This is the Time Financial Ratings Really Matter

It's easy to have faith in an insurance company when times are good.

However, it's in the times of crisis when that faith truly gets tested.

Actually, faith should have very little to do with your opinion, because math and complex statistical analysis are real things.

It's also important to know how deep the financial rating rabbit hole goes.

Stefan Holzberger, Chief Rating Officer, and Andrea Keenan, Senior Managing Director of Strategy & Communications at A.M. Best help you get to the bottom of what they know about your insurance companies.

Joey Giangola: Andrea, Stefan, how're you guys doing today?

Andrea Keenan: Doing great, thanks.

Stefan Holzberg:Yep, very well. Thank you.

Joey Giangola: I got to ask, since you guys are in the business of rating the financial character of insurance companies, I'm kind of curious if you have a sort of personal secret subtle rating system for your interactions with everybody day-to-day. Is there a little sort of tale that you put out there to the world to say, "No, I'm just kind of secretly seeing what's going on here?"

Andrea Keenan: Yes, but that's not because I work for a ratings agency. I think I evaluate everything in the form of a model. I'm an economist by background, so whether or not my husband goes to the refrigerator on a given day, I can probably do a utility optimization model and figure out, predict what's going to happen next. So I think the background is analytical. From my perspective I can't help but be analytical when I approach people, projects, anything. I think that's what probably attracted me to my work as opposed to the other way around.

Stefan Holzberg: Yeah. May be Joey to add to that, for you and the audience will quickly understand why Andrea is on the commercial business development side of AM Best business and I'm more the credit analyst, crunching the numbers and trying to keep the ratings up to date. But I think to your question, the rating work we do is a combination of an art and a science. Right? The number crunching part that I just alluded to, the kind of analytical models that we use to help determine the credit ratings, is just one piece of the puzzle. We definitely have that intense engagement with the companies that we rate with the management teams and that's really where the analytics, I think, makes a difference.

Joey Giangola: All right. I got to know, is there one thing, Andrea, that if you're looking at a refrigerator trip in terms of what that means for the greater world at large, for me, my question that I generally toss out to somebody is like, "What's your favorite sports team?" and then based on that answer, it's "Well, where did you grow up?" And if those two don't really go together, then I'm like, "Okay, I got to be careful. I don't know this guy can just jump around all over the place." Do you have anything like that. Is that sort of telltale sign?

Andrea Keenan: When approaching someone. No, I can't think of anything. Nothing comes to mind. I think it's hard for me to offend someone in the area of sports since I don't know much about sports at all. So it doesn't matter so much. So I definitely try to keep away from those things and try to find out what someone is passionate about before really getting into something meaty and once I find out what they're passionate about then we can move on from there.

Joey Giangola: It's certainly probably for the better because there's just a lot of wasted energy with sports passion, so probably all for the better. But really, I think one of the biggest questions that I wanted to ask both of you guys was, as agents, we toss out AM Best this, AM Best that. Right? We say this all the time to clients. It's a thing that we sort of hold to but I don't know that most of the agents that say that really know what it means and why it's important and even further, the end client, they probably have heard it over the years, but what goes beyond just that rating and the number that agents maybe don't take enough time to dive into and understand?

Andrea Keenan: I'd say first and foremost, the rating is information. It's information that's thoughtfully assembled. There's so much information out there these days that a rating is something that gives a quality assessment of the ability of a company to pay its policyholders and since the rating is a scale, the scale has a lot of information behind it. So, I mean, at the risk of getting a little too deep in the weeds, I'll just say generally, we as a ratings agency, we not only evaluate the companies that work with us but then we evaluate ourselves and look at the performance of our ratings. So over time, we study how our ratings do and those studies are published. We're a regulated rating agency and so we have an obligation to publish them but also it's a worthwhile document, it's called the Impairment and Transition Study.

So in the world of insurance, whether or not a company gets impaired, talks to whether or not when a company looks like it's in financial trouble and a regulator jumps in and takes over or shuts them down or whatever it is that a regulator decides to do in that case. And when we have ratings, we look at how often when we have a rating on a company, a regulator does that, where it goes into impairment and these statistical tables come out. So say if you have an A- on a company, looking at one of our studies right now, if you have an A- on a company that over the course of 10 years there's a 95% chance that that company is still going to be around to pay your claim and that's based on the history of our statistics.

