VideoThe scary thing about the demise of Reliance Insurance Co. was the sheer speed of it. As recently as December 1998, the property/casualty company was reporting a $1.7 billion statutory surplus, the biggest in its 181-year history. That same year, Reliance also boosted its profit to $585 million, a huge increase from the $62 million in earnings it recorded the year before.
But then, out of nowhere, Reliance fell into a tailspin. By the end of 1999, an onerous debt load and heavy workers'-compensation reinsurance losses had pushed the insurer toward the brink of insolvency. In its 1999 annual statement, Reliance management acknowledged that the company had lost $500 million of its surplus, on the heels of a $177 million loss in net income. That was followed by another net income loss of $198 million in 2000. A resultant salvage attempt by state insurance regulators failed, and in October 2001, M. Diane Koken, Pennsylvania's insurance commissioner, ordered the liquidation of the venerable company.
In the end, Reliance's liabilities outstripped its assets by $1.2 billion, making it the largest insurer liquidation in U.S. history, according to the Insurance Information Institute (III). But the size of the failure wasn't the only thing that disturbed commercial insurance buyers; many wondered why Reliance's financial woes had slipped under the radar of some top rating agencies for as long as a year. In fact, up until June 2000, A.M. Best Co. rated Reliance's financial strength as an A- (excellent), while Standard & Poor's assigned the insurer an A- (strong), according to Schiff's Insurance Observer.
Wayne Salen, then director of risk management for New Millennium Care, a nursing-home operator and customer of Reliance, recalls watching anxiously as the insurer's Best rating plunged first to a "secure" B++ (very good), then to a "vulnerable" B (fair) in little more than a month. And, although Salen was able to secure coverage with a new carrier, he worries that the Reliance debacle may not have been a one-off event. "It was shocking how fast it happened," he recalls. "It makes it incumbent on us to check the ratings quarterly — or even monthly."
Watch the Watchers
Salen is not alone in worrying about the health of the insurance industry. To a fair number of seasoned buyers, the reliability of corporate insurance policies has not been this shaky since the mid-1980s.
That's saying something. During that previous period, key liability coverages became practically unavailable, and 100 percent premium boosts were not uncommon. In addition, massive failures, such as those of Transit Casualty, Mission Insurance, and Integrity, had Congress threatening a federal takeover of the state-run insurance regulatory system.
Nothing like that surge of insolvency has happened this time — at least not yet. In fact, according to Weiss Ratings, the number of property/casualty insurer failures dropped from 39 in 2001 to 20 in 2002. The reason? Even though investment income was way off for most insurers last year, indemnifiers raised premiums high enough to assure their survival, says Stephanie Eakins, a Weiss financial analyst.
What insurers haven't been able to curb, however, is the number of property/casualty rating downgrades. Best, for instance, issued 151 ratings downgrades for insurers last year, up from 77 in 2000. And it's this perilous decline that should have CFOs poring over the analytical reports issued by insurance-industry rating agencies. Why? Despite missing some red flags in the past, the ratings that agencies such as Best, S&P, Moody's, Fitch, and Weiss bestow on insurers remain the best first step in assessing their financial strength.
At Peabody, Massachusetts-based athletic footwear and apparel supplier Saucony, for example, CFO and COO Michael Umana relies heavily on credit ratings in sussing out the reliability of insurers. Two of Saucony's main insurers, AIG and Chubb, get an A++ rating from Best, and Umana says he "puts a lot of value in that rating." Conversely, he is not as pleased about the financial health of Lloyd's of London, Saucony's business-interruption carrier, which is currently rated A- by Best. But, says Umana, "Lloyd's insures risks that many others won't touch."
Some insurers, however, claim CFOs should look beyond credit ratings to gauge the true financial health of a carrier. Arch Capital Group Ltd., for example, currently holds an A- rating from Best. But the carrier was formed only in 1995, and executive vice president and CFO John Vollaro says the Hamilton, Bermuda-based property/casualty insurer and reinsurer's relative youth is a mixed blessing. While Arch's rating has inevitably been discounted because of the company's short history, the businesses it has underwritten aren't saddled with the burdensome liabilities more-seasoned companies face, Vollaro contends. He argues that the period during which an insurer experiences premium growth is just as important as the magnitude of that growth, and should be taken into consideration in the rating. Moreover, he insists that measuring the staying power of any insurer should be a process that also includes examining how much exposure there is to adverse reserve development and to reinsurance receivables. "Don't blindly follow ratings," he warns.
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