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Analyzing Insurers’Financial Condition
Robert KleinRMI 4700Insurance Operations11/3/09
Who Needs to Know?• Buyers and Intermediaries
• Reinsurers
• Investors
• Creditors
• Vendors
• Regulators– State Insurance Commissioners– SEC
Insolvencies – Over the Hump?
… But Getting More Costly?
Different Roles• Regulators
– Monitor, Report, Enforce– Compel Transparency– Limit Insolvency Risk– Intervention
• Rating Agencies– Assess Claims-Paying Ability– Rate Debt
• Other Analysts– Assess Value and Risk
External Reporting Systems• Regulatory
– annual & quarterly statutory financial statements– special reports, e.g., risk-based capital– independent CPA audited statements– certified actuarial opinions– management plan of operation– other reports on request
• Rating Agencies– regulatory reports– other rater-specific questionnaires, interviews
Other External Parties• SEC
– 10K Form– 10Q Form
• Buyers, Investors & Creditors– GAAP Financial Statements– Company Annual Reports
• Internal Revenue Service• Statutory vs. GAAP Reporting
– Statutory: insurer ability to meet claims obligations– GAAP: value of firm as going concern
Different Perspectives
• Accounting– What are the values of the firm’s assets, liabilities,
net worth, cash flows; are they accurate?
• Actuarial– What risks is the insurer exposed to?– Is it charging adequate prices & estimating costs
(historical & future) accurately?
• Financial– How well is the insurer managing its overall
financial risk & return and their components?
Insurer Financial Risks• Actuarial
– underpricing
– catastrophe
– other underwriting
– inadequate reinsurance
• Systematic– asset/liability changes due to
broad economic factors
• Interest Rate Risk
• Credit– borrower fails to perform
• Liquidity– large cash demand
• Operational Risks– mistakes in transactions
– poor claims adjusting
– information system failures
– regulatory problems
• Legal Risks– change in laws affecting
contract obligations or asset values
– lawsuits
Sector Specific Issues• Property-Casualty
– underpricing– underreserving– concentration of exposures– rapid growth; new lines
• Life– valuation– economic assumptions– duration mismatch– concentrations of assets– lapse rates
• Health– underpricing– adverse selection– underreserving– poor loss control
Functions of Capital• Absorb unanticipated losses & still ensure continued
viability of firm.– significance of “franchise value”
• Protect claim holders (especially policyholders in case of insurers).
• Protect insolvency guarantors.• Fund liquidation expenses.• Support investment and growth of firm.
– mutual vs. stock company considerations
• Recall importance of sending “positive signals” to investors & customers.
Capital Adequacy
• Surplus Assets – Liabilities
• Risk-Based Capital TAC/RBC BCAR
• Leverage GPW/Surplus NPW/Surplus Liabilities/Surplus Surplus/Assets (Life)
Total Assets 19,842,695,554Total Liabilites 12,961,588,288Surplus 6,881,107,266
TAC 6,881,107,266RBC 1,200,098,848TAC/RBC 573.4%
BCAR 275.9%
Net Premiums Written 4,670,846,424NPW/Surplus 67.9%
Liabilities/Surplus 188.4%
St. Paul Fire & Marine
Financial Performance
• Profitability Loss Ratio Combined Ratio Operating Ratio Net Income Rate of Return
• Efficiency Expense Ratio Investment Return
Net Premiums Earned 4,676,657,681Net Losses Incurred 2,171,617,087Pure Loss Ratio 46.4%
Loss Adjustment Expense 570,879,443Other Underwriting Expenses 1,423,355,487Dividends to PHs 5,767,644Total Expenses 2,000,002,574Combined Ratio 89.2%
Net Investment Income 845,862,624Operating Ratio 71.1%
Net Income 1,147,844,986ROR on Surplus (A.M. Best) 21.1%
Expense Ratio 42.6%Investment Yield (A.M. Best) 4.8%
St. Paul Fire & Marine
Reserve Adequacy• Property-Casualty
– 1-Year Loss Development– 2-Year Loss Development– Reserve Deficiency
Incurred Losses All Years as of Year-End 2007 12,000,000less Incurred Losses AY 2007 1,000,000minus Incurred Loss All Years as of Year-End 2006 10,000,000
One-Year Loss Reserve Development 1,000,000
minus Incurred Loss All Years as of Year-End 2005 9,000,000Two-Year Loss Reserve Development 2,000,000
PHS 10,000,000One-Year LRD/PHS 10.0%Two-Year LRD/PHS 20.0%
Fictional Insurer
Financial Risk• Credit Risk
NIG/ Total Assets Default Rates
• Interest Rate, Market Risk Asset Concentrations Asset/Liability
Durations Lapse Rates (Life)
• Liquidity Risk Liquid
Assets/Liabilities
• Rapid Growth Change in premiums
• Earnings Volatility
Reinsurance Recoverables/PHS 1.3%
Quick Liquidity Ratio 12.7%Current Liquidity Ratio 109.1%Overall Liquidity 153.6%Operating Cash Flow 975,699,000
Change in NPW 0.3%Figures from A.M. Best
St. Paul Fire & Marine
Measurement Issues
• Reported surplus is as accurate as reported assets and liabilities.
• Under-reserving most problematic for property-casualty insurers.
• Capital and leverage need to be assessed against risks that firm faces.
• Reliance BCAR was 77.8 in 1998 and 122.6 in 1999.
• Decline can be rapid.
Further Observations
• Events can rapidly overtake remedial action.
• Regulators and rating agencies proceed cautiously with lagging information.
• Desire not to undermine efforts to restructure or sell company.
• Size and importance of insurer can make regulators and raters even more cautious.
• More pro-active, risk-based oversight requires new mindset for U.S. regulators.
Ratio Limitations
• There is no ratio measure that provides “real-time” indication of underpricing, poor underwriting, and under-reserving.
• Performance measures lag these practices, especially for long-tail lines.
• Early detection requires alternative approaches including “street knowledge.”
• Regulators & raters reluctant to use “subjective” indicators to issue warnings.
Dynamic Analysis & ERM• Use of dynamic modeling tools to assess risk of firm• Approaches
– deterministic, scenario based
– stochastic
• Voluntary or Compulsory– Makes sense for internal management
– Should regulators compel it?
– External reporting of results?
• Enterprise Risk Management (ERM)– Comprehensive, integrated approach to managing all
significant risks.
– Qualitative & quantitative analysis