How stability ratings help agents find the right carrier partner
Get a rundown on how ratings agencies work and why ratings are a valuable tool for agents and brokers.
There has been much talk in recent months about ratings agencies, with Florida insurers struggling to obtain adequate stability ratings. This past summer, ratings agency Demotech Inc. threatened 17 property insurers across Florida with downgrades in their ratings.
Agents and brokers are already advising clients on supply chain threats, a talent shortage, and much more right now, and making sure their clients are being placed with a financially stable and reliable carrier shouldn’t have to be a stressful process. While downgrades and lower ratings are rarely a good thing, what does an insurer’s stability rating really mean?
As many within the industry surely know, ratings systems are a valuable tool for evaluating the stability and therefore, the trustworthiness of a potential partner. A financial rating from an accredited ratings agency indicates how likely a company will be to have the financial means to meet its commitments. This can help provide the insured, as well as the agent or MGA representing the policyholder, with trust, comfort and confidence in the carrier bearing their risk.
A carrier with a strong financial rating conveys credibility and stability that policyholders can rely on even in uncertain times, such as we’ve experienced in the wake of the COVID-19 pandemic. Policyholders, as well as agents and brokers alike, can trust their carrier partners will be able to stay strong and maneuver through potential challenges.
What are the ratings systems?
There are several respected ratings systems out there, but in the insurance industry, the two most common are AM Best and Demotech. AM Best is the oldest service, providing ratings for more than 120 years. Its assessments are the most commonly used in the industry and cover domestic and multinational organizations. Demotech originated in the 1980s and assesses ratings for companies of all sizes, but historically has focused on smaller companies writing high-risk personal lines.
Both ratings agencies are respected and strong options for evaluating the financial strength of a carrier in the industry. Based on the specialty or geography, a rating from a particular ratings agency may make more sense. For example, a small business in a coastal state may prefer to rely on a Demotech rating, while a larger operation based in the Midwest may prefer to work with AM Best. In some scenarios, carriers will seek ratings from more than one agency allowing agents to look at both ratings to consider the strength of their potential partners.
Beyond just knowing the key rating systems, it’s also important to understand how they work and what the ratings mean.
The basics of a financial rating
Financial ratings primarily evaluate financial solvency. Ratings agencies often review carriers’ performance to confirm they have enough money to pay claims, are paying fairly and within terms and are selling at a fair price.
Financial strength is based on several key factors beginning with earnings and net profit, examining how much premium is retained and how much is used for reinsurance, and a few core components of the balance sheet, including:
- Surplus: How much money a carrier has above and beyond what is used for open claims. A larger surplus means there is more funding available to pay shareholders, or in the case of a mutual insurance company, to benefit policyholders directly.
- Liquidity: How well a carrier calculates what’s needed to pay claims and whether the money is available to do so. If a carrier has too much money on hand, it might not be adequately allocating its resources into higher-yielding investment options. Alternatively, if a carrier doesn’t have enough money on hand, it could be that checks for insureds are taking too long to process.
- Investment diversity: Agents and brokers should want to partner with a carrier that has a strong investment portfolio. Carriers with a diverse, balanced portfolio will have a much better chance of withstanding disasters and major economic shifts.
- BCAR: Best Capital Adequacy Ratio (BCAR) is a financial indicator designed by AM Best, which reviews underwriting, financial and asset leverage to determine capital adequacy. Agents and brokers will want to know their carrier partners’ BCAR and what determines this score because this information can demonstrate their industry knowledge and the financial integrity of the partners where they place business.
These key factors are the primary basis behind a financial rating. Ratings agencies then take this balance sheet information and evaluate the data based on two methods, generally accepted accounting principles (GAAP) and statutory (STAT).
GAAP is the accounting method used to examine most businesses’ balance sheets and can help to determine the long-term viability of a company, its ability to sustain quality operations, as well as its ability to grow and be attractive on the financial market should the company ever be publicly traded. The STAT method involves a more conservative approach to looking at liquidity, which highlights the company’s ability to withstand a major blow, such as a catastrophic weather event or bankruptcy.
Through these measures, ratings agencies can begin to determine whether a company is financially solvent and reliable. There are additional factors that matter as well depending on the rating agency.
A comprehensive review of ESG and Innovation
Financial solvency is more than just the basics of a balance sheet. Ratings systems also tend to account for the diversity of revenue streams, business strategy, how the company handles operational risk, and how it stays on top of evolving risks.
For example, an AM Best rating examines operational performance, business profile, and enterprise risk management and recently began examining environment, social and governance and innovation initiatives.
When evaluating these factors, there are a few important things AM Best considers, including:
- How insurers are accounting for climate risk and updating their modeling tools to address the latest in risk, such as new exposures like toxins created by new sources of energy. This also accounts for whether or not underwriters are considering proper risk dispersion in their portfolios and whether or not they have a strong balance of traditional and emerging companies in their portfolio.
- Social considerations that take social inflation, changing demographics and the value of social media to manage reputational risk into account.
- Board diversity and governance over intensified risks involving data, including cyber or privacy.
- Innovation as a core balance sheet issue. Carriers with a strong commitment to innovation often have a leg up on the competition. They may have more intuitive customer portals, or quicker claims handling, for example. The AM Best rating system evaluates how well executives encourage and fund ideas, how company culture embraces innovation, whether data is managed as a corporate asset and what results the company shows for acting upon ideas.
These factors in tandem with the balance sheet review will provide a comprehensive overview of the stability and trustworthiness of a business. When translated into the actual rating, agents and brokers will have some additional guidance on how to determine the right partner. At Pennsylvania Lumbermens Mutual Insurance Company, we look at the composite ratings of our peers as a benchmark and look at the driving analytical factors behind those numbers. We break these analyses down further by class of business, geography and trends over time to find optimization opportunities. Our team also looks at financial ratings to see where we can best place our non-risk-bearing revenue.
Financial ratings can be a valuable tool for agents and brokers as they look for the right partner to trust with the safety of their clients. While there can be many aspects involved in choosing a carrier partner, understanding how the ratings system work and what they evaluate will help agents and brokers find a carrier partner they can trust with their most valuable asset — their clients.
Erin Selfe is a vice president of information technology with Pennsylvania Lumbermens Mutual Insurance Company. She can be reached at (800) 752-1895 or by email at eselfe@plmins.com.
Opinions expressed here are the author’s own.
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