Joseph L. Petrelli
President
Demotech, Inc.
Demotech, Inc. is a financial analysis firm specializing in evaluating the
financial stability of regional and specialty insurers. Since 1985,
Demotech has served the insurance industry by assigning accurate,
reliable and proven Financial Stability Ratings® (FSRs) for Property &
Casualty insurers and Title underwriters. FSRs are a leading indicator of
financial stability, providing an objective baseline of the future solvency of
an insurer.
Demotech's philosophy is to review and evaluate insurers based on their
area of focus and execution of their business model rather than solely on
financial size. This philosophy was the catalyst for the Demotech Company
Classification System, which was published in Insurance Journal, in order
to stratify and categorize insurers into operational categories.
Visit www.demotech.com for more information.
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Incorporated in 1985, Demotech, Inc. is a financial analysis firm
specializing in evaluating the financial stability of regional and specialty
insurers.
Since 1989, Demotech has served the insurance industry by assigning
accurate, reliable and proven Financial Stability Ratings® (FSRs) for
Property & Casualty insurers and Title underwriters.
FSRs are a leading indicator of financial stability, providing an objective
baseline of the future solvency of an insurer.
Demotech's philosophy is to review and evaluate insurers based on their
area of focus and execution of their business model rather than solely on
financial size. This philosophy was the catalyst for the Demotech
Company Classification System, which was published in Insurance
Journal, in order to stratify and categorize insurers into operational
categories.
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Demotech was the first company to have its rating process formally
reviewed and accepted by:
 Fannie Mae
(1989)
 Freddie Mac
(1990)
 HUD
(1994 & 2005)
1996 - Worked with Florida Office of Insurance Regulation (then DOI)
to develop FSRs for Florida “take out” insurers to depopulate the
residual market.
2005 - Accepted by HUD for rating Professional Liability insurers of
long term care facilities
2009 – Began receiving carve-back on insolvency provision from
several insurance agents’ errors and omissions insurance carriers.
2010 - Participant in independent Florida State University and
Wharton School studies evaluating insurer financial ratings.
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Demotech’s business model is to support financially stable insurers that are
unrated or underrated by other services, typically regional and specialty
insurers.
Demotech encourages companies to focus on long-term solvency which
emphasizes increasing loss and loss adjustment expense (LAE) reserves to
adequate levels as opposed to reasonable levels.
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Adequate – no development
Reasonable – acceptable in regards to jurisdiction mandated levels, but may lead to
adverse development
Earnings should be stabilized by booking adequate loss and LAE reserves, not
manipulated by accruing loss and LAE reserves at an optimistic level and then
increasing today’s loss and LAE reserves tomorrow.
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Magnitude of surplus
Broad array of insurance products to diversify the insurer
Diversification as to geographical exposure
Well-known names
Access to capital if they are publicly traded companies.
In practice, size and diversity have had limited impact on financial
success or the risk of insolvency. Adequate premiums, liquid
investments, adequate loss and loss adjustment expense reserves and
the quality and quantity of reinsurance have proven to be more critical
to solvency then size alone, i.e. Mission, Transit, Kemper, Executive Life.
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Focus on their niche, not diversified, do not seek authority to dabble in
several lines of business.
May not be widely licensed in numerous jurisdictions because they are
state or regional specialists who know their markets and their
producers.
Purchase conservative reinsurance treaties that protect their surplus,
thereby forsaking potential profitability to retain the financial stability
and consistency required by their agents and insureds.
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Maintain consistent underwriting discipline – even if the cost is
marketshare.
Purchase large quantities of high quality reinsurance.
Maintain stable relationships with agents and core customers.
Support their niches because they understand them and thrive by
serving those sectors that their underwriters understand.
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Financial Stability Ratings® (FSRs) are a leading indicator of the financial
stability of Property and Casualty insurers and Title underwriters. An FSR
summarizes Demotech’s opinion as to the insurer’s ability to insulate itself
from the business cycle that exists in the general economy as well as the
underwriting cycle that exists in the insurance industry.
An FSR summarizes our opinion as to the relative ability of an insurer to
survive a downturn in general economic conditions as well as a downturn
in the underwriting cycle.
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Our focus is unique. While we acknowledge and recognize the importance
of profitability, we believe that balance sheet strength and financial
integrity are the ultimate determinants of the long term financial stability
required to honor meritorious claims.
