2009 STRIMA Conference
September 20 – 24, 2009
Seattle, WA
Number Slumber –
Understanding Rating Agency Evaluations
Agenda
 Role of Rating Agencies
 Ratings Process Overview
 Key Ratings Criteria
 Rating Rationales, Outlooks and Reports
 Resources
2
Role of Rating Agencies
3
Insurer Financial Strength Rating (IFSR)
Objective
 An IFSR provides an independent, prospective opinion of an
insurer’s long-term financial standing and its ability to meet
policyholder obligations
 An IFSR indicates relative risk based on both quantitative and
qualitative analysis. It is NEITHER a ranking of past performance,
NOR a prediction of the future.
Application
 Opinions are continuously derived by the agencies through
interaction with management and evaluation of company-specific
information against pre-defined, but ever evolving, standards.
 Opinions are expressed relative to each agency’s proprietary letter
rating scale. Opinions are explained in Rationales.
 The directions of ratings are indicated in Outlooks.
Relevance
 Reliable leading indicator of an insurer’s financial stability as
measured against historical impairment rates by rating level.
 Depends on line of business, position insurer occupies in program.
4
Impairment Rates by Rating Level
From A.M. Best’s U.S. Property Casualty – 1969-2007 Impairment Review published May 19, 2008
5
Comparison of IFSR Levels by Rating Agency
A. M. Best
S&P / Fitch
Moody’s
A++
A++
AAA
AA+
Aaa
Aa1
A+
A+
AA
AA-
Aa2
Aa3
A
A
A+
A
A1
A2
A-
A-
A3
B++
B++
BBB+
BBB
Baa1
Baa2
B+
BBB-
Baa3
B
B
BB+
BB
Ba1
Ba2
B-
BB-
Ba3
C++
C++
B+
B
B1
B2
C+
B-
B3
C
C
CCC+
CCC
Caa1
Caa2
CC-
CCCCC
Caa3
Ca
D
C
C
E,F
D
--
Secure Ratings
Vulnerable Ratings
6
Ratings Process Overview
7
The Interactive Rating Process
 Rating services agreement
 Analytical team
 Information exchange, including mandatory face-to-face meeting
 Analysis & recommendation
 Rating committee(s)
 Rating communication to management
Acceptance / non-acceptance of rating
8
Key Ratings Criteria
9
Key Evaluation Areas
Enterprise
Risk
Management
Income
Statement
Balance
Sheet
Business
Profile
Insurer Financial Strength Rating
10
Balance Sheet Evaluation
 Capitalization / leverage
 Capital structure / financial flexibility
 Adequacy of loss / policy reserves
 Quality & appropriateness of reinsurance & other risk
mitigation programs
 Quality & diversification of assets
 Liquidity
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Assessing Capitalization
Lagging or Volatile Earnings
Weak Risk Management
Limited Market Presence
“Target” BCAR
Limited Access to Capital
Leading and Stable Earnings
Strong Risk Management
Strong Market Presence
Financial Flexibility
Published Minimum Guidelines
Low
High
Exposure to Earnings and Capital Volatility
Source: A.M. Best
12
A. M. Best’s Capital Guidelines by Rating Level
Assessment
Rating
BCAR Range
A++
≥ 175
A+
160 – 175
A
145 – 160
A-
130 – 145
B++
115 – 130
B+
100 – 115
B
90 – 100
B-
80 – 90
Marginal
C++ / C+
60 – 80
Weak
C / C-
40 – 60
Superior
Excellent
Good
Fair
Secure Ratings
Vulnerable Ratings
13
S&P’s Capital Guidelines by Rating Level
Assessment
Rating
CAR
Extremely
strong
AAA/AA+
175 +
Very Strong
AA/AA-/A+
150 – 174
Strong
A/A-
125 – 149
Good
BBB+/BBB/
BBB-
100 – 124
Marginal
BB+ and
below
< 100
Secure Ratings
Vulnerable Ratings
14
Income Statement Evaluation
 Stability of historical / prospective earnings
 Pre-dividend combined ratios
 Return on equity (with & without capital gains)
 Sustainability of accident-year results
 Loss reserve impacts on loss ratio picks
 Catastrophe impacts (occurrence; annual
aggregate)
 Capital generation
 Surplus growth
15
Business Profile Evaluation
 Spread of risk (geographic,
product and distribution
diversification)
 Revenue composition
 Competitive market position
 Management and corporate
strategy
 Insurance market risk
 Event risk
16
Rating Rationales, Outlooks and Reports –
Three Case Studies
17
Attorneys’ Liability Assurance Society & Affiliate (ALAS) –
Rating History
S&P
Fitch
Rating Outlook
Date
Rating Outlook
Date
AA-
Negative
05/06/09
A+
Stable
05/01/09
AA-
Stable
04/04/08
AA-
Stable
01/01/08
A. M. Best – NR-1 Rating on the ALAS Affiliate in 2008 & 2009
