Peace of mind. That’s what insurance is supposed to be all about. Consumers and businesses spend thousands of their hard-earned cash every year for pieces of paper – or in the modern world PDFs – they hope to stuff in a drawer and never actually use. Why? Because that piece of paper gives them the reassurance that if – just if - something goes wrong, everything is going to be OK.
At least, that’s the theory. The reality, however, may be something steeply different if the insurer that’s written that paper isn’t on a solid financial footing. Then, in their hour of need, the customer may find themselves swimming in an ocean with no sign of a float – a situation the client thinks the broker will have considered how to avoid.
“Why are brokers in business?” asked Charles Manchester (pictured), CEO of Manchester Underwriting Management and chair of the MGAA, speaking rhetorically in an interview with Insurance Business following the company’s Litmus Analysis Talk in Manchester. “They are in business to arrange risk transfer, between their customer and the insurer – the customer transferring the risk to the insurer. If the insurer isn’t there to meet its obligations and fails to pay the claim, then that risk transfer fails – and the risk that the customer is running is totally exposed. It could put them out of business, it could ruin their lives. So, surely, it’s professional to care about the claims you are arranging insurance for being paid?
“Part of that involves knowing what those policies cover, what your customers’ risks are – but also, knowing a little bit about the insurers that are providing their cover and whether they are going to be there to fulfil their obligations.
“Some brokers think ‘if we’re not going to be legally liable, we’ve done enough.’ But it isn’t just about legal liability – it’s about the customer getting what they’re paying for and being protected. There is no perfect science to it – but a little bit of due diligence is not unreasonable.”
That due diligence is where the ratings system comes in. However, while we’re all familiar with names like AM Best, Fitch and S&P – do we really understand how their ratings systems work and what they actually mean?
“My big concern for years has been the lack of understanding over what ratings agencies do and how they work,” said Peter Hughes, of Litmus Analysis.
“There’s an underlying belief that a rating is a fact – it’s got an ‘A’ rating so that’s what the strength of the insurer is, it’s an ‘A’. Actually, it’s an opinion from the rating agency that is based on a judging process that is somewhat complex. They are taking into account all sorts of different factors to make that decision and publishing their own opinion. They’re also forecasts, so, they are trying to look forward, trying to predict the future.
“The danger is that brokers don’t think through the process behind it and understand that the financial position of an entity changes by the hour as they take on new risks, as investments go up and down, as new claims come in or whatever it might be. So, the ratings agencies are trying to look through that to predict the future – but I don’t think the industry ever treats them like that.
“They are also a reflection of probability – they are trying to differentiate between the probable survival of insurers over a period of time.”
Most brokers, of course, place around 95% of their business with rated carriers. If an Aviva, an AXA or a Zurich got down rated you’d be reading all about it in Insurance Business – it would be almost impossible to not know about it. While there are subsidiaries of major insurers that may go unrated the chances of a big name letting a subsidiary go bust are slim – as Hughes puts it, it would be “a bit like chewing their own leg off… it’s going to take a dramatic situation for them to do that.”
So, if the ‘big name’ insurers are relatively safe, should brokers just avoid the unrated insurers like the plague?
“There is a place for them,” said Manchester. “For me there are two types of unrated insurer – or potentially three – that I would regard as acceptable. One is the niche operator that is well run and doesn’t need a rating. A perfect example is PAMIA, the patent agents’ mutual insurer – it’s not rated, they only do patent agents’ insurance and they don’t need a rating because all their members know who they are. They appear to be very well run, like a P&I club.
“The second reason is if they are writing lines of business that have a low impact on the policyholder if things go wrong – an example would be a gadget insurer where, if they fail, the consumer would probably get most of their loss back from the FSCS and it wouldn’t impact their lives dramatically. It’s not like losing your home or losing your business.
“The third would be when you get somebody with billions, such as a state fund, who is happy having an insurance company that is running at a loss while they build it up.”
So, if a broker is going to deal with an unrated insurer what are the red flags they need to be watching for?
“I think what the small to medium sized broker should be looking at is the claims paying action of the companies they are dealing with,” said Manchester. “Are they being fair with their claims? Or are they nit picking everything? Are they paying promptly? Or are they delaying payments? Because that is the first sign of something going wrong – when an insurer doesn’t want to pay claims.”
“Ironically, that is something the rating agency doesn’t see as quickly as the broker because they aren’t trading in the market as the broker is,” added Hughes.
“The second thing is aggressive underwriting – fast growth in clearly dangerous areas at inadequate prices,” continued Manchester. “If they just don’t look right, then they probably aren’t.
“The other thing is that big insurers with lots of capital rarely go bust. They do sometimes – but they’re also rated so there’s lots of information about them. If it’s an unrated insurer they can go to the BIBA Litmus Test Report.”