Accordingly, while operating profit remains an important element in the
assignment of FSRs, the ability of an insurer to remain financially stable
under a variety of economic stress tests requires a focus on balance sheet
integrity.
Quality and quantity of reinsurance, relative adequacy of loss and loss
adjustment expense reserves, the liquidity and quality of assets and rate
adequacy are some of the more critical items we evaluate.
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Our rating process provides an objective baseline for assessing solvency
based upon changes in financial stability, as manifested in an insurer’s
balance sheet. FSRs are based upon a series of quantitative ratios and
considerations that comprise our Financial Stability Analysis Model.
The Financial Stability Analysis Model is the major component of the FSR
assignment process and can be applied to statutory insurance accounting
data or data compiled under Generally Accepted Accounting Principles
(GAAP). The Financial Stability Analysis Model includes a tactile review as
well as computation and analysis of critical financial ratios to determine
the current and anticipated financial stability of the insurance company
being reviewed. The Financial Stability Analysis Model cross checks and
analyzes financial statement calculations and relationships.
A critical item to determine the financial stability of a P&C insurer is the
calculation of financial stability ratios measured against our financial
stability benchmarks. These ratios and benchmarks have been compiled
on an industry-wide basis and have been substantiated by third parties.
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In February 2011, Florida State University’s College of Business Risk
Management and Insurance compared our FSRs with ratings issued by
Best, Standard and Poor’s, Moody’s and Fitch.
The study reviewed thousands of insurer ratings issued over a nine year
period. The results were released in a preliminary summary entitled A
Comprehensive Examination of Insurer Financial Strength Ratings.
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The study concluded that:
 Demotech serves the need of another unique group of insurers, namely those that
are geographically focused.
 Comparisons of Demotech ratings to other agencies show relative consistency in
the factors that drive Demotech ratings compared to agencies such as A. M. Best,
Moody’s, Standard and Poor’s, and Fitch.
 There is also general consistency in the firms that each agency would categorize
as financially secure.
 These results have important public policy implications for insurers, regulators
and consumers as they work to better understand the ratings process. Of
particular importance to most is the comparability of Demotech ratings to
other agencies.
 Given that lenders often have requirements related to the use of rated
insurers and some states require ratings to operate in a state, the results
suggest that Demotech serves an important service within the ratings
community and plays a very important role in the insurance market.
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Comparative Study of Demotech, Inc. versus A.M. Best Co.
Months of Survival Subsequent to Rating Assignment
Cumulative Average Survival Rates
Demotech, Inc. A"
A. M. Best Co. B++/B+
100%
95%
90%
85%
80%
75%
12
24
36
48
60
72
84
96
108
120
132
144
156
168
180
Months
Source:
A.M. Best Co. - Impairment Rate and Rating Transition Study Report as of December 31, 2010. Data excludes carriers not
assigned a rating due to insufficient size and/or operating experience.
Demotech, Inc. - Company status evaluated as of June 30, 2010. Data includes many carriers excluded by A.M. Best.
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Comparative Study of Demotech, Inc. versus A.M. Best Co.
Months of Survival Subsequent to Rating Assignment
Cumulative Average Survival Rates
Demotech, Inc. A'
A. M. Best Co. B++/B+
100%
95%
90%
85%
80%
75%
12
24
36
48
60
72
84
96
108
120
132
144
156
168
180
Months
Source:
A.M. Best Co. - Impairment Rate and Rating Transition Study Report as of December 31, 2010. Data excludes carriers not
assigned a rating due to insufficient size and/or operating experience.
Demotech, Inc. - Company status evaluated as of June 30, 2010. Data includes many carriers excluded by A.M. Best.
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Comparative Study of Demotech, Inc. versus A.M. Best Co.
Months of Survival Subsequent to Rating Assignment
Cumulative Average Survival Rates
Demotech, Inc. A
A. M. Best Co. B++/B+
100%
95%
90%
85%
80%
75%
12
24
36
48
60
72
84
96
108
120
132
144
156
168
180
Months
Source:
A.M. Best Co. - Impairment Rate and Rating Transition Study Report as of December 31, 2010. Data excludes carriers not
assigned a rating due to insufficient size and/or operating experience.
Demotech, Inc. - Company status evaluated as of June 30, 2010. Data includes many carriers excluded by A.M. Best.
