Alyssa Lane
When shopping for insurance, it's important to check the financial strength of the insurer to ensure they can pay out claims. This is known as solvency, and it's a key indicator of an insurance company's ability to meet its long-term obligations. There are several ways to check an insurer's solvency, including examining their solvency ratio, which is the ratio of a company's capital to its contractual obligations. This can be found on the insurer's website or requested directly. Additionally, there are external ratings agencies that assess and publish reports on insurers' financial health, providing an overview of their stability and ability to pay claims. These agencies include A.M. Best Company, Fitch, and Demotech, each offering their own unique rating systems and considerations. It's worth noting that these agencies may have differing criteria, so comparing ratings can be confusing. Ultimately, checking an insurer's solvency empowers consumers to make informed decisions and choose policies backed by reliable financial stability.
| Characteristics | Values |
|---|---|
| Definition of solvency | The ability to pay what you owe. In the case of insurers, it’s the ability to pay for claims. |
| Solvency ratio | The ratio of a company’s capital divided by its contractual obligations. |
| Solvency ratio calculation | Eligible own funds divided by the Solvency Capital Requirement. |
| Solvency ratio interpretation | A low solvency ratio indicates that the corporation may struggle to meet its financial obligations and make timely payments. A high solvency ratio indicates that the corporation has sufficient funds to meet its financial responsibilities. |
| Solvency ratio regulation | The regulation on solvency is based on the European Directive 2009/138/EC. |
| Solvency ratio compliance | A ratio above 100% means full compliance with regulatory requirements. |
| Solvency ratio sources | Solvency ratios are available on each insurer’s website or in their public reports. |
| Rating agencies | A.M. Best Company, Fitch Ratings, Demotech |
| Rating agencies' role | Top rating agencies provide an easily understandable report on the financial health of insurers. |
| Rating agencies' process | Rating agencies look at financial leverage, management stability, recent performance, and the rated company’s overall financial situation. |
| Own Risk and Solvency Assessment (ORSA) | An internal process for insurers to evaluate their risk management and solvency positions, under various stress scenarios. |
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What You'll Learn
Check the insurer's solvency ratio
When shopping for insurance, it is important to check whether the company is financially strong enough to pay the claims of its customers. Checking an insurer's solvency ratio is a good way to assess its financial health.
A solvency ratio is a measure of a company's cash flow compared to its liabilities. It is calculated by dividing a company's capital by its contractual obligations, essentially an assets-to-debt ratio. It is a measure of capital adequacy, and the excess of assets over liabilities is referred to as the Available Solvency Margin (ASM). The solvency ratio is also used to assess the risk an insurer faces of claims it cannot absorb.
There are several ways to check an insurance company's solvency ratio. Firstly, all insurance companies should publish an annual report that contains the solvency ratio, which can be found on their website. Secondly, financial rating agencies publish solvency ratios, which can be accessed online. These agencies include A.M. Best Company, which publishes Best's Insurance Reports, and Fitch, which provides a detailed business review and outlook for the company alongside its ratings. It is worth noting that different countries use different methodologies to calculate the solvency ratio, and have different requirements. For example, in India, insurers are required to maintain a minimum ratio of 1.5.
The solvency ratio is an important parameter when comparing insurance providers. A high solvency ratio indicates a company's stability, reliability, and long-term financial security, and a ratio above 100% indicates full compliance with regulatory requirements. Monitoring the solvency ratio can help assess a company's risk exposure and spot signs of inadequate capital management.
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Assess their risk management
An insurer's risk management can be assessed through its Own Risk and Solvency Assessment (ORSA). ORSA is an internal process undertaken by an insurer or insurance group to evaluate its risk management and solvency positions, both current and future, under various stress scenarios. It requires a thorough analysis of all reasonably foreseeable and relevant material risks (e.g., underwriting, credit, market, operational, liquidity risks) that could impact an insurer's ability to meet its policyholder obligations.
The ORSA Guidance Manual, adopted by the NAIC in 2012, provides guidance and instructions for conducting the ORSA and filing an ORSA Summary Report. The ORSA has two primary goals:
- To foster an effective level of ERM (Enterprise Risk Management) at all insurers, enabling them to identify, assess, monitor, prioritise, and report on their material and relevant risks using appropriate techniques to support risk and capital decisions.
- To provide a group-level perspective on risk and capital, supplementing the existing legal entity view.
Insurers subject to ORSA requirements are expected to conduct and document ORSA assessments regularly (at least annually) and provide confidential high-level ORSA Summary Reports to state commissioners and regulators. The ORSA is a dynamic and continuously evolving process and should be integrated into an insurer's ERM framework. It assists insurers in risk assessment, management, and planning by identifying potential threats to capital and solvency positions and exploring mitigating actions.
In addition to ORSA, solvency ratios are a key metric for assessing an insurer's financial health and long-term solvency. These ratios compare an insurer's capital relative to the premiums written and measure the risk associated with claims they cannot cover. Common solvency ratios include the debt-to-assets ratio, interest coverage ratio, equity ratio, and debt-to-equity ratio.
By considering both the ORSA assessments and solvency ratios, one can gain insight into an insurer's risk management capabilities and their ability to meet policyholder obligations in the present and future.
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Review their financial stability ratings
When shopping for insurance, it is important to buy protection from a company that is financially strong enough to pay the claims of its customers, even in the face of a major disaster. One way to check an insurance company's financial strength is to review their financial stability ratings.
