Best's: P-C Downgrades Beat Upgrades

Best's: P-C Downgrades Beat Upgrades

NU Online News Service, Nov. 5, 3:05 p.m. EST?For the third consecutive year, A.M. Best's downgrades in the property-casualty marketplace have outpaced upgrades despite the continued rate hardening, the insurance rater reported.

In a new study released this week, the Oldwick, N.J.-based ratings firm pointed out that during the 12-month period ended last July, it announced 188 downgrades in the p-c marketplace?representing some 10 percent of the total p-c ratings actions taken by Best during that time. In contrast, the firm upgraded only 57 p-c ratings during that period.

In fact, the number of Best's p-c downgrades has jumped over the previous year. During the prior 12-month period ended July of 2002, the ratings firm had downgraded 151 p-c ratings while upgrading 76.

Karen Horvath, an analyst at A.M. Best, told National Underwriter that reasons for ratings cuts haven't changed during the past year.

"There isn't anything new?main drivers of downgrades have been companies that under-priced and didn't fully recognize claim trends that were occurring during the depth of the soft market in the late 1990s," Ms. Horvath commented. "These companies continue to have adverse loss-reserve developments, which eroded capital, weakened their balance sheets and caused ratings downgrades."

Ms. Horvath said the adverse developments on prior accident-year loss reserves impacted many commercial-lines carriers exposed to long-tailed liability lines such as workers' compensation, construction defect and medical-malpractice coverage.

Commenting further on workers' comp, Ms. Horvath said the market "continues to spiral" as reserve shortfalls from years of inadequate pricing are made worse by rising loss-cost trends.

"No state highlights the troubles facing the workers' comp marketplace more than California," the ratings agency noted in its new report, "A.M. Best Rating Downgrades Outpace Upgrades for 3rd Consecutive Year." Best reported that despite improving current accident-year conditions, several insurers saw their ratings lowered because of adverse developments from prior accident-year loss reserves.

The med-mal market also suffered a high percentage of downgrades, A.M. Best added, caused by worsening loss-cost trends from medical-cost inflation and rising jury awards. Other adverse factors mentioned in the report included asbestos and environmental liabilities?which continue to develop unfavorably?as well as weather-related catastrophe losses.

The ratings firm also observed that many p-c insurers continue to suffer from a capital squeeze.

"Certainly we have been in a period of hard market and that has helped many companies," Ms. Horvath added. But at the same time, she explained, some insurers "are trying to grow in this hard market, but don't necessarily have the capital to do so?that has created a bit of dilemma for some companies."

A fair number of companies?mostly small- to midsized insurers?continue to face this quandary, Ms. Horvath said.

Depending on their capital position, "they may be okay for their current rating, but as they try to grow, they are taking on more risk and don't have capital to back that," she said. "This is constraining some companies as they try to grow."

Ms. Horvath also said the quality of capital has become more of an issue this past year, as companies look for alternative ways to strengthen their capital, rather than having just equity available to them.

"So you have seen a lot of debt issuance occur. You have seen companies relying more on reinsurance transactions, which are not permanent?they certainly have a term to them," she observed.

Some types of reinsurance transactions are finite, she said, and many of them have the effect of discounting loss reserves and making surplus look larger than it is. "But that doesn't really strengthen the capital position of the company?it's more of a visual," she said.

Ms. Horvath added she has seen companies whose parent corporations are "a little less committed" because of problems they have, and consequently put in nonpermanent capital that might be in a form of a loan or a guarantee.

A.M. Best noted in its report a continuing volatility in the investment environment, which has been causing further strain for the p-c industry.

Investment yields are still low, "given where the interest rates are at this point in the cycle," Ms. Horvath said. "The gains on stock portfolios have improved, certainly, since the market's been up."

She noted, however, that "when you look at the investment income?the yield on bonds is not improving."

Ms. Horvath also explained that this year there was a jump in what A.M. Best describes as "Other Changes" in its p-c ratings actions. She attributed this to a number of companies being converted to a different nonrated status. "A lot of these are conversions within our Not Rated category," she said.

She explained that when companies don't file data with A.M. Best, the data is purchased from the National Association of Insurance Commissioners. "Then we just publish a limited-data filing, and that gets assigned the NR-1 status," she said.

But this past year, many more companies filed their data with A.M. Best, Ms. Horvath observed, which means they were converted from NR-1 to NR-5 status. "We are now getting their data filed with us, but we have not initiated formal rating coverage on them yet," she said. "There were a few requests from companies not to be rated, and they were also included in ?other changes.' That made up a very small percentage."

Looking ahead, Ms. Horvath noted that the ratings agency expects the downgrade trend to "level out" in 2004, but she said it will take time to reverse "several years of inadequate pricing that led to poor underwriting returns."