I find that almost all agents and a high proportion of insurance company employees have insufficient knowledge of insurance carrier excesses. Also, many think that the knowledge they possess is accurate, however, in my experience, it is not.
Estimating the insurance company’s surplus is complex. This is why actuaries make big money. AM Best has developed a special rating system that is complex, but it is the best points system I have seen. The complexity of the scoring system makes it impossible for normal people to use it well, but most don’t even know it exists, so complexity is a moot point.
I don’t think a high quality points system can be simple. I know of one consulting firm, at least, that offers simplistic results, but simplistic is not appropriate. Simple becomes deceptive.
When I first entered the industry, redundancy seemed simpler. My mentors taught me about the ratio of net premiums written to excess, and that usually seemed to be enough.
However, at that time, if I’m not mistaken, the carrier surplus consisted of more or less the same assets. One of the main complexities today is how assets and the quality of those assets vary so much from one carrier to another.
The quality of the surplus is an important variable. When a carrier has to pay claims and their balance is in cash, there is no doubt about their ability to pay. When a carrier’s balance is a loan, the lending entity may not be excited to see the carrier’s ability to repay the loan disappear. They can even file a motion to prevent the carrier from paying the claims.
I analyze the financials of the insurance carrier in some way. I do not hold myself out as an expert in carrier redundancy analysis. However, I think I can shed some light on this topic which is important to agents and carrier workers who don’t know how excess quality varies. Here are some quality factors to consider.
The borrowed surplus is known as excess notes (there are other forms of borrowed surplus, but this is probably the most common). Here a carrier borrows money against its surplus (the surplus is the collateral). There are two calls for this money. Policyholders have a phone call and so does the entity that loaned money to the operator.
It has been a while since a shipping company with excess notes has been unable to meet interest payments (although at the time of this writing, a shipping company with some solvency problems and also with material excess notes has just entered the day when interest payments of interest are possible), at least as far as I know.
The last time I know this happened, the insurance department stepped in and stopped the carrier from making such interest payments. Failure to make interest payments often leads to bankruptcy, an obvious outcome. The insurance department usually insists that all interest and principal payments go to policyholders first, leaving holders of excess notes holding the bag. As one carrier executive said when it happened to his company, “We’re sure the noteholders understand.” I’m sure they did, but not in an understandable way.
Relatively few companies borrow money against their surplus using their surplus as collateral (perhaps about 15% of all property/casualty carriers) and even then, few borrow much. However, some well-known companies have borrowed billions.
I imagine most people are surprised that the federal government guarantees the ability of some carriers to pay claims. You probably thought this was a function of state guarantee funds. The structure is often problematic because these guarantees subsidize disability. While the carrier may still be competitive, management may take unnecessary risks because they know they have a guarantee. Some of these carriers have seriously low capital adequacy scores as calculated by AM Best, but their solvency is not a problem because the backstop is in place. That backstop is counted as additional surplus. It’s not a level playing field.
The question for agents and employees is this: If a carrier must borrow or depend on bailouts, how secure and stable is your future relationship with that carrier?
Many people in the industry believe that regulators require that insurance companies’ surpluses be invested in high-quality, ie, safe investments, and that junk bonds, or non-investment grade bonds, do not qualify as safe. Regulators seem to disagree because some large and well-known carriers have 30% to 50% of their surplus in the form of non-investment grade bonds.
Someone told me: “They didn’t learn from the credit crisis not to invest in mortgages!” Some shipping companies have invested a large portion of their surplus in mortgage-backed securities.
Reinsurance recoverable excess is based on the premise that the carrier will recover from its reinsurers $X amount of claims they have paid. This makes perfect sense and usually the amount of excess relief recoverable from reinsurance is small. Most of the carriers I analyzed do not rely heavily on these recoverables to support their surplus position. This is a good thing because reinsurers and primary insurers often disagree greatly on how much money the reinsurer will reimburse the primary carrier.
However, a small portion of carriers’ surpluses are entirely dependent on such recoverable reinsurance. In other words, if they don’t get the money from their reinsurers, their surplus goes to the pot in a hurry. Some may even go bankrupt.
Most of the time, at least based on the carriers I’ve analyzed, carriers that rely heavily on reinsurance recoverables add a twist. The reinsurer is simply another entity of the carrier’s company. This begs the question – if the reinsurer arm of the company pays the carrier arm full recoverables, will the reinsurer arm go bankrupt?
It’s always been strange to me how self-reinsurance still counts as reinsurance. I can see how this model could work for particular carriers if all the walls are thick, transparency is clear, and there is strong regulatory oversight. In the absence of these features, including a full audit of all parts with a full reconciliation of reinsurance recoverables between different groups, I wonder about the numbers presented.
One of my favorite examples of this type of asset was a fake Old Master painting (a Caravaggio if I remember correctly) that was included as surplus. Most other assets not otherwise classified as regular types of investment and recoverable reinsurance are more common. Sometimes these assets contribute to a significant portion of a carrier’s total assets.
Again, AM Best does a great job of determining exactly what the assets are, whether they are valued correctly, and how liquid the assets would be in a catastrophic loss scenario. Conveyancers do not like to disclose all of these investments for confidentiality purposes, and some appraisal companies have raised concerns, albeit self-centered, about accurately valuing these investments.
Accurately estimating the true value of these assets can be quite subjective and liquidity can be an issue. These assets are not the same as cash.
This brings me to market rules. We hope that carriers are following these rules correctly.
Not all surpluses are equal. In a pinch, I’ll take the carrier with cash and high quality liquid bonds any day over one that has borrowed money or is hoping their reinsurer will give them enough money quickly to survive. If I were an employee, especially with some retirement accounts, I would want a safe harbor.
I hope this overview helps agents and carrier employees better understand that because not all excesses are created equal, not all carriers offer the same insurance.
Excessive carrier redundancy