Feldblum: Rating Agencies

Question 1

List 3 agencies that produce credit ratings

Answer 1

S&P, Moody’s & Fitch

Question 2

List an agency that produces Financial Strength Ratings for life and P/C insurers

Answer 2

AM Best

Question 3

List 3 reasons why Financial Strength Ratings are important to insurers

Answer 3

1. Assess ability to pay claims
2. Reinsurers desire investment grade ratings to retain business
3. Independent agents use to place customers with higher rated insurers

Question 4

Give two criticisms of the use of rating agencies.

Answer 4

• Recent downgrades of highly rated debt
• Oligopolistic nature of rating agency industry
• Greater efficiency of free markets in determining bond yields

Question 5

2 reasons that Unrated Insurers can be at disadvantage

Answer 5

1. Independent agents may hesitate to use them
2. Banks require property insurance from rated insurer for mortgages

Question 6

The Ratings Process focuses on quality of insurer’s managers and business strategy. List a few factors that it considers

Answer 6

• Knowledge of industry trends
• Experience with adverse scenarios
• Handling of current problems
• Doesn’t cover underwriting or investment decisions, as both can be distorted by random fluctuations

Question 7

5 steps of an interactive rating

Answer 7

1. Background research by ratings analyst and proprietary data submitted by insurer
2. Interactive meetings between ratings analysts and senior managers of the insurer
3. Preparation of ratings proposal by lead analyst and additional data submitted by insurer
4. Decision by the ratings committee after lead analyst presents proposal
5. Rating published

Question 8

3 reasons that Public data insufficient for the Rating Agency analysis

Answer 8

1. investment schedules have little detail on derivatives
2. reserve schedules may not show the same segmentation that the insurer uses
3. reinsurance data doesn’t show attachment points / limits

Question 9

What type of data does the rating agency collect during the interactive meetings

Answer 9

Underwriting, reserving, investment, and operating performance with supporting data

Question 10

What happens if the insurer refuses an interactive meeting

Answer 10

Agency may issue a public rating using public information. Agency may issue public rating to inform others that past rating is no longer valid

Question 11

3 reasons that an insurer with a rating from A.M. Best may request another rating from S&P, Moody’s or Fitch

Answer 11

1. May want to issue debt through a holding company and wants rating from agency with more experience in debt ratings
2. Public company may want rating from agency better known to investors
3. May not like current rating and believes second will be better

Question 12

2 broad categories of requests that agencies may make during the interactive meetings between ratings analysts and senior managers of the insurer

Answer 12

1. High level requests
2. Insurer specific based on business written

Question 13

List some examples of high level requests that the agencies may make during the interactive meetings

Answer 13

Business strategy, risk concentration guidelines, how information travels from management to employees

Question 14

List some examples of the extensive background material that the agency requests from the insurer

Answer 14

• Statutory A.S. and GAAP financial statements
• History of company focusing on major events with biographies of senior executives
• Investment strategy & guidelines
• Organizational charts
• Product descriptions and business strategy by line

Question 15

3 reasons that the Insurer should not withhold damaging data that is not requested

Answer 15

1. Insurer loses credibility
2. Makes agency look bad to investors
3. May place insurer on ratings watch or lead to ratings downgrades

Question 16

Briefly explain the top-down approach used by the Rating Agencies

Answer 16

• Start with economic and industry forecasts
• Go to insurer’s position within the industry

Question 17

2 reasons that the agencies are reluctant to change ratings too quickly

Answer 17

• Erroneous downgrades anger clients
• Erroneous upgrades ruin agency’s reputation

Question 18

3 reasons most insurers are rated

Answer 18

1. Agents are cautious of unrated insurers
2. Third-parties rely on outside assessments of insurer solvency
3. Rating agencies are efficient at assessing financial strength

Question 19

List 4 lines of business where high ratings are important

Answer 19

1. reinsurance
2. surety
3. homeowners
4. structured settlements

Question 20

Briefly explain why high ratings are important for Reinsurance

Answer 20

• Many reinsurers are not licensed in the U.S.
• Often cover long-tailed, catastrophe, or other large claim risks
• Therefore, Primary insurers need financially strong reinsurers.
• Also, strongly capitalized reinsurers can charge higher premiums
• Also, Reinsurance treaties may specifically link ratings and security

Question 21

Briefly explain why high ratings are important for Surety

Answer 21

Principles may require construction firms obtain surety contracts from A rated insurers

Question 22

Briefly explain why high ratings are important for Homeowners

Answer 22

Banks require property insurance to issue mortgages. Due to risk of catastrophes in property, banks may require insurer has investment grade rating

Question 23

Briefly explain why high ratings are important for Structured Settlements

Answer 23

To protect claimants, courts may require A rated insurers

Question 24

List the A.M. Best financial strength ratings

Answer 24

• Secure (Superior - A++, A+/ Excellent - A, A-/ Good - B++, B+)
• Vulnerable (Fair - B, B-/ Marginal - C++, C+/ Weak - C, C-/ Poor - D/ Under Supervision - E/ In Liquidation - F/ Rating Suspended - S)