A.M. Best Report Targets New Company Formations

March 10, 2004

In recent years, regulatory and tax issues, as well as market dislocations, have contributed to the formation of new insurance and reinsurance companies. As a result, growing numbers of brokers, agents, lenders, capital market participants and corporate clients are seeking financial information about these new entities.

To meet this demand, A.M. Best Co. provides ratings on these new organizations and other risk-assuming vehicles using the methodology outlined in its latest methodology report, “Rating New Company Formations.”

A.M. Best’s interactive rating process for insurance companies involves numerous quantitative and qualitative factors that are grouped into three categories: balance sheet strength, operating performance and business profile. The analytical components of A.M. Best’s interactive rating process for new insurers can be grouped into the two evaluative categories of balance sheet strength and business profile. Since new companies lack a measurable track record of operating performance, A.M. Best applies a stringent set of qualitative due-diligence standards to the initial rating. These are grouped into a third evaluative category of operational controls. In particular, initial and prospective risk-adjusted capital levels typically will need to be well above the assigned initial rating level throughout the development phase of the company, even after factoring in conservative earnings and investment returns.

Evaluation of key financial ratios is integrated with a qualitative evaluation of the company’s operating plans and philosophies to gain a comprehensive understanding of the company’s initial standing and its future prospects.

As with A.M. Best’s traditional financial strength rating process, start-up entities are viewed within the context of the particular country risks to which they are exposed. Under these circumstances, A.M. Best utilizes its country risk methodology, whereby countries are classified into one of five tiers reflecting the various economic and political risks that can affect an insurer’s financial strength.

A.M. Best’s rating system applies the same rigorous criteria to all insurers, new or established, offering a means of directly comparing insurers regardless of longevity or country of domicile. However, because a new company rating opinion must consider a greater degree of uncertainty, A.M. Best is conservative in its initial rating assignment.

A.M. Best’s assessment of the strength and quality of a company’s balance sheet is the underpinning of any financial strength rating. In reviewing initial and prospective capitalization and leverage, A.M. Best begins with the capital requirements of the relevant regulatory authorities. This is followed by a rigorous capital analysis using Best’s Capital Adequacy Ratio to assess the capital that is necessary to support the new venture’s operations over a period of time and that is appropriate for the types of business written.

The new company should demonstrate that it can support the execution of its business plan while maintaining risk-adjusted capital adequacy at levels well above the assigned rating level for at least three to five years. The degree of additional capital needed will reflect the risk profile of the business.

A new company’s sponsors and/or strategic investors can significantly affect its success in meeting its objectives. Their experience and commitment to the company over the near and long term, including any potential exit strategies, are key considerations in the rating process. A.M. Best might give credit in the rating where the sponsor is a rated organization that provides turnkey capability to a new company that, in turn, supports the sponsor’s core business.

A.M. Best believes a clearly defined business plan is essential. The success of the company depends on management’s ability to effectively implement the business plan while remaining responsive to changing conditions. Key factors in A.M. Best’s evaluation include a well-defined, three-to-five-year business plan; distribution relationships; pricing methodologies and monitoring practices; and return expectations vs. market realities.

A.M. Best also looks at the depth of the senior management in terms of its track record in critical functional areas, such as underwriting and claims management; financial, investment and risk management; information technology; and marketing, sales and distribution.

Operational controls are important indicators of management’s ability and commitment to the quality and longevity of a new company. These controls should be linked to the monitoring and fulfillment of the business plan. Operational controls also are the means by which the new company’s growth is managed and provide a large measure of risk management.

For more information on A.M. Best’s rating methodologies or to download a copy of this methodology report, visit www.ambest.com/ratings/methodology.html.

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