- Email: [email protected]
The Rating of Insurance Companies during the Financial Crisis
Available online at www.sciencedirect.com
ScienceDirect Procedia Economics and Finance 32 (2015) 1494 – 1504
Emerging Markets Queries in Finance and Business
The rating of insurance companies during the financial crisis &ULVWLQD&LXPD܈a, *, Alexandra Onigaa, Irimie Popaa a
%DEHú-Bolyai University, Cluj-Napoca, Romania, 58-60 Teodor Mihali, 400591, Cluj-Napoca, Romania
Abstract This article aims to study the impact of rating agencies during the financial crisis and the ratings' role in insurance companies' behavior in the operating market. Important in a rating agency's assessment of overall financial strength is the insurer's ability to meet policyholder obligations. In the first part of this article we will present the context in which the major rating agencies are being analyzed and the market's attitude towards the qualifications awarded by them. During the time period of this study there were four major rating agencies that provided financial strength ratings of insurance companies: Standard & Poor's, Moody's, Fitch and AM Best. Next, we will study the important role of rating agencies in the economic crisis, but also the overreliance of firms, some relying solely on the ratings granted by rating agencies, not having a proper risk assessment system of their own. Despite the fact that the industry encourages insurers to have their private risk assessment methods, investors and policyholders still expect that ratings provide a realistic reflection of the outstanding risks to the market participants. The case of American International Group is presented in the third part of this article, analyzing the reasons which led to the 2008 liquidity crisis and the involvement of rating agencies in the group's affairs. It is important to identify the link between the AIG failure and understanding the systemic risks of financial institutions and to draw the lessons for protecting the financial stability of the insurance sector. Next, according to Moody's model for rating insurance companies, we will present a case study of the applicability of this model for two of the most important Romanian insurance companies, starting with 2006 until the last closed fiscal year, 2012. © ThePublished Authors. Published by Elsevier This is an and open access article under the CC BY-NC-ND license of Emerging Markets ©2015 2015 by Elsevier Ltd.B.V. Selection peer review under responsibility (http://creativecommons.org/licenses/by-nc-nd/4.0/). Queries in Finance and Business local organization. Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste Keywords: rating, risk assessment, financial stability
* Corresponding author. Tel.: +4.026.441 8652/3/4/5; E-mail address: FULVWLQDFLXPD܈#HFRQXEEFOXMUR
2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste doi:10.1016/S2212-5671(15)01536-1
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1495
1. Introduction Rating insurance companies has become a more prominent activity of agencies, due to the recent financial difficulties of the insurance sector and over-publicized failures of several large life insurers. Ratings issued by these agencies represent their opinions on the financial status of insurers and their ability to fulfill their obligations to policyholders. Ratings downgrade is monitored closely and can significantly affect an insurer’s ability to attract and retain customers. Even rumors of downgrades may precipitate a significant loss of customers, as in the case of "Mutual Benefit" and may exaggerate an insurer's financial problems. There is no doubt that rating organizations play a significant role in the insurance market. On the one hand, the ratings of insurers have been criticized for having been exaggerated or overly positive. On the other hand, there are concerns that reviewers, in an effort to regain credibility, reduced their ratings arbitrarily in response to the recent decline of the real estate markets, insurer’s failures and decreasing confidence of consumers. (Klein, 1992) Rating agencies have emerged in the United States of America. The first company that was launched in the rating business was "The Mercantile Agency" in 1841 in 1HZ
1496
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
The criteria for determining the insurer's financial strength have not changed explicitly since the financial crisis. S&P updated its capital adequacy model in June 2010, as it does periodically, but this was not a direct response to the turmoil. The reinsurance industry stood up remarkably well over the last three years. Demands for ratings were not so strong in markets such as Western Europe, but in emerging economies such as Central and Eastern Europe and the Middle East, demand has been significant. 3. The American international group case When American International Group (AIG) was close to bankruptcy in September 2008, few could have foreseen it. Probably the most astounded were rating agencies - AM Best, Moody's, Fitch and Standard & Poor's (S&P) - whose ratings gave no indication of problems in AIG's portfolio. Rating agencies awarded top ratings to high-risk mortgages, overstating debtors' ability to pay. Following the unexpected economic support of the U.S. government to AIG, the insurer’s financial strength ratings also attracted the spotlight, with buyers distrustful of AIG’s ability to pay their claims. Prior to 2008, AIG has operated a successful business in the insurance world, which provided the company's excellent ratings. Using their good position and global reach, AIG allowed its innovators to create new financial products that operated outside the purview of most regulatory surveillance bodies in the US. To be able to operate outside the insurance arena and its 200-year-old regulatory structure in the United States, AIG created AIG Financial Products Corp. (AIGFP). (Baranoff, 2012) The main key takeaways in considerable losses suffered by the company were : (1) AIGFP was not an insurance company, (2) AIGFP was not regulated by state-based insurance regulations, and (3) AIGFP’s credit default swaps were the key factor to the AIG collapse. AIGFP sold credit default swaps (CDS) , an unregulated product, which was the base of the liquidity crisis that brought the company down. Two other factors that led to the company's problems were securities lending activities and investments in mortgage-backed securities (MBS), so in 2008 when the real estate market collapsed, AIG's ratings were downgraded. (Baranoff, 2012) Rating agencies have been accused of lack of capital market expertise to understand the complex structure of AIG's business. AIG's problems are rooted in its portfolio of credit default swaps, which was driven by separate financial products. These operations cover assets related to corporate debt and mortgage-backed securities, including mortgages worth 80 billion dollars. Shortly before the federal aid, Moody's and Fitch have downgraded AIG because of unsecured debt to A2 from Aa3 and A from AA-, respectively, S&P downgraded AIG's long-term lending activities three steps to Afrom - AA. Details about the meaning of the symbols of the three rating agencies can be found in Appendix 1. The US insurance industry has not been immune to the effects of the widely downgrade of securities initially assessed as safe. The fact that AIG lost its AAA rating, gave counterparties the right to ask for guarantees to cover potential losses on products provided by the company. However, the AIG case is not representative because most U.S. insurers are not affiliated with a giant offshore trading operation and AIG's problems did not originate in subsidiaries that are covered by NAIC capital regulation. The case of bond insurers is representative because the entire industry is located in New York and is regulated by the State Department of New York and not by the NAIC. Mortgage insurers' losses originate primarily from their core business - mortgage insurance - rather than from their investments. The crisis has affected thousands of insurance companies in the United States, not just those who were affiliated with AIG.
