual obligations with one or more other insurance companies.  The modifier appears as a lower-case (small) suffix to the rating.  For example, you might see a rating of Ae.  The lower-case "e" is the modifier.  The Rating Modifier gives interested parties a quick reference to the technical basis of the assigned rating.  Anytime one of these modifiers appears, the agent will want to make note of the technical basis of the rating.

 

  There are different types of modifiers:

 

Performance Modifiers

 

"c" = Contingent Rating, which was eliminated in 1992, indicates there has been a modest decline in the company's current financial performance.  However, the decline has not been significant enough to warrant an actual reduction in the company's assigned rating.  A.M. Best's evaluation may be based on the availability of more information and/or contingent on the successful execution of a program of correction action by the company's management.  The evaluation by A.M. Best may also reflect situations involving matters of a more subjective nature.

 

"q" = Qualified Rating, which indicates the company's assigned rating has been qualified to identify those insurers whose financial strength could adversely be affected by:

            1.   Existing or pending state legislation which mandates rate restrictions or surcharges that cannot be passed on to the policyholders, or

            2.   Payments that are due from mandated state residual market programs or reinsurance facilities equal to, or in excess of, their policyholders' surplus.  The company's current rating does not reflect the potential impact of these programs as they represent a future circumstance which could not be quantified when the rating was assigned.

 

"w" = Watch List, which indicates the insurance company was placed on A.M. Best's watch list during the year to advise interested parties that the company is under close surveillance because it has experienced a downward trend in its current financial performance or may be exposed to a possible legal, financial or market situation which may adversely affect its performance.

 

 

"x" = Revised Rating, which indicates the rating shown was revised during the year.

 

 

Affiliation Modifiers:

 

  Affiliation Modifiers are used by A.M. Best to identify a company whose assigned rating is based on an affiliation or contractual relationship with one or more other insurers.

 

"e" = Parent Rating, which indicates the rating assigned by A.M. Best is actually that of the parent company of a domestic subsidiary in which ownership exceeds 50 percent.  The rating is based on the consolidated performance of the parent company and its subsidiaries.  To qualify for a Parent Rating under A.M. Best, the subsidiary must be eligible for a rating based on its own performance after attaining five consecutive years of representative experience; have common management with its parent; underwrite similar lines of business; and have interim leverage and liquidity performance comparable to that of its parent company.

 

"g" = Group Rating, which indicates the rating is assigned to an affiliated group of property/casualty companies.  To qualify for a Group Rating, the companies in the group must be affiliated by common management and/or ownership; pool a substantial portion of their net business; and have only minor differences in their underwriting and operating performance.  All members are assigned the same rating and Financial Size Category by A.M. Best Company, based on the consolidated performance of the group.

 

"p" = Pooled Rating, which indicates the rating assigned to companies under common management or ownership which pool 100 percent of their net business.  All premiums, expenses and losses are prorated in accordance with specified percentages that reasonably relate to the distribution of the policyholders' surplus of each member of the group.  All members participating in the pooling arrangement are assigned the same rating and Financial Size Category by A.M. Best Company, based on the consolidated performance of the group.

 

"r" = Reinsured Rating, which indicates the rating and Financial Size Category assigned to the company are those of an affiliated carrier which reinsures virtually all of the company's net premiums written.

 

"s" = Consolidated Rating, which indicates the rating is assigned to a parent company and is based on the consolidated performance of the company and its domestic property/casualty subsidiaries in which ownership exceeds 50 percent.  The rating applies only to the parent company, as subsidiaries are normally rated on the basis of their own financial condition and performance by A.M. Best Company.

 

 

RATING "NOT ASSIGNED" CATEGORIES:

 

  About 52 percent of the companies reported on by A.M. Best (Life/Health 1992 Edition of Best's Agents Guide) are not assigned a Best's Rating of A++ through F.  Those companies not receiving an A++ through F rating are assigned to a Rating "Not Assigned" category, which is abbreviated NA.  It is comprised of 11 categories to identify the reason why the company was not assigned a letter designation by A.M. Best.  The primary reason is identified by the appropriate numeric suffix.  If additional reasons apply, they are referred to in the full report in the A.M. Best's Insurance Reports publication.

 

NA-1 = Special Data Filing

  NA-1 is assigned primarily by A.M. Best to small companies that are exempt from the requirement to file the standard NAIC annual statement or have not provided A.M. Best with a copy of their NAIC statement.  The reports on these small companies are based on selected financial information which is collected by A.M. Best or which are purchased from the NAIC (Life/Health only).

 

NA-2 = Less than Minimum Size

  NA-2 is assigned to companies that file the standard NAIC annual statement, but do not meet A.M. Best's minimum size requirement.  In order to assure reasonable financial stability, A.M. Best requires a company to have a minimum policyholders' surplus of a designated dollar amount.  This rating category is also assigned to a company that is effectively dormant, has no significant premium volume, or has no net insurance business in force.  A company that is 100 percent reinsured by a Best's rated company would be an exception.  Also an exception is the company that is a member of a group participating in a business pooling arrangement or a company writing stable lines of business that has demonstrated a long history of above average performance when compared to Best's Rating standards. 