Financial Stability Ratings (FSRs) are a leading indicator of an insurer's financial stability. FSRs are based on a series of quantitative ratios and considerations that make up the Financial Stability Analysis Model. This model takes into account a company's balance sheet strength and financial integrity, as well as its ability to remain financially stable under various economic stress tests. While operating profit is an important element of FSRs, balance sheet integrity is a key factor in determining long-term financial stability.
There are five major agencies that regularly rate insurance companies and offer their ratings and analysis online for free:
- A.M. Best Company: The most experienced agency, having been in the business since 1906. They publish Best's Insurance Reports annually, which many large public libraries subscribe to. A.M. Best Company rates insurers on an alphabetical scale (A++ to F) or a numerical scale, with 9 being the highest rating and 1 being the lowest.
- Fitch: As of January 23, 2001, about 220 large, medium, and small-sized life and health insurers (nearly 85% of the industry) had Fitch ratings. Their website provides detailed business reviews and outlooks for each rated company.
- Demotech: This agency focuses on reviewing and evaluating insurers based on their area of focus and execution of their business model, rather than solely on financial size.
These agencies consider factors such as financial leverage, management stability, recent performance, and the company's overall financial situation. They also take into account external factors like competition, diversification, and market presence. Each agency provides a description of its analysis and the meaning of each rating level.
It is important to note that there may be differences between the rating agencies, making a fair comparison between ratings potentially confusing. Therefore, it is recommended to refer to the information provided by each rating service, including their criteria and rating processes. Additionally, some agencies, like Fitch, may separately rate specific aspects such as the debt obligations of an insurer.
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Compare ratings from different agencies
When shopping for insurance, it is important to assess the financial strength of the insurance company to ensure it can pay the claims of its customers. Ratings agencies provide an independent assessment of an insurance company's financial health.
There are five major agencies that rate insurance companies on a regular basis and offer their ratings and analysis online free of charge; A.M. Best Company, Fitch, Demotech, IFS, and ORSA. Each agency will have a different rating system, and it is important to understand what each rating means. For example, A.M. Best Company rates each company on either an alphabetical (A++ to F) or a numerical scale. The latter is the Best Financial Performance Rating (“FPR”), with 9 being the highest rating and 1 being the lowest. Fitch provides a letter rating, a detailed business review, and an overall outlook for the company. Demotech's Financial Stability Ratings ® (FSRs) are based on a series of quantitative ratios and considerations which together comprise the Financial Stability Analysis Model.
It is worth noting that there are differences between rating agencies, and so making a fair comparison between ratings can be confusing. Each agency will have a different rating criteria, and these criteria may change over time. It is important to be aware of the specific methodology and criteria used by each agency when reviewing their ratings.
By comparing ratings from different agencies, you can gain a more comprehensive understanding of an insurer's financial health and make a more informed decision about purchasing insurance from them.
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Analyse their balance sheet
A balance sheet is a financial statement that records a company's assets, liabilities, and shareholders' equity at a specific time. It is important to analyse an insurer's balance sheet to understand its financial health and ability to meet its obligations. Here are some key aspects to consider when analysing an insurer's balance sheet:
Technical Provisions
Technical provisions are a critical item on an insurer's balance sheet. These provisions represent the amount an insurer would need to transfer its insurance obligations to another insurer immediately. They are calculated based on expected future cash flows, potential risks, and regulatory requirements, considering the insurer's specific risk profile. Technical provisions ensure that an insurer holds sufficient assets to meet its ongoing commitments to policyholders.
Float
Float refers to the premiums paid by customers before claims are made. Insurers invest this float in securities to generate investment income. This creates a source of low-cost financing for the insurer. Analysing the float on the balance sheet provides insight into the insurer's investment strategies and financial stability.
Solvency Ratios
Solvency ratios are calculations that assess an insurer's ability to remain solvent and meet its long-term financial obligations. These ratios compare the insurer's assets, liabilities, and shareholders' equity. Common solvency ratios include the debt-to-assets ratio, interest coverage ratio, and equity ratio. Analysing these ratios over time and compared to industry peers provides a deeper understanding of the insurer's financial health.
External Ratings
In addition to analysing the balance sheet directly, consider external ratings provided by agencies such as A.M. Best Company. These agencies evaluate insurers' financial leverage, management stability, recent performance, and overall financial situation. They provide ratings and analysis that can offer insights into the insurer's financial strength and stability.
Off-Balance Sheet Items
It is important to consider not only the items listed on the balance sheet but also any off-balance sheet items. These may include contingent liabilities, commitments, or other obligations that are not reflected directly on the balance sheet. Understanding these items provides a more comprehensive view of the insurer's financial commitments and potential risks.
By carefully analysing an insurer's balance sheet and considering the above factors, investors, regulatory bodies, and customers can assess the insurer's financial health, stability, and ability to honour its obligations.
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Frequently asked questions
Solvency is the ability to pay what you owe. In the case of insurers, it’s the ability to pay for claims.
One way to check an insurer's solvency is to look at their solvency ratio, which is calculated by dividing a company's eligible own funds by its contractual obligations. A high solvency ratio indicates that the company has sufficient funds to meet its financial obligations.
A solvency ratio of above 100% means full compliance with regulatory requirements. According to Irdai guidelines, all companies are required to maintain a solvency ratio of 150% to minimise bankruptcy risk.
The solvency ratio is computed by dividing a company's after-tax operating income by its debt liabilities.
You can check an insurance company’s financial strength by finding out how they’re rated by experts. There are five major agencies that rate insurance companies on a regular basis and offer their ratings and analysis online free of charge. These include A.M. Best Company and Fitch Ratings.