1497
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
4. Case study - Moody's Model in Romania Moody's Investors Service was founded in 1900 by John Moody, who established a basis of the assessment of bonds in 1909. Today, Moody's evaluates securities of approximately 4,000 industrial companies, utilities, banks and other financial institutions. In the insurance sector, Moody's rated securities of insurance companies since the mid-1970s. Although Moody's grades less insurers than AM Best or S&P, it has acquired a solid reputation for reliability and expertise in its work in insurance rating. Financial strength ratings of insurance companies conducted by Moody's are based on the analysis of industry regulatory trends and an assessment of an insurer's business fundamentals. In order to determine the applicability of this model for the insurance market in Romania we have chosen to develop a study to determine the evolution of the first two insurance companies in Romania before the financial crisis in 2006 and until 2012. For the seven years we chose to develop the analysis, we used the financial statements of insurance companies namely the Balance sheet and income statement and the insurers technical and non-technical accounts of each entity. Table 1. Indicators of the Moody’s model
No.
Indicators
A. Commercial profile
Percentage 30%
Market positioning, brand and distribution 1. 2.
20%
1.1. Market share
40%
1.2. Underwriting expenses/Net written premiums
60%
Business diversification and geographic diversification
B. Financial profile
10%
70%
Asset quality 3.
20%
3.1. Risky assets/Total invested assets
40%
3.2. Amounts received from reinsurers/Capital 4.
Percentage subindicators
Capital adequacy
60% 15%
5.
Profitability: Capital return
10%
6.
Adequacy of reserves: Reserves for losses/Total reserves
15%
7.
Financial flexibility: Financial expenses coverage
10%
The analysis of the insurance sector reveals the structure of competition within the insurer's operating environment and competitive position within this structure. As a result, the first part of the model focuses on determining market share and diversifying the business and the geographic position, important elements in determining the insurer's business profile and positioning in the insurance market. The following table presents WKHPDUNHWSRVLWLRQRIWKHWZRFRPSDQLHV6&$VWUD$VLJXUăUL6$DQG6&$OOLDQ]- Tiriac S. A.
1498
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 2. Market share and related scoring according to Moody's model Year
2012
2011
2010
2009
2008
2007
2006
Indicator
Astra
Allianz - ܉LUiac
Gross written premiums
1,131,544,783
900,180,498
Market positioning
1
2
Score
100
97.561
Gross written premiums
1,008,544,317
898,416,364
Market positioning
1
2
Score
100
97.561
Gross written premiums
1,083,209,476
1,020,399,089
Market positioning
1
2
Score
100
97.561
Gross written premiums
809,471,525
1,285,882,261
Market positioning
2
1
Score
97.826
100
Gross written premiums
642,647,143
1,278,805,131
Market positioning
4
1
Score
93.182
100
Gross written premiums
367,207,389
1,137,608,897
Market positioning
7
1
Score
85.714
100
Gross written premiums
301,395,620
1,028,655,452
Market positioning
6
1
Score
87.805
100
From this table we can see the evolution of the insurance company Astra during the seven years from the 6th place in 2006 to the position of market leader in 2012. In Table. 3 we can observe the total subscription costs in relation to the net written premiums (both for life and non-life insurance).
