Fail to prepare—prepare to fail: AM Best’s new criteria will mean rating changes

AM Best is about to change its methodology, yet most brokers and reinsurers seem to be ignoring what is either a potential opportunity or an impending crisis, as Peter Hughes, founding director at Litmus Analysis, explains.

One of the lessons I learned when I moved into the world of ratings having been a broker was that the market only focuses on ratings when the bad news comes out. There are exceptions, but a lot of practitioners simply ignore the vast majority of the commentary and thought leadership coming from the agencies, waiting for something really newsworthy before they sit up and listen.

There is nothing wrong with that, except that occasionally my old buddies are blissfully unaware of changes on the horizon that could just have a big impact on their lives in the near future.

“Rating agency publishes request for comment (RFC) on new criteria” is not a headline that would generally attract that demographic. However, the likely underlying impact could well be more important to them than they realise.

Back in 2013, when S&P undertook a radical rewrite of its methodology, someone with a crystal ball might have written a headline saying “S&P to change nearly 10 percent of its ratings within the next 12 months”. That headline might have elicited a stronger response, because that is indeed what happened—just by changing the way the agency undertook the process, getting on for 10 percent of S&P’s ratings changed.

This was not because the financial profile of any given re/insurer had changed in any way—it was just because S&P’s approach had changed.

Earlier this year, AM Best announced an RFC on not just its rating criteria, but also the Universal Best’s Capital Adequacy Ratio (BCAR) capital model—a step further than S&P’s changes. For the majority of the market, this probably registered little more than a faint blip on the edges of the radar.

Of course, for Litmus, this was major news, and we’ve been talking about it, examining the RFC, and engaging with AM Best and our clients on the potential implications.

Our sense is that that many re/insurers with AM Best ratings haven’t even thought about the impact this might have on their own rating. And it’s only the largest or most sophisticated brokers who appear focused on the implications for their re/insurer clients.

It’s a strange world where the management of a re/insurer and their key professional advisors might be ignoring what could be either a major potential opportunity or an impending crisis.

A key element of this is that AM Best is required by agency regulation to announce which ratings may be impacted when it switches to the new criteria. This means that it will have had to determine who is impacted before the criteria take over—so it must be not just testing the criteria but ‘shadow rating’ with them now, ahead of time.

At some stage in 2017, the new criteria will drive the ratings—not the old. Our advice to our clients has been to address the shape of the new criteria now, to communicate with AM Best as if they were already in place, and to be considering how their credit profile looks through the new criteria ahead of time.