Keep tabs on your insurers in a difficult economy by reviewing evaluations by popular ratings agencies.
In addition to the health, safety, operational, and economic turmoil wrought by the COVID-19 pandemic, commercial property/casualty insurers in the U.S. and around the world have had to navigate large losses from a spate of natural disasters in recent years (i.e., the California fires), deteriorating loss experience in certain lines, and intense competition in others.
With these issues converging to bring nearly unprecedented uncertainty as to the economy and financial stability of a wide swath of business, including insurance companies, AEC firms need to be especially diligent in choosing their insurers and monitoring their financial condition. Accordingly, it may be instructive to review how insurers are evaluated by popular ratings agencies in terms of financial security and claims-paying ability.
This is relevant not just for the long-term viability of the AEC firms’ carriers to be “around” to pay for claims, but also for you to remain compliant with any contractual obligations that may require your firm to be insured by carriers with a minimum A. M. Best rating (typically “A-VII” or higher). Historically, A.M. Best Company has been the most widely used source of ratings for insurers.
A.M. Best’s letter rating provides an assessment of an insurer’s security; the Roman numeral refers to the insurer’s financial size. Together, the two ratings represent A.M. Best’s assessment of how well an insurer will be able to meet its ongoing obligations to investigate and pay claims.
Security ratings. A.M Best’s security ratings range from A++, meaning “Superior,” to F for “In Liquidation,” and S for “Rating Suspended.” There are also ratings beginning with “N” for such conditions as NR-1 for “Insufficient Data” and NR-2 for “Insufficient Size and/or Operating Experience.” A.M. Best considers three key elements in determining an insurer’s letter rating:
- Capital (combined liquid and fixed assets)
- Operating performance (underwriting results over time)
- Business profile and management, including major niches (such as architects and engineers), and related track record of management and insurer
Financial size rating. This rating is based on an insurer’s policyholders’ surplus, or net worth.
The rankings range from Category I (policyholders’ surplus under $1 million) to Category XV, $2 billion or more.
Rating outlooks. A third aspect of A.M. Best ratings, “Rating Outlooks,” indicates whether the insurer’s prospects are considered improving, stable, or deteriorating. The outlooks, which have ratings from A++ to D, indicate the insurer’s potential direction typically 12-36 months into the future. The outlooks can be: positive, reflecting a possible upgrade in the near term; negative, a pending potential downgrade; or stable (no change anticipated).
Be aware that although any rating outlook is not a guarantee of future viability, it may offer some insight. While an upgrade – either in security rating or financial size – might be considered a positive development, a downgrade calls for further examination.
AEC firms should determine what rating meets their own threshold of acceptability. Because you are relying on your insurance broker to “vet” carriers they present to you during your renewals, ask them to confirm their own requirements for carrier security; many only work with insurers with certain A.M. Best ratings or better.
In addition to A.M. Best, other prominent ratings companies include Standard & Poor’s and Weiss Ratings. S&P’s ratings range from AAA (extremely strong) to R (regulatory action pertaining to solvency); it considers insurers with BBB rating or higher “highly likely” to be able to meet their “financial commitments.”
Weiss Ratings range from A (Excellent) to F (Failed). Fitch Ratings, Moody’s Investors Service, and Duff & Phelps are other companies that also analyze insurers’ financial strength. While A.M. Best rating may be generally sufficient; a second opinion might be worth checking if A.M. Best assigns a negative outlook to an insurer.
Meeting contractual obligations. Even though the primary reason to choose insurers with strong ratings is to rely on them to honor their financial obligations and pay claims, design firms also must scrutinize carrier ratings to comply with their contractual obligations.
In many professional service contracts it’s common for clients to stipulate not only the insurance limits to maintain, but also to set minimum ratings requirements of the design firm’s insurers. If an insurer’s rating drops below what’s acceptable, the design firm will be in breach of this provision. This breach is a basis not to pay you and force you to secure replacement coverage (in some instances, such an event allows your client to secure replacement coverage and charge you any amounts incurred to do so).
In the current economic environment, it’s prudent for design firms to try including a clause in their contracts that designates a specific timeframe, such as 60-90 days, to replace their coverage if their insurer’s rating falls below the required level. Additionally, design firms should consider requesting a similar modification to the cancellation clause in their insurance policies. Most insurance policies impose costly penalties on insureds for cancelling coverage before their policy expires; however, if cancellation is prompted by the carrier’s ratings downgrade, it should be an excusable event for which the policy holder is not penalized.
As design firms manage various aspects of their business in these difficult times, they need to be sure they work with financially sound insurers that can be counted on if and when they’re needed. In addition to using ratings agencies, AEC firms can get valuable information by reviewing their publicly held insurers’ financial reports, checking with peers in trade associations, and consulting their insurance advisors. Besides helping you choose insurance companies that meet your criteria for financial security, brokers can help you stay abreast of material developments that might affect an insurer’s financial condition.
Rob Hughes, senior vice president and partner, Ames & Gough. He can be reached at rhughes@amesgough.com.
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