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1499
Table 3. The Subscription costs and Net written premium ratio Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Subscription costs
210,999,249
177,337,835
Net written premiums
778,856,145
728,885,178
Coefficient 1.2
27%
24%
Score
75
80
Subscription costs
247,986,174
175,652,498
Net written premiums
1,016,095,508
808,952,499
Coefficient 1.2
24%
22%
Score
80
80
Coefficient 1.2
20%
18%
Score
80
85
Coefficient 1.2
22%
13%
Score
80
90
Coefficient 1.2
25%
18%
Score
75
85
Coefficient 1.2
28%
17%
Score
75
85
Coefficient 1.2
29%
5%
Score
75
95
From table 3. we can notice the dependence of Astra of other insurance channels (legal entity, insurance brokers), not relying solely on its own insurance business. Since 2006 and until now this rate remained constant, while Allianz-Tiriac's ratio is constantly increasing ranging from 5% in 2006 to 24% in 2012. From the business diversification we can see the number of insurance lines in which the companies VXUYH\HG$VWUD$VLJXUăULLV active almost all seven years in 17 of the 18 classes of insurance, while AllianzTiriac only in 15 classes. Hence the better score obtained by Astra for this indicator. Changing over to the financial profile, we start by studying the quality of assets. First, the ratio of risky assets and the invested assets highlights the total assets whose income is not stable or fixed from the total investment made by these companies. Allianz-Tiriac holds a risky assets portfolio, enabling it to achieve the maximum score of the indicator, while the share of risky assets in the total invested assets for company Astra is about 14% in 2012.
1500
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 4. Business diversification - Number of business lines Year 2012 2011 2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
16
14
Score
88.889
77.778
Lines of Business
16
14
Score
88.889
77.778
Table 5. The ratio of risky assets and total invested assets Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Risky assets
40,431,361
4,940,759
Invested assets
283,600,691
1,350,415,021
Coefficient 3.1
14%
0%
Score
80
100
Risky assets
42,376,370
3,644,777
Invested assets
374,537,154
1,333,340,017
Coefficient 3.1
11%
0%
Score
80
100
Coefficient 3.1
11%
1%
Score
80
100
Coefficient 3.1
9%
1%
Score
90
100
Coefficient 3.1
9%
0%
Score
90
100
Coefficient 3.1
10%
1%
Score
90
100
Coefficient 3.1
0
0%
Score
100
100
The analysis of a company's financial fundamentals focuses mainly on financial aspects, such as capital adequacy, investment risk, return and liquidity management or organizational structure.
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1501
Table 6. The ratio of the amounts received from reinsurers and the total capital Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Amounts received from reinsurers
14,945,672
42,476,257
Capital
192,712,534
94,393,890
Coefficient 3.2
8%
45%
Score
100
100
Amounts received from reinsurers
5,938,367
47,651,029
Capital
192,712,534
94,393,890
Coefficient 3.2
3%
50%
Score
100
100
Coefficient 3.2
2%
91%
Score
100
100
Coefficient 3.2
1%
250%
Score
100
80
Coefficient 3.2
1%
232%
Score
100
80
Coefficient 3.2
1%
217%
Score
100
80
Coefficient 3.2
0%
388%
Score
100
70
The ratio of the amounts received from reinsurers and capital quantify the dependence of insurance companies' activity as reinsurers and implicitly of the reinsurance damages and reinsurance commissions. Table 7. Net profit and Subscribed share capital ratio Year
2012
2011
2010
2009
Indicator
Astra
Allianz - ܉LULDF
Net Income
6,671,058
-42,742,255
Subscribed share capital
192,712,534
94,393,890
Coefficient 5
3%
-45%
Score
40
0
Net Income
81,013,945
24,513,434
Subscribed share capital
192,712,534
94,393,890
Coefficient 5
42%
26%
Score
100
100
Coefficient 5
13%
-20%
Score
100
0
Coefficient 5
3%
44%
Score
40
100
1502
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
2008
2007
2006
Coefficient 5
2%
34%
Score
20
100
Coefficient 5
-36%
50%
Score
0
100
Coefficient 5
0%
89%
Score
10
100
The return on equity is determined by the ratio of net profit of the company and share capital. Depending on the net result (profit or loss) we can establish the insurance company's profitability, a high value determines a proportional high score of the indicator. Table 8. The ratio of the reserves for losses and the total reserves Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Reserves for losses
0
21,855,353
Total reserves
1,166,577,709
910,252,741
Coefficient 6
0%
2%
Score
100
80
Reserves for losses
0
17,367,997
Total reserves
1,045,832,166
857,384,696
Coefficient 6
0%
2%
Score
100
80
Coefficient 6
0%
1%
Score
100
80
Coefficient 6
0%
1%
Score
100
80
Coefficient 6
0%
1%
Score
100
100
Coefficient 6
0%
1%
Score
100
100
Coefficient 6
0%
2%
Score
100
80
Provisions are recognized in the balance sheet when the company acquires a legal or constructive obligation related to a past event and it is probable that in the future a consumption of economic resources is necessary to extinguish the obligation. The loss reserves are larger, the need for provisions is greater, therefore Moody's indicator is lower. The company Astra, not having reserves for losses obtained the maximum score.