Moody’s does not rate ALAS
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Attorneys’ Liability Assurance Society & Affiliate (ALAS) –
2008 Rating Rationale
S&P
Fitch
“The insurer financial strength ratings
“Strong competitive position and strategy
on ALAS reflect ALAS‘ very strong
of ALAS... Exceptionally strong capital
competitive position supported by
loyal owners/insureds, strong and
experienced management team,
position. Based on Fitch‘s new economic
capital model, ALAS exceeds our
standards of confidence for the AA+
level... Comprehensive reinsurance
extremely strong capital base,
protection that provides significant
conservative underwriting, and
protection against large losses...
consistently strong profitability.
Underwriting volatility inherent in line of
Offsetting these positive factors are
business, concentration risk as a
ALAS‘ narrowly focused competitive
monoline insurer and the competitive
position, high reinsurance reliance,
and aggressive investment strategy.”
Source: Standard & Poor’s Ratings Direct report dated 4/4/2008
nature of the lawyers‘ professional liability
market.”
Source: Fitch Ratings report dated 1/9/2008
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Attorneys’ Liability Assurance Society & Affiliate (ALAS) –
2008 Rating Outlook
S&P
Fitch
“We expect ALAS’ competitive position to
“Fitch’s Stable Rating Outlook reflects its belief
remain very strong... Its superior underwriting,
that ALAS will maintain its strong capital position
loss prevention, and claims management
and continue its growth in capital... Fitch
practices should produce consistent, ongoing
expects that prior underwriting period reserves
profitability. That said, we expect underwriting
will be adequate and that the reinsurance
results in 2008 to weaken... Capitalization will
program will remain high quality with no
likely remain extremely strong in 2008.
siginificant increase in the amount of relative
“In the event that the company suffers a
risk retained by ALAS... ALAS has generally
significantly large loss because of an
unfavorable reserve development or a
significant drop in value in its equity or
alternative investment portfolio, the outlook
might be revised to negative. Considering the
been successful at balancing its desire to
remain price-competitive and provide
exceptional loss-prevention and claimsmanagement services to its insureds with its
need to maintain its financial strength.”
company’s risk profile, a change in the outlook
to positive is unlikely in the midterm.”
Source: Standard & Poor’s Ratings Direct report dated 4/4/2008
Source: Fitch Ratings report dated 1/9/2008
20
Attorneys’ Liability Assurance Society & Affiliate (ALAS) –
2009 Rating Rationale
S&P
Fitch
“The outlook revision reflects our view that
“The rating downgrade primarily reflects ALAS ’
ALAS still has an aggressive investment
above-average exposure to equity and alternative
strategy even though it reduced its maximum
markets and the impact of investment market
allowed exposure to equities and alternative
declines on ALAS’ capital in 2008... The action also
investments to 25% of total invested assets
[which we believe is still aggressive relative to
its Bermudian peers] in April 2009 from 38%
previously...Furthermore, the amount of these
reflects a somewhat more conservative perspective
taken by Fitch than in the past with respect to
concentration risk as a monoline insurer. Given the
reliance on a single market and low frequency/high
severity nature of lawyers’ liability claims, Fitch
invested assets currently held could further lead
believes ALAS could be exposed to a higher
to a decline in members’ net worth...
potential level of earnings volatility than its peers in
“Amid the current recession, ALAS faces a
the prior rating category. Offsetting these factors,
potential reduction in the number of insured
Fitch believes ALAS has a solid competitive
lawyers...
position and strategy... ALAS’ reinsurance program
provides significant protection... Fitch also believes
“On the positive side, ALAS has a very strong
ALAS’ high-quality bond portfolio provides ample
competitive position in its ...niche market...”
liquidity...”