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Insurance agents are generally not legally liable for an insurer's failure to pay
a loss due to the insurer's financial impairment.
According to IRMI, the insolvency exclusion in an agent’s errors and
omissions insurance policy (E&O) is “an exclusion found in some insurance
agents E&O liability policies that precludes coverage for claims resulting
from an insurer's inability to pay a claim due to its insolvency. *
Favorably worded versions of the insolvency exclusion bar coverage
only when the agent should have known or failed to discover the insurer's
financial problems at the time coverage was arranged.
Other insurers provide exceptions to the exclusion, provided coverage is
placed with insurers of a stated Best's rating and financial class (e.g.,
B+/X) or a Demotech Financial Stability Rating® of A or better.
*(http://www.irmi.com/online/insurance-glossary/terms/i/insurer-insolvency-exclusion.aspx)
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These cases, and an analysis prepared by C. Burke Coleman, Demotech’s
counsel, indicated that the legal standard for agents’ liability on insolvency
does NOT include a Best’s rating.
Essentially the legal standard is:
1.
Carrier must be licensed or otherwise authorized to do business in
the state.
2.
Carrier must be in good standing with department of insurance
3.
Carrier should be solvent, based on its published financial statements
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Your E&O carrier does not sit on your board,
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Is not part of your management team and,
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Is not a shareholder in your agency.
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Yet they somehow feel entitled to restrict the markets you can use.
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The wording of insolvency exclusions is inconsistent.
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The court cases involving whether or not an E&O claim is related to an
“error” or an insolvency are inconsistent.
Independent agents need and deserve well defined, consistent E&O
coverage to be able to effectively generate competition among carriers
for production.
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Arch Insurance Company
Lexington Insurance
Darwin
Century Surety Company
Gotham Insurance Company
Allied World Assurance Company
NAMICO Insurance Company
Professional Underwriters Group, Jay Martin (Axis)
More Coming!
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As a courtesy to producers of a rated carrier, Demotech will work with
the agent to secure an exception to the insolvency exclusion in their
policy.
Demotech will work with the carrier to obtain Insolvency Gap
Coverage, a fully insured program offered by Century Surety Company,
to protect agents of record against insolvency. The policy indemnifies
and defends when a gap in an Agent of Record’s E&O coverage is
created by the insolvency exclusion.
Demotech will work with the carrier to secure an excess E&O policy
from Gotham Insurance Company. Gotham’s excess E&O policy
expands the insolvency exclusion to explicitly provide coverage for
insolvency when carriers earn an FSR of A or better.
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Our multi-faceted program is designed to assist agents, markets and clients:
1.
2.
3.
Option 1 - E&O insurance written with a carve back to provide coverage for the
insolvency of carriers rated A or better by Demotech, Inc.
Option 2 - Agents of XYZ Insurance Company Master Policy for E&O
Option 3 - XYZ Insurance Company purchases an Insolvency Gap Coverage to
protect its producers.
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E&O insurance written with a carve back to provide coverage for the
Insolvency of carriers rated by Demotech.
For any agent or agency that meets or exceeds the otherwise applicable
underwriting criteria;
The agent or agency can submit its latest available, previously
completed application provided to their current carrier;
With a copy of their current declarations page and receive a quote that
provides errors and omissions insurance coverage INCLUDING an
insolvency carve back.
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An “Agents of XYZ Insurance Company” E&O policy to provide agents
appointed by an insurer with E&O policy including insolvency coverage.
In this situation, XYZ Insurance Company purchases a master errors
and omissions policy to protect “Agents of XYZ Insurance Company” on
an excess basis.
This coverage INCLUDES the insolvency carveback that is necessary to
developing and sustaining a relationship between a producer and a
market.
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XYZ Insurance Company purchases a policy to provide protection
against the insolvency gap in an agent’s existing E&O coverage.
XYZ Insurance Company can apply for an insolvency gap coverage that
provides its agents with protection against the unlikely insolvency of
XYZ Insurance Company.
This policy is financially underwritten by Demotech, Inc. with quotes
issued by Century Surety Company.
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Insolvency Exclusions are arbitrary, inconsistently constructed and
the decisions issued in court cases demonstrate this!
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Demotech has been able to assist independent agents and their markets
due to the long-term credibility of our Financial Stability Ratings®.
The list of E&O solutions continues to grow. In the meantime, please let
us know how we can assist you.
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