1503
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 9. Financial expenses coverage Year
2012
2011
2010
2009
2008
2007
2006
Indicator
Astra
Allianz - ܉LULDF
Financial result
16,756,707
28,870,047
Financial expenses
2,046,643
11,747,048
Coefficient 7
819%
246%
Score
100
90
Financial result
97,426,642
33,935,306
Financial expenses
22,769,259
5,408,036
Coefficient 7
428%
627%
Score
100
100
Coefficient 7
558%
631%
Score
100
100
Coefficient 7
167%
843%
Score
80
100
Coefficient 7
106%
356%
Score
80
100
Coefficient 7
201%
878%
Score
90
100
Coefficient 7
246%
450%
Score
90
100
The coverage of financial expenses (financial felixibilility) is determined through the non-technical account, namely the ratio of financial result and financial expenses. For both companies, the coverage level is very high, Astra recording an increase of this share from 2006 to 2012 by 600%. Table 10. 0RRG\ VUDQNLQJIRU$VWUD$VLJXUăULDQG$OOLDQ]-܉LULDF Year
Score Astra
Score
2012
89.122
2011
Allianz-܉LULDF
Ranking Astra
Ranking
82.572
Aa2
Aa3
95.722
93.572
Aaa
Aa1
2010
95.722
84.172
Aaa
Aa3
2009
88.348
92.567
Aa2
Aa1
2008
85.377
94.967
Aa2
Aa1
2007
83.502
94.689
Aa3
Aa1
2006
85.469
91.689
Aa2
Aa1
Allianz-܉LULDF
)ROORZLQJ 0RRG\ V UDQNLQJV IRU WKH VHYHQ \HDUV ERWK $VWUD $VLJXUăUL DQG $OOLDQ]-܉LULDF WKH ILUVW WZR insurance companies on the Romanian insurance market, received excellent ratings. Thus, companies with high ratings offer great financial stability, serving as a model for other companies in the market even in times of crisis when there was a huge decrease in consumer confidence for the insurance products.
1504
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
5. Conclusion An assessment of the financial strength by rating agencies, although important, should not be the only factor used by insurance consumers. Perhaps the most important question for future research is how well the various rating agencies predict, in fact, the insolvency of insurers. Credit risk - referring to the risk of an insurer's investments that will no longer be able to be paid or paid otherwise than agreed - is particularly important for insurers, who often hold investments for a long period of time to meet obligations that will occur in the distant future, such as life insurance or claims of middle-aged insurers. Banks and brokers, on the other hand, may be more concerned about liquidity risk - the risk that all creditors demand reimbursement at the same time. This risk has managed to bring to the ground many institutions during the financial crisis. During this period of financial instability, insurance companies in Romania have largely succeeded in PDLQWDLQLQJYHUWLFDOLW\HVSHFLDOO\WKHWZRFRPSDQLHVDQDO\]HGE\0RRG\ VPRGHO$VWUD$VLJXUăULDQG$OOLDQ]܉LULDF7KH\ZHUHDEOHWRDFKLHYHKigh scores and to rank very high on the rating agency's scale. Higher ratings than Aa3 (i.e. Aa2, Aa1 or Aaa) show an excellent financial security, even exceptional in case of the Aaa rating. The fact that these two companies have managed to maintain the profitability of the insurance business even during the financial crisis, their evolution from 2006 to the present being constant in terms of Moody's rating agency model, shows a strong business model and assumed responsibility towards the consumers of insurance products. References Hunt, J.P. (2011) Credit Ratings in Insurance Regulation: The Missing Piece of Financial Reform Washington and Lee Law Review, Volume 68, Issue 4, pp. 1667-1697 Feinberg M., Shelor R., Cross M., Grossmann A. (2006), A Comparison of the Solicited and Independent Financial Strength Ratings of Insurance Companies, Journal of American Academy of Business, Cambridge, Volume 9, Number 2, pp. 37-43 Baranoff E. (2012) An Analysis of the AIG Case: Understanding Systemic Risk and Its Relation to Insurance, National Association of Insurance Commissioners 2012 Klein R. (1992) Insurance Company Rating Agencies: A Description of Their Methods and Procedures, National Association of Insurance Commissioners 1992 Elkhoury M., (2008) Credit rating agencies and their potential impact on developing countries, United Nations Conference on Trade and Development, Volume 168. /ă]ăUHVFX6$QJKHODFKH* 5DWLQJDJHQFLHV UROHRQWKHILQDQFLDOPDUNHW$FDGHP\RI(FRQRPLFDO6WXGLHV%XFKDUHVW5esearch Project CSA, (2006) Activity Report on Insurance Market Development for the year 2006 CSA, (2007) Activity Report on Insurance Market Development for the year 2007 CSA, (2008) Activity Report on Insurance Market Development for the year 2008 CSA, (2009) Activity Report on Insurance Market Development for the year 2009 CSA, (2010) Activity Report on Insurance Market Development for the year 2010 CSA, (2011) Activity Report on Insurance Market Development for the year 2011 CSA, (2012) Activity Report on Insurance Market Development for the year 2012
ScienceDirect Procedia Economics and Finance 32 (2015) 1494 – 1504
Emerging Markets Queries in Finance and Business
The rating of insurance companies during the financial crisis &ULVWLQD&LXPD܈a, *, Alexandra Onigaa, Irimie Popaa a
%DEHú-Bolyai University, Cluj-Napoca, Romania, 58-60 Teodor Mihali, 400591, Cluj-Napoca, Romania
Abstract This article aims to study the impact of rating agencies during the financial crisis and the ratings' role in insurance companies' behavior in the operating market. Important in a rating agency's assessment of overall financial strength is the insurer's ability to meet policyholder obligations. In the first part of this article we will present the context in which the major rating agencies are being analyzed and the market's attitude towards the qualifications awarded by them. During the time period of this study there were four major rating agencies that provided financial strength ratings of insurance companies: Standard & Poor's, Moody's, Fitch and AM Best. Next, we will study the important role of rating agencies in the economic crisis, but also the overreliance of firms, some relying solely on the ratings granted by rating agencies, not having a proper risk assessment system of their own. Despite the fact that the industry encourages insurers to have their private risk assessment methods, investors and policyholders still expect that ratings provide a realistic reflection of the outstanding risks to the market participants. The case of American International Group is presented in the third part of this article, analyzing the reasons which led to the 2008 liquidity crisis and the involvement of rating agencies in the group's affairs. It is important to identify the link between the AIG failure and understanding the systemic risks of financial institutions and to draw the lessons for protecting the financial stability of the insurance sector. Next, according to Moody's model for rating insurance companies, we will present a case study of the applicability of this model for two of the most important Romanian insurance companies, starting with 2006 until the last closed fiscal year, 2012. © ThePublished Authors. Published by Elsevier This is an and open access article under the CC BY-NC-ND license of Emerging Markets ©2015 2015 by Elsevier Ltd.B.V. Selection peer review under responsibility (http://creativecommons.org/licenses/by-nc-nd/4.0/). Queries in Finance and Business local organization. Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste Keywords: rating, risk assessment, financial stability