Source: Standard & Poor’s Ratings Direct research update dated 5/6/2009
Source: Fitch Ratings press release dated 5/1/2009
21
Attorneys’ Liability Assurance Society & Affiliate (ALAS) –
2009 Rating Outlook
S&P
“We expect ALAS’ competitive position to remain very strong... We expect the underwriting results in
2009 to weaken because of softer pricing, increasing competition and possible lower favorable
development on prior-year loss reserves. Nevertheless, we expect the company to report an
underwriting profit...
“ALAS operates in a mature industry... Premium volume could decline by 5-10%.
“We could revise the outlook to stable over the next 12 months if ALAS further reduces its allocation ot
equities and alternative investments while continuing to generate strong underwriting results without
losing a significant number of member firms. Conversely, if the company’s financial position weakens
because of one of the following occurrences, we might lower the ratings by one notch.
 Further drop in the value of its equity and alternative investment portfolio.
 Evidence of deterioration in its competitive position, such as a significant exodus of its members.
Material unfavorable reserve development.”
Source: Standard & Poor’s Ratings Direct research update dated 5/6/2009
Fitch – no Outlook commentary
22
Affirmative Insurance Company – Rating History
Moody’s
A.M. Best
Rating Outlook
Date
Rating Outlook
Date
B
Stable
04/21/09
Ba2
Negative
04/30/09
B
Stable
03/25/08
Ba2
Negative
(on review)
03/19/09
B
Stable
02/02/07
Ba2
Negative
01/23/09
B+ u
Negative
10/18/06
Ba1
Negative
10/23/08
B+
Positive
10/11/05
Ba1
Stable
12/11/06
B+
Stable
07/12/04
Fitch and S & P do not rate Affirmative Insurance Company
23
Affirmative Insurance Company –
2009 Rating Rationale
A.M. Best
Moody’s
“The rating and outlook reflect the [company’s]
“ ...confirmed the Ba2 insurance financial strength
elevated underwriting leverage position, limited
rating of Affirmative... In the same action Moody’s
business scope and high tangible financial
assigned a negative rating outlook. The
leverage position of its parent company.
confirmation concludes a review for possible
Offsetting these negative rating facotrs are the
downgrade that was initiatied on 3/19/09...
[company’s] adequate risk-adjusted
“The confirmation... reflects the additional flexibility
capitalization, conservative investment portfolio
the company has under its amended loan
and unique business model.
covenants as well as the absence of an impairment
“...considerable pressure exists on [the
charge related to its substantial goodwill as detailed
in its Form 10-K filed on 3/31/09. The ratings also
company] to meet debt service requirements
reflect Affirmative’s weak operating results in recent
and other holding company obligations. While it
years, its moderate market share... and its
is expect that [the holding company] financial
conservative investment portfolio. Moody’s notes
leverage will remain elevated over the near
that the company has a limited operating history,
term, adjusted debt to capital leverage
substantial financial leverage, particularly on a
measures are within A. M. Best’s guidelines for
tangible basis, and weak profitability... ”
the current rating level.”
Source: AMB Credit Report – Insurance Professional dated 5/12/09
Source: Moody’s Investors Service Rating Action dated 4/30/09
24
Affirmative Insurance Company –
2009 Rating Outlook
A.M. Best – no Outlook commentary
Moody’s
“The following factors could lead to a downgrade: i) a reduction in headroom
under the amended loan covenants; ii) material adverse developments resulting
from its interim or annual goodwill impairment testing; iii) continued weakening
of its revenue and earnings (with coverage of fixed charges below 1.5 times); or
iv) financial leverage greater than 65%.