That letter, even if you don't know anything about how we get to the conclusion of the rating, the conversations, the information that goes into it, which is considerable, you do know that is highly implied by statistical history that a rating of a certain level is going to imply a certain probability of impairment. [inaudible] probability of default, it's an even higher number because default is past the level of impairment when a company goes insolvent. So I have more to say on the topic but I don't know if Stefan wanted to jump in a little on that?

Stefan Holzberg: Yeah. I mean, maybe just to kind of add to those high level statistics reviews that we take across our rated universe on a yearly basis. When you kind of go down into the individual ratings themselves and the analysis that we do, our emphasis is stability of the ratings. Right? So what we want to do is we want our ratings to stay as stable as they can be across the market cycle. Right? So you have ups and downs and GDP, unemployment, general economic conditions. We think it wouldn't be particularly helpful if during that business cycle, we were constantly upgrading and downgrading companies.

So the threshold that we hold the companies to really requires them to have a capital and operating performance such that the rating can stay stable at that given level across the business cycle. We know that insurance carries long tail liabilities, like Andrea said, take that 10-year timeframe. We look even beyond that to say, we want our ratings highly rated insurance company to have the stable balance sheet, stable operations over a lengthy period of time because we feel that that is kind of a critical factor in terms of the stability of the industry as a whole.

Joey Giangola: Very true. I know you said you had more to kind of go into that, but I have to ask right now because you brought me here Stefan, is that, I mean, so basically what you're saying is you're not chasing headlines. Right? Of the insurance paparazzi of what's reactionary, you're kind of letting things set a little bit. You're just taking a levelheaded approach to it. I guess you could say we're in one of those periods right now. A pretty substantial one. I mean, what are you guys thinking in terms of this? Because this is probably something that you guys haven't seen anything of this extent for a while. How is that going to impact everything? And what does that sort of longevity look like in terms of duration and not being too reactive and giving companies time to kind of let those ratings set in?

Stefan Holzberg: Yeah. So it's when you have a crisis, we feel that ratings really matter. Right? When the economy is chugging along, doing great, unemployment's low, the insurance market is growing. We're not seeing heavy losses from catastrophes or casualty classes of business. With those really positive market conditions, gradings of course, are going to be inherently stable and dependable. It's when a crisis comes into the equation, I think that ratings have the most value. We saw it in the 08 09 crisis. We're certainly seeing it today under COVID-19 where there are so many sources of stress and pressure in the market, whether it be certain lines of business or certain classes of investments. So in reaction to a crisis like we're in today, at AM Best, we start with getting in touch with all of our rated companies globally talking to them about their operations, talking to them about their risk management, disaster recovery. Right?

Is this insurance company going to be able to be in touch with its policy holders? Is it going to be able to interact with it's distribution. Right? It's agents, it's brokers, it's wholesalers, so that the process of binding, quoting, getting policies out the door doesn't come to a grinding halt. Same thing on the claims side. How are you going to adjudicate claims if you can't go out and inspect the loss? We're really talking to companies about how they operate under this remote environment because well-rated companies should prepare for situations that alter their ability to run their business. And I'm sure you've read about it in the headlines. And we've issued reports on the subject. It's really a positive story, how well the insurance companies are able to operate in these adverse and suddenly adverse conditions.

Maybe one other point to bring in terms of COVID-19 and what it means to financial strength ratings. The other thing we did early on in March is we ran what we call a stress test. Right? So we evaluate the balance sheet strength, the assets and the liabilities, of insurance companies all day, all year. It's a big part of the rating but when you have a stress situation or you expect the loss ratio to spike, you expect investments to decline in terms of their value. Well, what does that mean to the balance sheet strength of the insurance companies? And that piece of information is very critical to the rating assessment. So we ran this capital stress test as well as a liquidity analysis across all of our ratings. And those companies that were showing us a significant amount of pressure, those companies would go back to our rating committee for a potential downgrade. So that's kind of, I guess, a long winded way of talking about what our actions are when we have a stress environment like we do today.

Joey Giangola: I kind of want to see that reality show of you guys going around to the different companies and having those conversations. I mean, it sounds boring on the surface but I think we could make it work. Andrea, I mean, what does that look like then in terms of that downgrading process? So is it kind of to use another sports reference of getting cut from the team? How does that feel? You put a little red ticket in the locker on the company? How has that conversation had? And is that something that agents, or maybe, I guess maybe I'm not paying enough attention but when does that become, sort of, hit the radar for people like, "Oh, so and so just went from an A to an A-?

