Do we place too much emphasis on a carrier’s rating while ignoring other factors and trends that might hold significant insight into a company’s overall outlook? Chris Burand advises you to take a broader view of carriers and their role in the insurance industry.
Confidence in the rating companies’ evaluations of insurers is important to agents, their customers, and possibly to E&O claims. However, agents are losing this confidence. I’ve heard many agents lament about the rating services’ slow action to identify problem companies. I believe this frustration and loss of confidence results partly from a misunderstanding of what the ratings mean.
Insurance company ratings deal with solvency and claims paying ability — not stability. Most agents aren’t aware of and don’t understand the difference. A.M. Best has become the de facto insurance company rating. However, Best’s fine print offers this disclaimer: 'The objective of Best’s rating system is to provide an opinion of an insurer’s financial strength and ability to meet ongoing obligations to policyholders' (emphasis added). Insurers’ only obligation to policyholders is to pay claims and sometimes, dividends. Thus, a good rating means the company has enough money to pay all current, foreseeable claims. It does not mean the company’s operations are sound and stable, that it’s well run, and that it won’t need dramatic changes in order to survive tomorrow. It does not mean agencies can grow with the company. These are operational stability issues that require a different analysis.
Because rating companies focus on claims paying ability and solvency, they concentrate on the balance sheet and reserving. In my experience, rating companies don’t adequately consider the operational issues needed to predict future stability. Although adequate capital is important, no company can maintain adequate capital if it’s operating results are continually poor. Even though operational and claims paying issues go hand-in-hand, an insurer’s balance sheet often lags six to 24 months after its operations are recognizably poor. Then, there’s often an additional lag time before the rating companies look at the balance sheet and issue a downgrade. This delay causes many agencies to do business with companies possessing poor operating financials. However, agents who don’t understand ratings don’t worry as long as the company has a high A.M. Best rating.
I’ve analyzed the stability of many carriers for my independent insurance agency clients. Even without re-examining reserving, leverage, and the like — I’m not an actuary, so I have to take the rating companies’ word on these issues — I’ve found that operating results are critical and often an excellent predictor of an insurance company’s future stability. By examining operational issues, I identified problems with MRM (Legion), Reliance (insolvent), and HIH (insolvent), among others, before any of these companies were downgraded.
In an ideal world, rating companies would provide separate ratings for insurers’ financial stability and their claims paying ability. Because rating any company accurately is difficult — especially insurers — it’s all too easy for agents to make mistakes when they extrapolate and apply a single letter grade to every carrier in our highly complex industry. However, because rating companies will probably never provide two ratings, agents must realize that ratings only apply to a carrier’s ability to honor its obligations to policyholders. If you use ratings, I strongly recommend going to multiple rating services such as A. M. Best, Standard and Poors, Moody’s, and Fitch. For L&H, consider using Weiss.
A company’s operational strength is a separate issue that requires a different analysis.