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MAY 28, 2021 08:20 AM (EDT)

Best’s Special Report: AM Best Benchmarking Analysis Shows Volatility More Frequent, Severe for Lower-Rated P/C Companies


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 Lauren Magro
Associate Analyst, Industry Research
and Analytics
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Michael Lagomarsino, CFA, FRM
Senior Director
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FOR IMMEDIATE RELEASE

OLDWICK - MAY 28, 2021 08:20 AM (EDT)

AM Best analysis of the U.S. property/casualty (P/C) industry under the rating agency’s Best’s Credit Rating Methodology highlights the impact that volatility has on a company’s financial strength, which in turn affects AM Best’s analysis of their balance sheet strength and operating performance.

The new Best’s Special Report, “Volatility More Frequent and Severe for Lower-Rated Companies,” states that median capital losses for AM Best rating units with balance sheets assessed at the Strongest level were 3%, while those assessed as Weak/Very Weak lost a significant 29% of capital. The report notes that surplus volatility can lead to less stable balance sheets and a weakening of overall financial strength. For example, companies with balance sheet assessments of Strongest reported a decline in surplus in just one of the last ten years, while those with Weak/Very Weak balance sheet strength assessments lost surplus in four of those years. The primary quantitative tool used to evaluate balance sheet strength is Best’s Capital Adequacy Ratio (BCAR), which helps determine a company’s capitalization; however, AM Best takes all of the balance sheet components into consideration, as the BCAR itself is not the sole determinant of the balance sheet strength assessment.

Along with balance sheet strength, the key pillars AM Best uses in its credit analysis are operating performance, business profile and enterprise risk management (ERM). Operating performance in particular is a leading indicator of future balance sheet strength and long-term financial stability, and can be impacted greatly by volatility. Higher return on equity metrics, favorable combined ratios and stable operations are all leading indicators for a more favorable assessment of operating performance. These characteristics are critical given all of the different headwinds and risks the P/C industry faces. Those companies that have sustained performance are in a much better position given the lower-for-longer interest rate and ever-evolving underlying risks.

As detailed in the report, AM Best also conducts benchmarking against industry composites, given the inherent differences. Each insurance line and market composite faces different challenges and operating environments, which leads to varying performance expectations, highlighting the importance of comparing metrics not only to the industry, but also against peers in similar industry composites.

Volatility exists at every company and at every assessment level, but it is subject to the risk appetite of the rating unit. Risk management tools, such as data analytics and innovative technology, play a role in a company’s overall efficiency and influence the volatility of key metrics in the rating assessment overall. Companies that fail to keep up with emerging technologies will likely underperform in the benchmarking process and will be at risk of being adversely selected against.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=308990 .

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City.