“The following factors could lead to a stable rating outlook; i) maintaining
comfortable headroom under its amended loan covenants; ii) improved business
prospects and operating performance with fixed charge coverage consistently
above 1.5 times; and/or iii) restoration of dividend capacity of 1x debt service
from the insurance subsidiaries. ”
Source: Moody’s Investors Service Rating Action dated 4/30/09
25
Affirmative Insurance Company –
2006 Rating Rationale
A. M. Best
Moody’s
“ The ratings have been placed under review following
“ ... assigned a Ba1 insurance financial strength
the announcement that Affirmative Holdings has signed
rating to Affirmative. The oulook... is stable.
a definitive agreement to acquire 100% of the
membership units of USAgencies. While it is anticipated
“ ... ratings reflect the company’s profitable
the combined entities will maintain favorable risk-
operating results in recent years, its significant
adjusted capitalization and operating performance
share ...of the... market, the short-tail nature of
relative to Affirmative’s current rating level, A. M. Best is
concerned with the elevated financial leverage position
of the parent company. The ratings wil remain under
the loss reserves..., the stable profit margins ...
and its conservative investment portfolio. These
review pending the closing of the transaction, at which
strengths are offset by the company’s limited
time A. M. Best expects to lower the financial strength ...
operating history, operational and execution
ratings to a vulnerable level.
risks associtated with the acquisition of
“ The rating and outlook reflects the [company’s]
USAgencies, existing material weaknesses in
favorable capitalization, improved profitability, parent
controls over financial reporting as well as
company’s capital position, management‘s knowledge of
substantial pro forma levels of financial
...the market and additional geographical expansion.
leverage.”
Partially offsetting these positive rating factors is the
significant premium growth over the last few years,
Source: Moody’s Investors Service Rating Action dated 5/11/08
elevated leverage measures and increased competition
in the... marketplace. ”
Source: AMB Credit Report – Insurance Professional dated 10/18/06
26
Affirmative Insurance Company –
2006 Rating Outlook
A.M. Best – Outlook is embedded in “under review” rationale
Moody’s
“ ... the following factors could place positive pressure on the ratings: remediation
of Section 404 material weaknesses, and a reduction in adjusted financial
leverage below 45%. Conversely, a continuation or widening of the scope of
Section 404 material weaknesses and/or material deterioration of operating
results (combined ratios consistently above 100%) could place downward
pressure on the ratings.”
Source: AMB Credit Report – Insurance Professional dated 5/12/09
Source: Moody’s Investors Service Rating Action dated 4/30/09
27
Magna Carta Insurance Group –
Rating History
A. M. Best
S&P
Rating Outlook
Date
Rating Outlook
Date
B++
Stable
06/24/09
BBB
Stable
02/27/09
B++
Stable
04/29/08
BBB-
Positive
02/26/08
B++
Stable
04/30/07
BBB-
Stable
07/25/07
B++
Stable
12/13/05
BBB-
Stable
06/30/06
B++
Stable
10/07/04
BBB-
Stable
11/05/05
Bbpi
--------
03/12/04
Fitch and Moody’s do not rate Magna Carta Insurance Group
28
Magna Carta Insurance Group –
2009 Rating Rationale
A. M. Best
S&P
“The rating reflects the group’s strong
“... reflect Magna Carta’s good
capitalization, strong earnings since 2004,
competitive position in the small
and comprehensive risk management
regional market, very strong capital
practices that emphasize writing low
hazard business. These positive factors
are offset by Magna Carta’s historically
adequacy, and good underwriting
profitability in the past three years.
subpar underwriting results which, though
Modestly offsetting some of these
much improved in recent years, are under
favorable rating factors are the
pressure from current soft market
group’s geographic concentration in
conditions. These positive rating factors
New York, weak operating cash flow,
are also offset by potential litigation risk
and relatively high expense ratio
associated with ongoing proceedings
compared with that of its peers.”
regarding the BAIC acquisition.”
Source: AMB Credit Report – Insurance Professional dated 7/20/09
Source: Standard & Poor’s Classic Direct dated 3/16/09
29
Magna Carta Insurance Group –
2009 Rating Outlook
A.M. Best
S&P
“The rating outlook reflects A.M.