Andrea Keenan: Well, during a crisis I think we wish to be in the middle of the storm to a certain extent because we need to communicate, communicate, communicate. There is panic going on. Part of the reason we exist is to give assurances of stability. If a company has rated highly, then the idea is that it's going to be able to weather the storm with a certain amount of stability. And the idea of a downgrade, I mean, this is not a binary thing. It's not you get rated or you're not rated, or you get an A or you fail. Companies can be up and down the scale. And that's not necessarily meaning that there's a destabilization of the company or the event to a severe extent. I think the press finds it very sexy or can be very sexy to have something like an upgrade or downgrade. But that's why I go back to the statistics. The statistics have meaning. It means that a probability of default has increased but by a marginal amount and there's something to be concerned about or something to look at.

Another thing about the communication, we try to be as transparent as possible. We have to protect confidential information but we want to be able to communicate to the outside world that whether everything's okay or not okay. And in part of that communication with individual companies because we have a very structured methodology, and Stefan's been in these conversations real live life and I have not, but the methodology that we have allows for a basis of that communication. We can say, listen, of the seven main things we're looking at with this particular company, there's one place here where you have a flaw, maybe it's in the business profile or enterprise risk management. And that discussion can be a very fruitful one with the company because of the interactive process, it provides them an opportunity to look in the mirror and say, "Oh, you know what there is a panic going on. I'm trying to answer all of my policy questions but I have to make sure that I'm also financially stable."

And we can provide a little bit of a map as to where a problem might be. Maybe it's agents balances, you never know what it is, but we do have a pretty structured methodology that can be the basis of that conversation. And when that decision is made and we do release it to the public, we're quite explicit as to what the problem is. So again, it's not binary, there's more information that accompanies a rating besides just the letter. It's the reporting, it's the commentary it's interviews. It's helpful to take in the whole picture.

Joey Giangola: Would you mind I jumped back to that probability because that was interesting. I've never heard that statistic in terms of, if it's this, if it's this rating that it has this percentage of probability of being around for X amount of years, because I think that should be a nice little chart that kind of sits beside of that. I don't think we're seeing that enough. Can you maybe walk us through a little bit of that scale in terms of those probabilities?

Andrea Keenan: Sure. Well, first and foremost, I should say a rating is not a guarantee. Nothing's for sure. That there's all this disclosures that go and the go with all of that but-

Joey Giangola: Probable, probability. Right? Probable.

Andrea Keenan: Probable probable probable. One of the reasons why it's not front and center in the literature is because it's complex. There are multiple types of default. Like I said, there's impairment, there's default, there's liquidation. And so we've actually been looking internally as to how we can communicate that better particularly with agents and try to put it in something that can be understood quickly. So that's why you haven't seen it. I'd say it's perilous in that it is complex. However, if I had my more visuals, I'd be able to show it to you and I'm looking at it on my screen now but you say take an A group plus company in one year there's essential. It implies essentially a 0% probability of impairment. And in 15 years, it's still less than 1%. A company that has an A++ rating, they're choosing to be an A++ rated company. To be honest.

It's not that two companies are striving to do the same thing. Companies have to make a determination between return for their investors and being rock solid as far as financial stability and strength goes. So buying an insurance policy from A++ carrier carries with it certain implications. My life insurance policy with New York life, they're A++, I know they'll be around forever and ever based on that information. And that's a long tail policy. With shorter tail policies maybe you don't have those concerns as a buyer or a risk manager. You need to make those decisions. And so what you're paying versus how they're treating their balance sheet. So the demands that a company has, it doesn't necessarily mean that both companies are trying to be A++. It means that you've got two companies are making different business decisions. And if it's an A++ it's 0.1% chance in 15 years of default. But if you go to a C or C- in 10 years that goes up to 30% chance of impairment. So the scale matters. I don't know, Stefan, if I haven't said that clearly enough, it is complex. It's easier with pictures.

