Ratings agencies play an important role in insurance policy placement and regulation. The best known insurance rating agencies are AMBest, Moody, Fitch and Standard & Poors. However, the ratings agency that is drawing the most attention these days in the property insurance market, especially in the state of Florida, is Demotech.
Demotech, based in Ohio, was formed in 1989 to provide financial stability ratings to the property & casualty insurance industry. After Hurricane Andrew in 1992 upended the property insurance market, insurers realized that worst case loss scenarios needed to be accounted for in their rates, reinsurance, capital and surplus. Financial stability ratings like those provided by Demotech became more vital tools for regulators, producers and policyholders to assess the financial condition of an insurer. In addition they fill a need to rate insurers that are unrated by the larger ratings firms either because they have declined to be rated by the larger ratings services (some of the larger agencies operate on a pay to rate basis), because of their smaller size or limited territory of operations; this is the case with many of the Florida property insurers.
When an insurer is downgraded by Demotech, it is often taken as a sign of financial troubles at the insurer, and a leading indicator of possible regulatory actions such as consent orders, rehabilitation orders or liquidation proceedings being issued or forthcoming.. This was true in 2021 and 2022 with the downgrades by Demotech preceding various insurers being put under consent orders, entering run-off, non-renewing policies,or pulling out of the state(s). Multiple insolvencies were declared in Florida and Louisiana. Demotech has recently indicated that at least 17 Florida property insurers are facing possible downgrades, and the newly created Property Insurer Stability Unit in their first report has indicated that 27 property insurers have been referred to the unit.
Demotech is used by many as the rating agency of choice for the Federal Housing Finance Agency in Florida. Mortgages backed by Freddie Mac and Fannie Mae required a minimal rating of "A" from Demotech in order for an insurance policy to be acceptable on these federally backed mortgages, or the lenders will force place the coverage with insurers who meet their standards often at higher cost to the homeowner.
Demotech has indicated that a number of Florida property insurers are facing a ratings downgrade to "S" Substantial indicating that the insurer has adequate surplus and is able to meet its policyholder obligations. And others are facing a downgrade to "M" Moderate indicating that the insurer has moderate or "acceptable" financial stability to meet its policyholder obligations depending upon any economic downturn or deterioration in the insurance cycle. Insurers with an "S" or "M" rating are more likely to run into difficulties or be subject to regulatory proceedings, and while the companies are technically able to meet financial obligations, mortgage lenders require coverage to be placed with "A" rated insurers.
It should be noted that regulatory action often is a fast moving process once deficiencies are found at an insurer, and some ratings actions just happen to coincide with the regulatory action. Other times a ratings downgrade with the exception of those indicating the company is under regulatory oversight or are insolvent, are made before any corresponding regulatory action or the regulator has determined that action is not necessary at the time of a downgrade. In other words not all downgrades lead to an action, but any significant downgrades should always be noted by producers and policyholders alike, as they are signs of distress at an insurer.
With the current state of the property insurance market in Florida, any downgrades by Demotech or other rating agencies should be watched carefully. The market is still highly unstable, and the excessive litigation continues. The recently enacted legislative reforms will take time for results to be seen in the marketplace, and much more needs to be done to fix Florida's perfect storm.