Brokers Backing Solvency

Replacing coverage becomes an immediate problem for insurance brokers and the policyholders they represent the moment an insurance company is ordered to wound up. Insurer insolvencies are a fact of life and they will continue to occur, despite the best efforts of insurance regulators.

One problem that has occurred in all insurer insolvencies is unearned premium. Fortunately, the magnitude of the problem has been reduced, but it has not been eliminated. First, more premiums are being paid on a monthly basis, reducing the risk that policyholders will have any large unearned premiums to recover. Second, PACICC has had a substantial, but partial coverage for the refund of unearned premium in place since ’98.

Can brokers take steps to minimize the risks of insurer insolvency, both to the policyholders they represent and to themselves? Yes.

ANALYZING INSURERS

PACICC has inquired about the steps brokers take to understand the financial strengths and vulnerabilities of the insurers companies with which they place their clients. PACICC’s own brokers gave the authors a lengthy description of their procedure, which appears to be sound. As one of the larger companies, they have substantial resources available and follow a comprehensive risk management strategy for their clients. But some brokers seem to conclude that if an insurer is licensed, it is proof of a solid financial backing. Unfortunately, history proves this wrong.

PACICC looks closely at the various rating agency reports to see which companies have reached a level of solvency risk that causes us concern. It is also sound practice for brokers to check the ratings of the insurance companies they represent. The Office of the Superintendent of Financial Services (OSFI) publishes online information, which is available free-of-charge, about all federally licensed companies. Financial information for provincially licensed companies is not so readily obtained. A.M. Best publishes their ratings online and these are available free-of-charge. Brokers may need to complete a registration screen, but it is not necessary to purchase a product or pay a fee to obtain ratings. Two additional sources cover financial strength, but obtaining them may involve payment. These include the reports of MSA Research (at www.msaresearch.com) and Fitch Ratings (at www.fitchratings.com).

OBTAINING RATINGS

A.M. Best Ratings Co.:

To access A.M. Best online, use www.ambest.ca and click on “Financial Strength.” An alphabetical listing will appear. The listing is lengthy because it includes U.S. companies. Type in the company name you want to check and the information will appear. If you want to see what the ratings mean, click on the company name; below the company details, you will find an item named “view definitions.” Once you click on this, the descriptions appear together with “Not-Rated Categories.” (A.M Best does not rate all companies.)

Once you look at the rating for a particular insurer, you don’t need in-depth knowledge to understand what the categories mean. Any company that has an “A” rating from A.M. Best, whether it is (+) or (-), can generally be accepted as financially sound. However, this is not an absolute. A rating of “B++” or “B+” indicates there are some concerns, but not to the point that the company is threatened. When a company has been downgraded to a “B,” “B-,” “C++” or “C+” rating, there is growing cause for concern. Those companies can now be considered financially vulnerable.

Do these ratings mean that the company is heading towards insolvency? No, they do not. Most companies reaching these levels are actively taking steps to improve their performance and ultimately will do well. But it is a warning sign to a broker of potential financial vulnerability that can be assessed by checking the ratings more frequently.

If the outlook for an insurer with ratings at or below a “B” remains negative, a broker might want to begin advising clients placed with the company of the situation and offer choices as to what actions clients might take. In some cases, the choices may be limited, but at least the policyholder will have been advised of the potential vulnerablity. PACICC’s own broker says they will warn clients well before a company reaches a “B” rating. Anything at or below a “C” rating tells you the company is already under the watchful eye of the Superintendent.

OSFI:

To use OSFI’s online site, go to www.osfi-bsif.gc.ca. On the left side of the screen you will find a list of regulated entities. Click on “Property and Casualty Insurance Companies.” Scroll down and select “Financial Data-Property and Casualty Insurance Companies.” Next, select the insurer you want to check, then scroll through the box to where “Assets” appears and select “Minimum Capital Test” (MCT) and leave the date as the latest quarter. If the company you need to research is a branch of a foreign company, the Branch Adequacy of Assets Test can be found under foreign property and casualty. The test score will appear at the bottom of the screen. Most companies will have a score well above 150. A score under 150 is below OSFI’s target level and is generally considered a higher-risk institution.

PACICC’s own study of the financial strength of companies operating in Canada (See Chart 1) is a combination of various ratings.

HIGH RATINGS = LONGER-TERM STABILITY

Although the majority of companies receiving an “A” rating in 2000 are still there in 2004, the trend is drifting disturbingly to lower levels, with a significant number of insurance companies at a “B” rating or lower.

The number of insurer insolvencies in Canada is relatively small. A.M. Best’s April 2005 report, Best’s Impairment Rate and Rating Transition Study-1977 to 2004, provides good insight into the track record of companies over a 25-year period (see Chart 2). This study includes property and casualty, as well as life insurers in the U.S. It clearly indicates insurers with “A” ratings rarely take a sudden drop into insolvency (impairment). The vast majority remains within all the “A” categories in the following year. However, if we look at the “B” and “B-” rating figures, after one year 15.43% have improved, but 1.8% slipped to the impaired category. Insurers with ratings below “B/B-” fare much worse.

ALL INDICATIONS

Brokers should also consider indicators that they know from experience might cause concern. For example, new companies have figured prominently in recent insolvencies. Hiland Insurance Ltd. in Newfoundland, Gisco, La Compagnie d’Assurances in Qubec, and Markham General Insurance Company in Ontario were all under three years old when they failed. Being a new company is not a ticket to insolvency, but it can be a significant risk factor.

A second indicator is rapid growth. By itself, this is not a sign of pending insolvency, but when a company experiences rapid growth accompanied by aggressive pricing below the rest of the market, brokers could take steps to protect their clients with heightened monitoring of the company’s financial health.

In closing, recall that refunding unearned premium is important. It potentially affects far more policyholders than payment of indemnity claims, so the disruption can be more widespread. Actions that can be taken at an earlier stage to reduce or avoid the problem are worthy of the time and effort.

PACICC is aware that some brokers have gone to considerable lengths to help their clients following the issue of a winding-up order. Policy-holders would certainly benefit if these efforts became uniform across the industry. Is it time for brokers to start and administer a formal plan, perhaps separate from or in conjunction with PACICC, to ensure that clients receive equal treatment of the highest standard?