Stefan Holzberg: Yeah. I think that's a great point. Right? The fundamental premise is that our ratings are a relative measure of credit worthiness. Right? So the scale is hugely important. We've got thousands of insurance companies rated and we have them rated from all the way down, like Andrea said, in the C range all the way up to the A++. Maybe one takeaway that I think might resonate to the agents and the brokers who are listening. We know a huge amount of value is placed on the A- rating, particularly for certain classes of business on the commercial side or on the reinsurance side.

When you look at those statistics that Andrea is referencing, those companies with a financial strength rating of B+, B++ those are very secure credits. I mean, obviously it's a relative measure. So a B+ rated company has a different historic performance track record than the A++. But if you look at our statistics, which we provide to our regulator the SEC every year they scrub those numbers very carefully, the stability and the strength of that B+ and B++ financial strength rating is really there. Those are companies that have very strong credit quality as well.

Joey Giangola: Yeah. I definitely found it interesting. When you said it's a choice to be an A++. I think that opens the eyes of agents out there who're saying, listen, yeah, it's nice, but maybe they don't want to be an A++ company. Maybe they've had a different strategy. Oh, that was kind of fun. But moving forward I'm curious, how does that sort of look to the future in terms of those ratings? What do you think is going to change? Is this sort of a business that it is what it is. Right? Math is math and we kind of know things, but is there any benefit, downside to looking at ratings differently moving forward? Is there anything that is on your guys' plates that you want to dabble with? I don't know. I mean, I'm very curious.

Andrea Keenan: It's an interesting question. Right? Because our eyes are wide open. There's a lot of data out there and a lot of information. And I started out by saying that we're an information provider. So there's competition for being a credible, reliable, available, all of those things. And I think in some cases as a flood of information comes in. Any website you can pull up information or data about companies or little star ratings as to whether or not you're having a pleasant experience with your carrier. Lots of that stuff is out there but the fact is that you can get lost in that noise. And a company like ours you've got 120 years experience, looking at these companies there's a bit of stability with that. And I see the path going forward personally of continuing to be a bit of a touchstone, boring, changing times of... We're looking at things in a thoughtful way, in a way that evolves over time, but that doesn't get caught up in some of the other metrics that are out there.

From the commercial side is, as Stefan mentioned, I look at positioning our ratings and how they'll be positioned going forward. And it's a matter of really making sure that we're still adding value along with the these all the myriad of information that you get out there is still something that's valuable about the rating and what we have to offer. So I think it's a bit of a consistency.

Stefan Holzberg: If I could add maybe just a point to that. One of the things that we are kind of excited about as insurance geeks is the new forms of risk transfer that we're seeing in the market. Right? You hear more and more about cell captives, protected cell structures, transformer vehicles, side cars, there's been a real push to more dynamic, more real time, ways of transferring risk from the policy holder, either to the insurer, the reinsurer or all the way out to the capital markets in the form of insurance-like securities.

So being a single sector, credit rating agency only focused on insurance and risk. We feel that we're in a good position to explain to the market the benefits and the pitfalls of some of these more new age re-transfared techniques. So it is something we expect to see more and more. They'll always be brick and mortar insurance companies, but there may be a risk-like catastrophe risk and others that find their way to the capital in a different way than we've traditionally seen. So I think there's a lot more to come on that.

Joey Giangola: Yeah, it's interesting because data is certainly all the rage these days in terms of how companies, agents, and everybody can be using it better, faster, quicker, all that fun stuff. Is there one piece of, you'd said, Andrea, is there one piece of information or data that, like you said, you're trying to stay consistent with what you're looking at. Is there something that maybe is more of a smokescreen, more of a distraction that you guys were seeing that maybe again, should be kind of put out there saying, listen, this seems attractive and alluring but really it's not giving you much information?

Andrea Keenan: The star ratings is a funny one. And as I say it sounds kind of silly to us simply because I know what goes into our ratings, but there's so much ability for consumers to rate things and say, I liked it. I didn't like it. This person was mean to me, all of these things. And there was an insuretech that spoke to me a few years back saying, "Oh, ratings are going to go away because anyone can crowd rate a company with these scoring systems, these online scoring systems." And I thought that was incredibly ill-informed, but it was from a very serious person who understood that there is value to these crowded and crowd opinions, but that is totally a smokescreen. And sometimes over the years, we get calls from disgruntled policy holders who want to complain about their insurance company.