* Corresponding author. Tel.: +4.026.441 8652/3/4/5; E-mail address: FULVWLQDFLXPD܈#HFRQXEEFOXMUR
2212-5671 © 2015 The Authors. Published by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).
Selection and peer-review under responsibility of Asociatia Grupul Roman de Cercetari in Finante Corporatiste doi:10.1016/S2212-5671(15)01536-1
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1495
1. Introduction Rating insurance companies has become a more prominent activity of agencies, due to the recent financial difficulties of the insurance sector and over-publicized failures of several large life insurers. Ratings issued by these agencies represent their opinions on the financial status of insurers and their ability to fulfill their obligations to policyholders. Ratings downgrade is monitored closely and can significantly affect an insurer’s ability to attract and retain customers. Even rumors of downgrades may precipitate a significant loss of customers, as in the case of "Mutual Benefit" and may exaggerate an insurer's financial problems. There is no doubt that rating organizations play a significant role in the insurance market. On the one hand, the ratings of insurers have been criticized for having been exaggerated or overly positive. On the other hand, there are concerns that reviewers, in an effort to regain credibility, reduced their ratings arbitrarily in response to the recent decline of the real estate markets, insurer’s failures and decreasing confidence of consumers. (Klein, 1992) Rating agencies have emerged in the United States of America. The first company that was launched in the rating business was "The Mercantile Agency" in 1841 in 1HZ
1496
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
The criteria for determining the insurer's financial strength have not changed explicitly since the financial crisis. S&P updated its capital adequacy model in June 2010, as it does periodically, but this was not a direct response to the turmoil. The reinsurance industry stood up remarkably well over the last three years. Demands for ratings were not so strong in markets such as Western Europe, but in emerging economies such as Central and Eastern Europe and the Middle East, demand has been significant. 3. The American international group case When American International Group (AIG) was close to bankruptcy in September 2008, few could have foreseen it. Probably the most astounded were rating agencies - AM Best, Moody's, Fitch and Standard & Poor's (S&P) - whose ratings gave no indication of problems in AIG's portfolio. Rating agencies awarded top ratings to high-risk mortgages, overstating debtors' ability to pay. Following the unexpected economic support of the U.S. government to AIG, the insurer’s financial strength ratings also attracted the spotlight, with buyers distrustful of AIG’s ability to pay their claims. Prior to 2008, AIG has operated a successful business in the insurance world, which provided the company's excellent ratings. Using their good position and global reach, AIG allowed its innovators to create new financial products that operated outside the purview of most regulatory surveillance bodies in the US. To be able to operate outside the insurance arena and its 200-year-old regulatory structure in the United States, AIG created AIG Financial Products Corp. (AIGFP). (Baranoff, 2012) The main key takeaways in considerable losses suffered by the company were : (1) AIGFP was not an insurance company, (2) AIGFP was not regulated by state-based insurance regulations, and (3) AIGFP’s credit default swaps were the key factor to the AIG collapse. AIGFP sold credit default swaps (CDS) , an unregulated product, which was the base of the liquidity crisis that brought the company down. Two other factors that led to the company's problems were securities lending activities and investments in mortgage-backed securities (MBS), so in 2008 when the real estate market collapsed, AIG's ratings were downgraded. (Baranoff, 2012) Rating agencies have been accused of lack of capital market expertise to understand the complex structure of AIG's business. AIG's problems are rooted in its portfolio of credit default swaps, which was driven by separate financial products. These operations cover assets related to corporate debt and mortgage-backed securities, including mortgages worth 80 billion dollars. Shortly before the federal aid, Moody's and Fitch have downgraded AIG because of unsecured debt to A2 from Aa3 and A from AA-, respectively, S&P downgraded AIG's long-term lending activities three steps to Afrom - AA. Details about the meaning of the symbols of the three rating agencies can be found in Appendix 1. The US insurance industry has not been immune to the effects of the widely downgrade of securities initially assessed as safe. The fact that AIG lost its AAA rating, gave counterparties the right to ask for guarantees to cover potential losses on products provided by the company. However, the AIG case is not representative because most U.S. insurers are not affiliated with a giant offshore trading operation and AIG's problems did not originate in subsidiaries that are covered by NAIC capital regulation. The case of bond insurers is representative because the entire industry is located in New York and is regulated by the State Department of New York and not by the NAIC. Mortgage insurers' losses originate primarily from their core business - mortgage insurance - rather than from their investments. The crisis has affected thousands of insurance companies in the United States, not just those who were affiliated with AIG.