“The stable outlook refects Standard & Poor’s
Best’s belief that, notwithstanding the
expectation that Magna Carta will continue to
maintain good underwriting discipline, regardless of
numerous initiatives taken in recent
any downward pricing pressures. The group’s
years to improve earnings,
recent acquistion of BAIC and Proformance will
help grow its top-line premiums, which are
management may be challenged in
expected to generate at least 10% of the group’s
sustaining the recent improvement in
overall net premiums written in the next couple of
the medium term as margins shrink
due to increasing competition.”
years. In addition, we expect Magna Carta’s capital
adequacy to remain very strong; the statutory
combined ratio to be close to 100%, including
potential volatility from any acquistions; and the
pretax ROR to be 5%-8% over the next two years.
Source: AMB Credit Report – Insurance Professional dated 7/20/09
We expect the group’s expense ratio to stabilize at
about 35% over the next few years, assuming an
expected increase in premium writings form the
recent acquisitions. If Magna Carta is unable to
Source: Standard & Poor’s Classic Direct dated 3/16/09
meet these expectations over the next two years,
we could revise the outlook to negative. ”
30
Magna Carta Insurance Group –
S & P Upgrades
S&P
Outlook: “The stable outlook reflects our expectation that Magna Carta will continue to improve its operating
performance using prudent pricing and underwriting discipline throughout the next underwriting cycle. In
addition, the company is expected to grow its business at a measured pace... In addition, we expect the
statutory combined ratio near 100% and pretax ROR to be 5%-8%... The company’s capital adequacy is
expected to remain strong...
“If the company exceeds all these expectations consistently... the outlook could be revised to positive. However,
if the company falls short of these benchmark[s]... the outlook could be revised to negative. ”
Above Source: Standard & Poor’s Classic Direct dated 7/25/07
Below Source: Standard & Poor’s Classic Direct dated 2/26/08
“ The outlook revision is based on the company’s consistently exceeding our prior expectations, significant improvement in
operating performance and a sizable reduction of asbestos and environmental reserves in its balance sheet due to two
large commutations...
“ ... believes Magna Carta will continue to maintain strong underwriting discipline and grow its business in the newer
states/regions organically or through small strategic acquisitions throughout the next underwriting cycle. However, the
company’s overall premium volume is expected to remain flat or slightly down... in the current soft pricing environment.
During the next 12-18 months... expects Magna Carta’s capital adequacy to remain very strong ... its statutory combined
ratio to be less than 100% and pretax ROR to be 5-8%.
“If the company exceeds these expectations ... the rating could be raised by one notch. However, if there is a material
downward shift from these expectations, the outlook could be revised to stable. ”
31
Ten Items to Key in on when Reading Reports
 Net Leverage
 Investment Leverage
 Combined Ratio
 Operating Ratio
 Return on Revenue (ROR)
 Return on Equity (ROE)
 Diversification
 Retentions
 Reinsurers
 Management Team
32
Resources
 Rating agencies websites and personnel
 Brokers
 Trade journals
 Peers
There is no substitute for doing your homework
and being an informed consumer!
33
Thank you very much for your attention.
Carol M. Pierce, CPCU, ARe
Disclaimer
This presentation and the information contained herein are based
upon various publicly available sources including rating agency
publications and websites. The rating agencies maintain proprietary
models and their assumptions and analyses may differ from those
underlying this presentation and information. This presentation and
information are not intended to be, and the recipient agrees that they
should not be relied upon as, financial, legal or any other type of
professional advice. Munich Reinsurance America, Inc. disclaims
any liability or warranty of any kind with respect to this material. The
recipient acknowledges that this material does not imply, certify or
guaranty any particular rating assignment or regulatory outcome.
The material as presented within this document is proprietary to
Munich Reinsurance America, Inc. and is presented solely for the
information of such personnel at your company that needs to know
the information. This presentation and its contents are confidential
and the recipient shall not distribute it to any third party without the
prior written consent of Munich Reinsurance America, Inc. Any
retention or use by the recipient of this material constitutes the
recipient’s acknowledgement and agreement to the foregoing.
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