We're not a business bureau, it's completely different thing. So I think that's just a matter of understanding what it is the rating says versus what it doesn't say. It's about stability, financial strength, not about a customer experience per se. Some of the customer experience feeds it's way into the rating. Because obviously a company that's not being kind to its customers is not going to have a good business profile and that eventually affects capital. But that is funnily enough something that I have seen misunderstood.

Joey Giangola: I guess I've got two more questions for you. And if you had to tell an agent one thing to better communicate ratings, we've covered a lot. Right. But if there's one thing that you would want them to know about what you do and why it's important and what they need to be telling their end customers about these ratings, what is that and how should they be delivering it?

Andrea Keenan: I guess it's understanding your buying choices. If you're a risk manager or a policy holder looking to make an investment and spend your hard-earned money on something like protection, then be informed to learn what you can about your insurance company, how they treat you from a customer standpoint, which the agents have a lot of influence over? What it is they're offering? It's a protection product. So make sure that the entity offering the protection is strong and able to do what it's promising to do.

Stefan Holzberg: And maybe I would add to that. I think maybe be aware of how much analysis and interaction with the insurance company goes into the financial strength rating. Anybody can see what the balance sheet looks like at the last reporting date. Anybody can see the last three, five years of performance, but we have in-depth live conversations with the management teams of the companies that we follow, we scrubbed their business plans extensively, really try to understand how they're going to compete in the market over the next one, three, five years so. Our emphasis is on those ratings being a leading indicator of the financial strength of the companies on a going forward basis. So we look at trends and we emphasize like I said before stability. There's a lot of qualitative aspects to the rating that I think doesn't always get a lot of attention but I think that's really where the value of that interactive rating approach that we take at AM Best.

Joey Giangola: All right. Last question to you guys and you can answer it in whichever order you feel most excited about. If I were to hand both of you a magic wand of sorts to kind of grant your insurance excitement across the industry, where's it going? What's it doing? And what's happening?

Andrea Keenan: I'll go. From a personal standpoint, I think the insurance industry has a lot to offer. I think that it's about protection. It's about resilience, actually Stefan and I were both involved in a study, a couple of years ago, about the history of the insurance industry just over the past 25 years. And seeing that the insurance industry is there to protect and rebuild during times where there is human crisis is it's inspiring. And there are technological solutions and interesting things being developed in all industries and the insurance industry, however, has an ability to touch thousands of millions of people. So I like that the insurance industry will be able not only to protect people and floods in their homes and making sure that businesses get back online.

But I also like that the development piece of it closing the protection gap. Microinsurance, places where there's protection being offered to people who don't have access to finance. In my own world I've been involved in microinsurance and in UN efforts with the insurance development forum. There are things that the insurance industry has been recognized as a source of relief from poverty and inequality. And you have some very intelligent executives and some great insurance talent that's working on solving world problems with the tools that we've had over the past 500 years in the insurance industry. So I think that it would be inspiring for anyone in the industry to realize that there are efforts beyond sort of your textbook idea of what insurance is that are gaining a lot of traction now both nationally and globally.

Stefan Holzberg: And maybe to add to that. And I think Andrea referenced kind of the tools available to the insurance industry. We're spending a lot of time looking at innovation, looking at technology, whether it's artificial intelligence, digitalization is leaping forward in this remote environment that we're in, predictive analytics that are available through cloud computing. There's going to be a revolution in the way risk and data is utilized and understood and analyzed. And I think it's great news for the insurance industry. There's going to be capabilities to get deeper knowledge of the risk, which will improve pricing reserving, et cetera. I think there are a lot of exciting innovations that are going to come around the corner.

And then maybe also to touch upon another subject Andrea just brought up is that the protection gap, microinsurance many of the folks on this podcast will probably be aware of the business interruption issues that are taking place in the market, whether BI is or is not available to businesses that have lost revenue as a result of COVID-19 shutdowns? At AM Best we're very much engaged with policymakers at the state and national level as well as within the insurance industry to help devise a solution. So that the next time a pandemic rolls around you don't have these businesses forced to shutter lose revenue and lay off workers. Right? So it's again, the insurance industry has got such a role to play in the broader economy and at AM Best we're pretty excited to be a part of that conversation.

Joey Giangola: Andrea, Stefan, that was a lot of fun and I'm going to leave it right there.

Andrea Keenan: Thank you.