1497
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
4. Case study - Moody's Model in Romania Moody's Investors Service was founded in 1900 by John Moody, who established a basis of the assessment of bonds in 1909. Today, Moody's evaluates securities of approximately 4,000 industrial companies, utilities, banks and other financial institutions. In the insurance sector, Moody's rated securities of insurance companies since the mid-1970s. Although Moody's grades less insurers than AM Best or S&P, it has acquired a solid reputation for reliability and expertise in its work in insurance rating. Financial strength ratings of insurance companies conducted by Moody's are based on the analysis of industry regulatory trends and an assessment of an insurer's business fundamentals. In order to determine the applicability of this model for the insurance market in Romania we have chosen to develop a study to determine the evolution of the first two insurance companies in Romania before the financial crisis in 2006 and until 2012. For the seven years we chose to develop the analysis, we used the financial statements of insurance companies namely the Balance sheet and income statement and the insurers technical and non-technical accounts of each entity. Table 1. Indicators of the Moody’s model
No.
Indicators
A. Commercial profile
Percentage 30%
Market positioning, brand and distribution 1. 2.
20%
1.1. Market share
40%
1.2. Underwriting expenses/Net written premiums
60%
Business diversification and geographic diversification
B. Financial profile
10%
70%
Asset quality 3.
20%
3.1. Risky assets/Total invested assets
40%
3.2. Amounts received from reinsurers/Capital 4.
Percentage subindicators
Capital adequacy
60% 15%
5.
Profitability: Capital return
10%
6.
Adequacy of reserves: Reserves for losses/Total reserves
15%
7.
Financial flexibility: Financial expenses coverage
10%
The analysis of the insurance sector reveals the structure of competition within the insurer's operating environment and competitive position within this structure. As a result, the first part of the model focuses on determining market share and diversifying the business and the geographic position, important elements in determining the insurer's business profile and positioning in the insurance market. The following table presents WKHPDUNHWSRVLWLRQRIWKHWZRFRPSDQLHV6&$VWUD$VLJXUăUL6$DQG6&$OOLDQ]- Tiriac S. A.
1498
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 2. Market share and related scoring according to Moody's model Year
2012
2011
2010
2009
2008
2007
2006
Indicator
Astra
Allianz - ܉LUiac
Gross written premiums
1,131,544,783
900,180,498
Market positioning
1
2
Score
100
97.561
Gross written premiums
1,008,544,317
898,416,364
Market positioning
1
2
Score
100
97.561
Gross written premiums
1,083,209,476
1,020,399,089
Market positioning
1
2
Score
100
97.561
Gross written premiums
809,471,525
1,285,882,261
Market positioning
2
1
Score
97.826
100
Gross written premiums
642,647,143
1,278,805,131
Market positioning
4
1
Score
93.182
100
Gross written premiums
367,207,389
1,137,608,897
Market positioning
7
1
Score
85.714
100
Gross written premiums
301,395,620
1,028,655,452
Market positioning
6
1
Score
87.805
100
From this table we can see the evolution of the insurance company Astra during the seven years from the 6th place in 2006 to the position of market leader in 2012. In Table. 3 we can observe the total subscription costs in relation to the net written premiums (both for life and non-life insurance).
