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2 types of ratings provided by agencies
- credit ratings: corporate, municipal, and government bonds - S&P, Moody’s, Fitch
- financial strength: life and P&C insurers - A.M. Best
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Benefits to insurers
- reinsurer may need investment grade ratings to retain customers
- independent agents use ratings to place policies with highest rated insurer
- AA must consider ratings of reinsurers when evaluating uncollectible reinsurance
- some jurisdictions require insurer to have an A- or better to write surety business
- Statutory accounting values bonds rated BB or lower at market value
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Unrated and publicly rated insurers
- agents hesitate to use unrated insurers
- some banks don’t issue mortgages without property coverage from a rated insurer
- public ratings (free) provide less control over information and greater chance of errors
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Benefits to policyholders
- they depend on insurer’s financial strength but don’t have the expertise and resources
- rating agencies can access proprietary information about operating strategy
- insurers are willing to pay $1M+ per year for ratings, sign of public acceptance
- rating agencies don’t respond as quickly as the bond and stock markets
- in contrast rating downgrades are slower - give time to verify information
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Rating process
- background research by ratings analyst and submission of proprietary data by insurer
- interactive meetings between rating analysts and senior managers of the insurer
- preparation of rating proposal by lead analyst and submission of additional data
- decision by rating committee (no permanent members) after presentation by the lead analyst
- publication of rating on public website and analysis for fee-paying subscribers
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Effect of insurer strategy on ratings
- rating agencies meets with insurer officers responsible for UW, reserving, reinsurance, financial reporting, investments, risk management, and major lines of business
- business strategy & internal management are clues to resilience against adverse scenarios
- analysts don’t focus on past decisions, but rather on quality of management: knowledge of industry trends, experience with adverse scenarios, handling of current problems
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Data provided by insurers
- insurers decide the substance of their presentation and select the data they provide
- rating analysts can question views, but generally don’t specifically ask for data
- they analyze integrity, which can be tainted by deceptive, misleading or incomplete info
- Schedule F doesn’t have reinsurance attachment points and limits
- Schedule D doesn’t have derivatives details
- Schedule P does not show segmented data used for reinsurance estimates
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3 reasons why insurers are rated
- agents are wary of unrated insurers, since they might be financially distressed
- third-parties rely on outside assessments of insurer solvency
- rating agencies are efficient in assessing financial strength
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Rating agencies capital requirements
- business decisions used to be around surplus leverage ratios; now it’s about required capital to achieve desired rating from Best’s, S&P, Moody’s, or Fitch
- all use data from Annual Statements, SEC filings, analyst meetings, and earning reports
- however formulas differ greatly, producing salient differences in capital standards
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Types of models by agency
- A.M. Best uses risk-based capital analysis (EPD to calibrate risk)
- Moody’s and Fitch use stochastic capital models (cash flow) to model economic capital
- Standard and Poor uses principle-based models and ERM practices (they assume insurers evaluate their capital need better than a rating agency can, so focus on ERM)
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