 

NA-3 = Insufficient Operating Experience

  NA-3, Insufficient Operating Experience, is assigned to companies that meet, or that A.M. Best anticipates will meet, their minimum size requirement, but has not accumulated five consecutive years of representative operating experience.  This requirement pertains only to the age of the company's financial performance and does not relate to the actual experience of its management team.  A.M. Best's operating experience requirement requires consistency in both the types of coverages written and the relative volume of gross and net premium writings.  Additional years of operating experience may be required by A.M. Best if the company exhibits substantial growth in new business or changes in product mix whereby the development of the company's business or reserves may not be sufficiently mature at the end of five years to permit a satisfactory evaluation.

 

NA-4 = Rating Procedure Inapplicable

  NA-4, which is assigned to any company by A.M. Best when the nature of its business and/or operations is such that Best's normal rating procedures do not properly apply.  An example of this would be a property/casualty company that is writing a line of business that does not commonly come in that line of coverage.  This is only one example, but there are many more situations that would also apply.

 

  This rating is also assigned by A.M. Best Company to life/health companies whose sole operation is the acceptance of business written directly by a parent, subsidiary or affiliated insurance company.  It is also assigned when writing predominantly property/casualty insurance under a dual charter.

 

NA-5 = Significant Change

  NA-5 is generally assigned to a previously rated company that experiences a significant change in ownership, management or book of business whereby its operating experience may be interrupted or subject to change.  A.M. Best may assign this rating to any relevant event that has or may affect the general trend of a company's operations.  This would include, but may not be limited to, such things as mergers, sale to a new owner, substantial growth in premium writings or a significant redirection of marketing emphasis.  Depending on the nature of the change, A.M. Best may require a period of one to five years before the company is again eligible for a rating.

 

NA-6 = Reinsured by Unrated Reinsurer

  NA-6 is assigned to companies by A.M. Best when the company has a substantial portion of its book of business reinsured by, or has reinsurance recoverable from, non-Best's rated reinsurers, which represents a substantial portion of its policyholders' surplus.  Exceptions are non-Best's rated foreign reinsurers that do comply with A.M. Best's reporting requirements and satisfy their financial performance standards.

 

NA-7 = Below Minimum Standards 

  The category of NA-7 was discontinued in 1992 and replaced by the Best's Rating of D.

 

NA-8 = Incomplete Financial Information

  The NA-8 rating is assigned to insurance companies that are eligible for a rating by A.M. Best, but fails to submit complete financial information for the current five-year period under review.  This requirement includes all domestic insurance subsidiaries in which the company's ownership exceeds 50 percent.

 

NA-9 = Company Request

  The NA-9 rating is assigned to companies eligible for an A.M. Best rating, but requests that the rating not be published.  The majority of insurance companies making such a request operate in markets that do not require a rating, but cooperate with A.M. Best’s request for financial information in order that a report can be prepared and published on their company.  The classification is also assigned to a company that request its rating not be published because it disagrees with either A.M. Best's rating assignment or their rating fee.  In this situation, A.M. Best normally requires a minimum of two years to elapse before the company is again eligible for the assignment of a rating.

 

NA-10 = Under State Supervision 

  This designation was discontinued in 1992 and replaced by A.M. Best with a rating of either E or F.

 

NA-11 = Rating Suspended

  The NA-11, Rating Suspended, is assigned by A.M. Best to a previously rated company which has experienced a sudden and significant event affecting the company's financial position and/or operating performance, of which the impact cannot be evaluated due to a lack of timely or appropriate information.  This rating was added in the Rating "Not Assigned" category.

 

  It should be noted that this is not a complete explanation of everything that goes into the process used by A.M. Best to rate the individual insurance companies.  However, it should provide a basic guide to their rating systems.  It should also again be pointed out that there are other companies that also rate the financial stability of insurance companies.  Often the ratings assigned are not in agreement.

 

 

MANY RATING COMPANIES TO CHOOSE FROM

 

  As previously noted, A.M. Best is not the only rating company and agents are encouraged to check with more than one company when applying their due diligence for insurer financial stability.

 

  The A.M. Best Company was founded in 1899 by Alfred M. Best (thus the name A.M. Best) with the goal of reporting on the financial stability of insurers and the insurance industry. It is the oldest and most widely recognized provider of ratings, financial data and news with an exclusive insurance industry focus.

 

  Ratings are issued on over 3,500 companies in more than 80 countries worldwide. Best's Credit Ratings are recognized as a benchmark for assessing a rated organization's financial strength as well as the credit quality of its obligations.

 

  A.M. Best is the exclusive provider of all products containing Best's Credit Ratings and related analysis. The rating company covers 16,000 insurance companies globally through a wide range of analytical resources, references, directories and periodicals that provide insurance professionals and consumers with the critical information they need to make informed business decisions.

 

  For agents, this type of research is vital.  Clients, who are much less likely to do the research, would benefit if they did.

 

 

End of Chapter 20

United Insurance Educators, Inc.