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1499
Table 3. The Subscription costs and Net written premium ratio Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Subscription costs
210,999,249
177,337,835
Net written premiums
778,856,145
728,885,178
Coefficient 1.2
27%
24%
Score
75
80
Subscription costs
247,986,174
175,652,498
Net written premiums
1,016,095,508
808,952,499
Coefficient 1.2
24%
22%
Score
80
80
Coefficient 1.2
20%
18%
Score
80
85
Coefficient 1.2
22%
13%
Score
80
90
Coefficient 1.2
25%
18%
Score
75
85
Coefficient 1.2
28%
17%
Score
75
85
Coefficient 1.2
29%
5%
Score
75
95
From table 3. we can notice the dependence of Astra of other insurance channels (legal entity, insurance brokers), not relying solely on its own insurance business. Since 2006 and until now this rate remained constant, while Allianz-Tiriac's ratio is constantly increasing ranging from 5% in 2006 to 24% in 2012. From the business diversification we can see the number of insurance lines in which the companies VXUYH\HG$VWUD$VLJXUăULLV active almost all seven years in 17 of the 18 classes of insurance, while AllianzTiriac only in 15 classes. Hence the better score obtained by Astra for this indicator. Changing over to the financial profile, we start by studying the quality of assets. First, the ratio of risky assets and the invested assets highlights the total assets whose income is not stable or fixed from the total investment made by these companies. Allianz-Tiriac holds a risky assets portfolio, enabling it to achieve the maximum score of the indicator, while the share of risky assets in the total invested assets for company Astra is about 14% in 2012.
1500
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 4. Business diversification - Number of business lines Year 2012 2011 2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
17
15
Score
94.444
83.333
Lines of Business
16
14
Score
88.889
77.778
Lines of Business
16
14
Score
88.889
77.778
Table 5. The ratio of risky assets and total invested assets Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Risky assets
40,431,361
4,940,759
Invested assets
283,600,691
1,350,415,021
Coefficient 3.1
14%
0%
Score
80
100
Risky assets
42,376,370
3,644,777
Invested assets
374,537,154
1,333,340,017
Coefficient 3.1
11%
0%
Score
80
100
Coefficient 3.1
11%
1%
Score
80
100
Coefficient 3.1
9%
1%
Score
90
100
Coefficient 3.1
9%
0%
Score
90
100
Coefficient 3.1
10%
1%
Score
90
100
Coefficient 3.1
0
0%
Score
100
100
The analysis of a company's financial fundamentals focuses mainly on financial aspects, such as capital adequacy, investment risk, return and liquidity management or organizational structure.
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
1501
Table 6. The ratio of the amounts received from reinsurers and the total capital Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Amounts received from reinsurers
14,945,672
42,476,257
Capital
192,712,534
94,393,890
Coefficient 3.2
8%
45%
Score
100
100
Amounts received from reinsurers
5,938,367
47,651,029
Capital
192,712,534
94,393,890
Coefficient 3.2
3%
50%
Score
100
100
Coefficient 3.2
2%
91%
Score
100
100
Coefficient 3.2
1%
250%
Score
100
80
Coefficient 3.2
1%
232%
Score
100
80
Coefficient 3.2
1%
217%
Score
100
80
Coefficient 3.2
0%
388%
Score
100
70
The ratio of the amounts received from reinsurers and capital quantify the dependence of insurance companies' activity as reinsurers and implicitly of the reinsurance damages and reinsurance commissions. Table 7. Net profit and Subscribed share capital ratio Year
2012
2011
2010
2009
Indicator
Astra
Allianz - ܉LULDF
Net Income
6,671,058
-42,742,255
Subscribed share capital
192,712,534
94,393,890
Coefficient 5
3%
-45%
Score
40
0
Net Income
81,013,945
24,513,434
Subscribed share capital
192,712,534
94,393,890
Coefficient 5
42%
26%
Score
100
100
Coefficient 5
13%
-20%
Score
100
0
Coefficient 5
3%
44%
Score
40
100
1502
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
2008
2007
2006
Coefficient 5
2%
34%
Score
20
100
Coefficient 5
-36%
50%
Score
0
100
Coefficient 5
0%
89%
Score
10
100
The return on equity is determined by the ratio of net profit of the company and share capital. Depending on the net result (profit or loss) we can establish the insurance company's profitability, a high value determines a proportional high score of the indicator. Table 8. The ratio of the reserves for losses and the total reserves Year
2012
2011
2010 2009 2008 2007 2006
Indicator
Astra
Allianz - ܉LULDF
Reserves for losses
0
21,855,353
Total reserves
1,166,577,709
910,252,741
Coefficient 6
0%
2%
Score
100
80
Reserves for losses
0
17,367,997
Total reserves
1,045,832,166
857,384,696
Coefficient 6
0%
2%
Score
100
80
Coefficient 6
0%
1%
Score
100
80
Coefficient 6
0%
1%
Score
100
80
Coefficient 6
0%
1%
Score
100
100
Coefficient 6
0%
1%
Score
100
100
Coefficient 6
0%
2%
Score
100
80
Provisions are recognized in the balance sheet when the company acquires a legal or constructive obligation related to a past event and it is probable that in the future a consumption of economic resources is necessary to extinguish the obligation. The loss reserves are larger, the need for provisions is greater, therefore Moody's indicator is lower. The company Astra, not having reserves for losses obtained the maximum score.
