A.M. Best Reports P/C Insolvencies Trends Continued in 2001

June 20, 2002

Thirty property/casualty insurers were declared insolvent in 2001, according to the special report, “P/C Industry—2001 Insolvencies,” just issued by A.M. Best Co. The same number of companies became insolvent in 2000, compared with seven insolvencies in 1999 and 18 in 1998.

Inadequate reserves, improper pricing and unsustainable growth levels were by far the most significant causes of the 2001 insolvencies. Twenty-three insurers out of the 30, or 77 percent, became insolvent due to deficient loss reserves. The proportion is similar to the 2000 insolvencies, at 70 percent, and represents a significant increase over historical trends, where the insolvency rate from insufficient reserves ranged from 30 percent to 35 percent.

A.M. Best examined the correlation between insolvencies and the financial strength rating of companies over the past 10 years, tracking the rating distribution for the three years prior to, two years prior to, one year prior to, and the year of impairment. Data show that of the total insolvencies, 78, or 71 percent, of the insurers that were rated by A.M. Best and subsequently failed had a vulnerable rating in the year of insolvency. Additionally, among these companies, 24 percent were rated vulnerable three years prior to insolvency, 33 percent were rated vulnerable two years prior, and 70 percent were rated vulnerable one year prior.

Insolvencies are off to another rapid start in 2002, with both Legion Insurance Group and Highlands Insurance Group having come under some form of regulatory control. Some carriers are experiencing financial difficulties that are leading them toward a likely insolvency that cannot be reversed by rising rates.

Nonetheless, additional capital is flowing to established insurers, and new companies are forming in certain market segments. This reflects an attempt on the part of some to benefit from hardening market conditions, whereas others have committed capital with an indication of long-term confidence in the insurance business.

A.M. Best expects the pace of downgrades to “E” (Under Regulatory Supervision), the level at which a company is considered insolvent, will remain high for at least the next one to two years. Certain market segments will experience a disproportionate share of the activity.

The commercial-lines market is likely to face a greater number of insolvencies than either the personal-lines or the reinsurance segments. Under pricing and under reserving have been more egregious in the commercial segment than in personal lines, and reinsurers generally have strong parental support.

While commercial-lines rate firming has occurred, it is not clear how long the hard market will continue. The overall increases might not be enough to offset the cumulative effect of prior-year rate decreases combined with the impact of rising medical costs. In addition, the capitalization of certain insurers could be impacted by further development in asbestos and environmental exposures.

The disparity between rate increases and rising loss costs from existing or emerging loss causes, including mold and guaranty-fund assessments, will exert the greatest pressure on marginally capitalized personal-lines insurers that lack balance-sheet integrity. The insurers that remain at risk of burning capital in the coming years are those that have had prior-year loss-reserve redundancies evaporate while current accident-year reserves proved to be inadequate.

c In addition to a continuing high rate of insolvencies, A.M. Best anticipates continued downward rating pressures for rated companies in 2002. In fact, several ratings have already been downgraded to the vulnerable category based on year-end 2001 financial statements.

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