Insurers undertake enormous risk against small amount of premium, as such clients looking for insurance protection should ideally look for insurer with the strongest financial strength. Financial strength rating (formerly Claim Paying Ability rating) is an assessment of an insurer’s financial strength and capability to meet its ongoing insurance policy and contractual obligations in timely manner.

Beacon Ratings insurer financial strength rating is essentially forward looking and assess the insurance entity’s capacity to withstand stress and meet policyholder liabilities. The assessment covers factors such as operating environment, risk undertaken, re-insurance strategy, risk management, financial performance, sustainability and competition, parent company support, corporate governance and management quality.

The operating environment assessment provides a clue of the setting in which insurance entities operate, determining their state and prospects for their development. It clarifies risks within the operating setting.

• Operating environment assessment provides a clue of the setting in which Insurers operate, determining current state and prospects for development.
• Industry dynamics have significant effect on Insurer’s operating position, product, market, pricing strategies and long-term core profitability.
• Regulatory environment sets out the framework for business practices, policies and incentives for products that have significant effect on operations of Insurers.
• Sound and transparent regulatory framework with independent and credible regulator with best practices, promotes healthy industry environment.

Well-diversified insurance product portfolio and mix of underwriting income stream from insurance products and fees provide sustainable operating profile and impact positively on revenue streams. Furthermore, insurance products are evaluated for risk mitigation and pricing adequacy, especially for return guarantee schemes. Factors evaluated include:

• Persistency ratio
• Pricing policy and strategy
• Diversity of risks underwritten
• Product mix and performance
• Distribution strength and cost
• Market position and market share
• Quality of agency force and distribution channels

Re-insurance arrangements are vital to insurance risk management as it spread underwriting risk, support underwriting capacity and overall loss that devolve the primary Insurer. Appropriateness of re-insurance structure relative to nature and size of underlying risk exposures and credit quality are assessed. Other parameters include: 

• Re-insurance strategy and its linkage to business growth strategy
• Net retention per risk/event in relation to capital
• Net retention in relation to net premium income
• Premium retention trends and strategy outlook
• Re-insurance receivables in relation to capital
• Relation between retention ratio and claims ratios

• Competitive position: A sustainable competitive position results from solid control over distribution channels, adequate agreements with brokers, efficient underwriting cost structure and easy access to target or captive markets.
• Market share arises from solid position per market and product, client recognition, brand name, strong niche.
• Distribution channels per underwriting expenses over net premiums measures the strength and dominance to keep control over such distribution channel.
• Size of operation: Large Insurers are sustainable and competitive. Medium and small Insurers – in terms of asset size or gross premiums – can enjoy a significant competitive advantage when sustainable market positions are taken in niche segments.
• Diversification: Geographic and product diversification help to spread concentration of underwriting risks and reduce exposure and unexpected losses as a consequence of specific events. In addition, diversification promotes resilient business model that allows for premiums to be generated from several business lines.
• Business franchise: Franchise may arise from brands and products to meet the range and varying needs of clients. Solid business franchise leads to strong market position, market growth, core profitability and internal capital generation.

Insurers should be well capitalised to withstand adverse changes in operating, regulatory, underwriting and investment cyclicality, and impact of shock scenarios such as catastrophe losses and investment market volatility. Strong capitalization improves insurers’ capacity to withstand financial stress. Factors include:

• Financial leverage
• Adequacy of surpluses
• Unexpired risk surpluses
• Underwriting leverage
• Exceptional loss surpluses
• Technical surplus models
• Extent of shareholder support
• Sustainable earnings to support internal capital

Profitability of insurer is a function of underwriting and investment strategy. Underwriting profitability is a function of premium income, agency commission, staff costs and claims experience. Indicators include: 

• Loss ratio
• Expense ratio
• Net premium
• Risk retention
• Combined ratio
• Gross premium
• Return on assets
• Return on equity
• Operating premium 

Insurers invests policyholder surplus and returns on such investments are factored in pricing of insurance products. Solid investment yield without compromising asset quality, liquidity of portfolios and key investment risks such as credit risk, market risk and liquidity risk. Parameters considered include:

• Investment yield 
• Portfolio diversification
• Adequacy of provisioning
• Credit quality of investments
• Non-performing investments
• Liquidity of the investment portfolio
• Investment strategy and philosophy
• Asset classes – equities, fixed income securities, etc.

Insurer’s capability to meet its anticipated short-term and long-term obligations to policy holders and other creditors. Primary sources of liquidity such as underwriting cash flows, operating cash flows and investment portfolio liquidity are assessed for impairment, concentration of exposure and returns.

• Insurers’ liquidity depends on holdings of sound cash and cash equivalents.
• Primary sources of liquidity include underwriting, operating and investment portfolio cash flows.
• Cash flows from investment portfolios are evaluated for healthy liquidity, impairment, concentration of exposure and returns. Other factors assessed include liquid assets in relation to technical surplus.

Financial flexibility: Insurance entities are expected to have adequate financial flexibility to meet unforeseen contingencies.

• Insurers are expected to have adequate financial flexibility to meet unforeseen contingencies.
• Lines of credit facility from banks to meet short term liquidity requirements and capital commitment from promoters are important sources of financial flexibility.
• Cash call facility from re-insurers to meet large claims are key sources and provide additional comfort and positive feature of re-insurance strategy.

Insurance entities with proven ability and expertise to successfully manage underwriting and investment risks are likely to maintain their long-term financial sustainability. Underwriting and investment risks, product risk, operational risk and regulatory compliance risk are assessed.

• Underwriting investment strength in terms of underwriting policies, risk acceptance, pricing and re-insurance policies to determine the level of overall product risk and ability to manage catastrophic events in the long-term.
• Product risk provides an indication of overall risk appetite and ultimately risk absorption. Product risk mix in terms of granularity, loss ratio volatility, surplus requirements and product underwriting policies and limits are key.
• Operational risk involves analysis, grading, hazard studies, safety audit, and risk management of portfolios. Adequate information technology to generate various reports for timely decision making to reduces operational risk. Measures for operational risks includes: (i) Clients grading, (ii) Clients hazard studies, (iii) Client safety audit, (iv) Risk management training, and (v) Portfolio analysis.
• Regulatory compliance risk involves due compliance with relevant laws and regulatory requirements, lapses or inconsistencies leads to regulatory risk.

Management quality is a differentiating factor in the performance of Insurers. Parameters include:

• Senior management stability 
• Senior management pro-activeness
• Senior management’s credibility and track record
• Depth, breadth and succession plans
• Capability of second layer of management.

Sustainability of Insurer is heavily influenced by policies and support provided by governing board over time. Parameters include:

• Board committees
• Oversight responsibilities
• Board practices and track record
• Board support for management
• Board composition and independence

Insurers in most cases are affiliates of larger business groups hence any form of implicit or explicit support available from parent/sponsors serves as credit enhancement. Financial strength of parent entity includes:   

• Financial position of parent entity
• Sources of operating cash flows
• Commitments and allocation of funds
• Strategic significance to parent entity