1503
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
Table 9. Financial expenses coverage Year
2012
2011
2010
2009
2008
2007
2006
Indicator
Astra
Allianz - ܉LULDF
Financial result
16,756,707
28,870,047
Financial expenses
2,046,643
11,747,048
Coefficient 7
819%
246%
Score
100
90
Financial result
97,426,642
33,935,306
Financial expenses
22,769,259
5,408,036
Coefficient 7
428%
627%
Score
100
100
Coefficient 7
558%
631%
Score
100
100
Coefficient 7
167%
843%
Score
80
100
Coefficient 7
106%
356%
Score
80
100
Coefficient 7
201%
878%
Score
90
100
Coefficient 7
246%
450%
Score
90
100
The coverage of financial expenses (financial felixibilility) is determined through the non-technical account, namely the ratio of financial result and financial expenses. For both companies, the coverage level is very high, Astra recording an increase of this share from 2006 to 2012 by 600%. Table 10. 0RRG\ VUDQNLQJIRU$VWUD$VLJXUăULDQG$OOLDQ]-܉LULDF Year
Score Astra
Score
2012
89.122
2011
Allianz-܉LULDF
Ranking Astra
Ranking
82.572
Aa2
Aa3
95.722
93.572
Aaa
Aa1
2010
95.722
84.172
Aaa
Aa3
2009
88.348
92.567
Aa2
Aa1
2008
85.377
94.967
Aa2
Aa1
2007
83.502
94.689
Aa3
Aa1
2006
85.469
91.689
Aa2
Aa1
Allianz-܉LULDF
)ROORZLQJ 0RRG\ V UDQNLQJV IRU WKH VHYHQ \HDUV ERWK $VWUD $VLJXUăUL DQG $OOLDQ]-܉LULDF WKH ILUVW WZR insurance companies on the Romanian insurance market, received excellent ratings. Thus, companies with high ratings offer great financial stability, serving as a model for other companies in the market even in times of crisis when there was a huge decrease in consumer confidence for the insurance products.
1504
Cristina Ciumaș et al. / Procedia Economics and Finance 32 (2015) 1494 – 1504
5. Conclusion An assessment of the financial strength by rating agencies, although important, should not be the only factor used by insurance consumers. Perhaps the most important question for future research is how well the various rating agencies predict, in fact, the insolvency of insurers. Credit risk - referring to the risk of an insurer's investments that will no longer be able to be paid or paid otherwise than agreed - is particularly important for insurers, who often hold investments for a long period of time to meet obligations that will occur in the distant future, such as life insurance or claims of middle-aged insurers. Banks and brokers, on the other hand, may be more concerned about liquidity risk - the risk that all creditors demand reimbursement at the same time. This risk has managed to bring to the ground many institutions during the financial crisis. During this period of financial instability, insurance companies in Romania have largely succeeded in PDLQWDLQLQJYHUWLFDOLW\HVSHFLDOO\WKHWZRFRPSDQLHVDQDO\]HGE\0RRG\ VPRGHO$VWUD$VLJXUăULDQG$OOLDQ]܉LULDF7KH\ZHUHDEOHWRDFKLHYHKigh scores and to rank very high on the rating agency's scale. Higher ratings than Aa3 (i.e. Aa2, Aa1 or Aaa) show an excellent financial security, even exceptional in case of the Aaa rating. The fact that these two companies have managed to maintain the profitability of the insurance business even during the financial crisis, their evolution from 2006 to the present being constant in terms of Moody's rating agency model, shows a strong business model and assumed responsibility towards the consumers of insurance products. References Hunt, J.P. (2011) Credit Ratings in Insurance Regulation: The Missing Piece of Financial Reform Washington and Lee Law Review, Volume 68, Issue 4, pp. 1667-1697 Feinberg M., Shelor R., Cross M., Grossmann A. (2006), A Comparison of the Solicited and Independent Financial Strength Ratings of Insurance Companies, Journal of American Academy of Business, Cambridge, Volume 9, Number 2, pp. 37-43 Baranoff E. (2012) An Analysis of the AIG Case: Understanding Systemic Risk and Its Relation to Insurance, National Association of Insurance Commissioners 2012 Klein R. (1992) Insurance Company Rating Agencies: A Description of Their Methods and Procedures, National Association of Insurance Commissioners 1992 Elkhoury M., (2008) Credit rating agencies and their potential impact on developing countries, United Nations Conference on Trade and Development, Volume 168. /ă]ăUHVFX6$QJKHODFKH* 5DWLQJDJHQFLHV UROHRQWKHILQDQFLDOPDUNHW$FDGHP\RI(FRQRPLFDO6WXGLHV%XFKDUHVW5esearch Project CSA, (2006) Activity Report on Insurance Market Development for the year 2006 CSA, (2007) Activity Report on Insurance Market Development for the year 2007 CSA, (2008) Activity Report on Insurance Market Development for the year 2008 CSA, (2009) Activity Report on Insurance Market Development for the year 2009 CSA, (2010) Activity Report on Insurance Market Development for the year 2010 CSA, (2011) Activity Report on Insurance Market Development for the year 2011 CSA, (2012) Activity Report on Insurance Market Development for the year 2012