S&P defines a failure as a company placed under regulatory supervision because of financial stress.

The declines were surprising to analysts at the New York-based rating agency, who had predicted that p-c failures would reach dangerous levels in the event of an economic downturn. (See NU, March 5, 2001, page 1.)

Don Watson, director of insurance ratings, noted that roughly 2,000 of the 2,300 p-c companies in the United States are small entities, with less than $10-to-$15 million in capital. Such companies tend to get “a lot of noise in their numbers,” as a result of “localized phenomena.”

“If the wind blows, if a hailstorm comes in, if an employer goes bust”any of those could prompt a small-insurer failure, he said, noting that while events like Tropical Storm Allison and Midwest hailstorms occurred in 2001, the failure numbers remained below 2000's.

Mr. Watson noted that “the big event” of 2001 was not “a small insurance company phenomenon,” noting that Sept. 11 losses are concentrated in large insurers. The report notes that 20 insurers and reinsurers had 80 percent of the total loss exposure from Sept. 11, adding that none of the companies were rated below the “A” category, and that none has exposure large enough to threaten solvency.

In 2002, Mr. Watson predicts there will be an uptick in p-c failures that is “not insignificant.” That is “paradoxical,” he said, because “rate improvement is significant” even for the small players.

“This is catch-up time,” he said. “While the market has improved, the catch-up of the underpricing of the last three or four years” will damage financials, prompting regulatory action, he predicted. The rate hikes wont be sufficient to offset losses that come in from policies written three years ago, he said.

The report notes that all the insurers that failed in 2001, which were also rated by S&P, carried financial strength ratings of “double-B” or lower before regulators took control. (Under S&Ps system, ratings of “triple-B” or better are considered “secure,” while those at “double-B” and lower are considered “vulnerable.”)

But the timeframe between the assignment of a “double-B” rating and regulatory action may be shrinking, if recent events are any indication.

One of the shortest lapses in recent memory came just two days after S&Ps insolvency study was released, when Pennsylania Insurance Commissioner Diane Koken put Mutual Risk Managements “double-B”-rated Legion Insurance Company and Villanova Insurance Company in rehabilitation on March 29.

In mid-February, just before MRM reported a net loss of $86.2 million for 2001 and nearly $100 million for the fourth-quarter of 2001, S&P kicked Legion and Villnovas ratings down to “triple-B” from “single-A.” S&P had put the “single-A” ratings on CreditWatch with negative implications in mid-December, when MRM first indicated that it would take reserve charges and report a fourth-quarter loss.

Just after the earnings announcement, which revealed bigger losses than those pre-announced in December, A.M. Best in Oldwick, N.J., lowered the two Legion group companies to “B” (fair) from “A-minus” (excellent) and S&P downgraded the ratings again, this time to “double-B.” Mr. Watson said the triggering event for S&Ps second downgrade was the fact that MRM revealed that it had sold its mutual fund business in conjunction with its earnings announcement.

“That was important because the cash-generating [mutual fund] business” was no longer present “to offset the weaknesses in their insurance operation.”

Ironically, during an earnings conference call, MRM Chairman Robert Mulderig revealed that main reason for the mutual fund company sale “was to contribute capital to avoid a downgrade” by A.M. Best.

An “NU Online News Service” report on March 29 further revealed that the Best downgrade was one of the events that prompted the Pennsylvania departments move to rehabilitate the insurers. Other problems cited by a department representative were an inability to raise cash because of a negative auditors report, and an inability to collect reinsurance balances.

In general, Mr. Watson said that S&Ps “double-B” rating is not ultimately a failing grade for an insurer. Citing published default statistics that the firm releases each year, he said that only 16.6 percent of the companies rated double-B will ultimately fail. “Youre talking about 85 percent that will still be around in a year, or even five years from now,” he said, stressing that a “double-B” company is just in a category where failure is more likely to occur.

S&P reports that of the 1,317 p-c companies in its ratings universe, 219 companies, or 17 percent of those ratings, are not in a financially secure category. While the percentage of vulnerable ratings is the same as it was in the 2000 report (when S&P reported 225 of 1,300 ratings as vulnerable), the pace of downgrades picked up considerably in 2001.

According to the report, S&P lowered 209 financial strength ratings in 2001 and raised only six. In 2000, by contrast, the rating actions had only tipped slightly in favor of downgrades, with 148 downgrades versus 118 upgrades.

The report is available at http://www.standardandpoors.com/Forum/RatingsCommentaries/Insurance.

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, April 8, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.