G9. Feldblum: Rating Agencies

Question 1

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

Answer 1

AM Best

Question 2

List 3 agencies that produce credit ratings:

Answer 2

S and P, Moody’s, Fitch

Question 3

Give two criticisms of the use of rating agencies.

Answer 3

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

Question 4

List 3 reasons why Financial Strength Ratings are important to insurers:

Answer 4

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 5

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

Answer 5

• 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 6

2 reasons that Unrated Insurers can be at disadvantage:

Answer 6

1. Independent agents may hesitate to use them

2. Banks require property insurance from rated insurer for mortgages

Question 7

3 reasons that Public data insufficient for the Rating Agency analysis:

Answer 7

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 8

5 steps of an interactive rating:

Answer 8

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 9

What happens if the insurer refuses an interactive meeting:

Answer 9

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Agency may issue public rating to inform others that past rating is no longer valid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 10

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

Answer 10

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

Question 11

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

Answer 11

1. High level requests

2. Insurer specific based on business written

Question 12

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

Answer 12

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 13

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

Answer 13

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

Question 14

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

Answer 14

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

Question 15

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

Answer 15

• Start with economic and industry forecasts

- Go to insurer’s position within the industry

Question 16

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

Answer 16

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

Question 17

3 reasons most insurers are rated:

Answer 17

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 18

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

Answer 18

• Erroneous downgrades anger clients

- Erroneous upgrades ruin agency’s reputation

Question 19

Briefly explain why high ratings are important for Reinsurance:

Answer 19

• 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 20

List 4 lines of business where high ratings are important:

Answer 20

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

Question 21

Briefly explain why high ratings are important for Homeowners:

Answer 21

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

Question 22

Briefly explain why high ratings are important for Surety:

Answer 22

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

Question 23

List the A.M. Best financial strength ratings:

Answer 23

• 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)

Question 24

Briefly explain why high ratings are important for Structured Settlements:

Answer 24

To protect claimants, courts may require A rated insurers

Question 25

Describe the ratings process

Answer 25

• Intrusive, time consuming, and expensive
• Focus on quality of insurers managers and business strategy
• Insurers choose what to include in presentations
• Ratings analyst evaluate integrity of insurers

Question 26

Why did financial crisis of 2008-2009 lead to rating agencies reconsidering the weighting of capital charges by risk?

Answer 26

• Large losses have been caused by CAT, equity, and financial derivatives
• Little adv development on major lines’ reserves
• Asbestos reserves led to large losses
• Reinsurance recoverables have led to few problems