Chapter 10 - Financial Strength Of Insurance Companies Flashcards
What are the four main rating agencies?
Standard and poor, Moody’s, AM best and Fitch.
All customers buying insurance are essentially buying…
A promise.
What are some of the reasons insurance companies bother paying a fee to the rating agencies for their services in assessing their financial rating?
- demonstrates to policyholders and other third parties how likely the company is able to pay its claims
- allows for comparisons between insurers
- would allow an extremely strong insurer to charge a higher amount e.g AAA rated can charge more than BBB as they can say to customers they are buying into stronger and more secure company.
- brokers will likely only deal with companies of a certain rating, e.g A- but none less than this.
Which areas are part of standard and poors common analytical framework?
- economic and industry risk
- competitive position
- management and corporate strategy
- enterprise risk management
- operating performance
- investments
- capital adequacy
- liquidity
- financial flexibility
In regards to standard and poors analytical framework, what is economic and industry risk concerned with?
This looks at the environmental framework in which insurance companies operate. Typical points would be to look at the threat of new entrants, volatility of the sector and the potential tail to liabilities or risk of catastrophic losses.
In regards to standard and poors analytical framework, what is competitive position?
The profile of the business mix in terms of the competitive strengths and weaknesses. This is particularly relevant in terms of the insurance company’s strategy.
In regards to standard and poors analytical framework, what is management and corporate strategy section?
This looks at the quality and credibility of an insurers senior management team. Standard and poor believe that this is one of the most important elements in determining how successful a company will be going forward.
In regards to standard and poors common analytical framework, what is enterprise risk management?
ERM is the method by which a company manages risk (both risks that have an upside as well as a Downside.) ERM looks at assessing the frequency and severity of risk, risk mitigation, monitoring and reporting. Some insurers ERM looks at encomic capital model.
In regards to enterprise risk management, standard and poor have said that in the future…
Require companies to have an effective ERM to earn the stronger financial strength ratings.
Standard and poor incorporate the results of ERM modelling in their analysis of ….
Capital adequacy.
In regards to standard and poors analytical framework, what is looked at in the section, operating performance.
This involves looking at the performance ratios, loss ratio, expense ratio, combined ratio, return on equity etc.
In regards to standard and poors common analytical framework what is looked at in regards to liquidity?
The company’s ability to manage cash flows efficiently and easily borrow money if required.
What does an AAA rating show?
The highest rating. Extremely strong financial security. Perhaps also seen as too cautious.
An insurer related as BB or lower is regarded as…
Having vulnerable characteristics that may outweigh its strengths. BB Is better than CC.
What is the additional term, credit watch, that standard and poor use?
Highlights the potential direction of a rating following short term events causing standard and poor to place the rating under surveillance. Negative means the rating may be lowered, positive means the rating may be raised and developing means that the rating may be raised, lowered, or affirmed.
What have academics claims may be a good indicator of deteriorating financial strength and why?
Yield spreads. The reason for this is that a yield spread is the difference between a yield on a bond and a benchmark yield. Corporate bonds start to expand as credit quality deteriorates but before a rating downgrade, implying that these may be a good early indicator of deteriorating financial strength.
Do insurance companies and reinsurance companies pay rating agencies to asses their financial strength and ability to pay claims?
Yes
What are the steps of the rating process?
- insurance company meets the agency and signs the contract
- at least two analysts spend a day with the senior executives to understand the insurance company’s business
- an exhaustive analysis is u ever taken over the next few weeks and may require answers to further questions
- lead analyst will recommend a rating to a committee of eight analysts who then debate the methods and reasoning.
- committee will vote on the rating
- insurance company is then told the rating and can either accept it or appeal and the committee re sits. Once agreed the rating issues a press release which is negotiated with standard and poor prior to issue.
- the rating agency will then monitor the insurer and carry out an annual review.
An AAA rating may mean that a company is…
Over capitalised, which from an investors perspective could mean return on equity is depressed. Investors would earn a higher return on equity if company could deliver same returns using a lower capital base.
Who has responsibility for deciding a company’s risk appetite?
The board
The risk appetite statement would typically include:
- a statement of the risk that it is acceptable for the company to bear
- what risk are not acceptable
- the probability of failure that is deemed to be acceptable and
- the maximum loss that is acceptable from any one incident
The Prudential Regulation Authority require that the probability of failure should not be…
Higher than one chance in a two hundred over a twelve month timescale.
