Insurer Solvency Rating Methodology (General Guidance)

The rating methodology, developed by Expert RA since 1997, received a positive opinion from a PricewaterhouseCoopers audit-consulting team in April 2001.

The underlying principle for appraising the insurer solvency boils down to getting the relevant performance indicators brought against the weighted-average benchmarks for the Russian insurance market in order to identify either upside or downside factors bearing on the given insurer’s solvency. This kind of approach makes it possible to diverge from “ideal” characteristics and spot the more credible operations under the given set of political and economic environments.

The Expert RA methodology primarily differs from its international analogies in that the pertinent valuation scale is geared to the Russian landscape, with insurers being appraised against the backdrop of local realities and practices. Measured against the generally accepted international benchmarks, Russian insurance companies have been performing rather poorly because of the prohibitive country risk level.

To define an insurer rating number, experts generally use the model of rating grade being reflective of the factors standing for the given company’s varied dimensions. Those factors normally include assorted financial performance figures standing for the current solvency and hard-to-quantify in-house-risk-management characteristics standing for the insurer’s sustainability.

The methodology provides for calculation of the rating functional while proceeding from the application of established rating factor values and pertinent weighting ratios. Notably, the secured rating class explicitly stands for the given insurer’s solvency status and relevant risk/investment management quality.

Understandably, insurers for the most part have been rated on the basis of their solvency standings. Generally, the notion of insurer solvency amounts to the ability to honor the committed-customer liabilities, while relying on the available assets and add-on reinsurance resources when achieving settlements on reinsurance-risk-related claims. The current liquidity ratio has been normally used as a key characteristic underpinning any effort to arrive at the given insurer’s solvency grade.

The notion of insurer financial stability stands for the ability to sustain the current solvency level for a certain length of time under prevailing external and internal conditions adversely impacting the cash flows.

The insurer financial stability is defined on the basis of modeling the following hard-to-quantify integral factors:

• size of the company,
• external stability factors,
• maturity of the insurance portfolio,
• size and sustainability of the customer base,
• reinsurance policy pursued,
• sustainability of cash flows,
• investment policies and strategies applied,
• maturity of the branch office network,
• years of operation in the marketplace and goodwill,
• equity adequacy.

The crucial principle underpinning the insurer sustainability modeling methodology under the current set of external conditions basically comes down to the given insurer’s performance indicators per each of the aforementioned factors being brought against the weighted-average benchmarks for comparable companies operating in the domestic marketplace.

The following chart features a range of tiers, with a number of indicators being examined per each one of the integral factors. With the given insurer's engagements being thoroughly researched, each factor eventually gets an appropriate index from the following range: -1, 0, 1.

Whenever the available knowledge is incomplete and the integral factors could not be properly weighted, the right index level would obviously come to stand at -1.

Methodology to assign grading classes for Russian insurers

Total of grading classes: 12.

Indices:

1-a, 1-b (maximum),

2-a, 2-b (high),

3-a, 3-b (medium),

4-a, 4-b (sub-medium),

5-a, 5-b (low),

6-a, 6-b (minimal).

The grading class breaks down into the following two components. The prime component (1, 2, 3, 4, 5, 6) reflects the insurer’s size of premiums and real-world value of available liquid assets. The incremental component (a, b) hinges of the maturity of customer base and business diversity.

Quantifying the prime component:

The following three year-end indicators for the reporting and previous years shall be thoroughly examined:

An insurer gets the "1" grading class index whenever all relevant indicators have come to be meaningfully in excess of the weighted market-average (higher than СЗ+СКО) per either reporting date.

An insurer gets the "2" grading class index whenever the indicators (1) and (3) have come to be meaningfully in excess of the weighted market-average per either of the reporting dates, with the indicator (2) being higher than RUR30 million or meaningfully higher than the weighted market-average, indicator (1) beating the “25% level” (reflective of the insurers accounting for smaller than 25% of aggregate premiums), indicator (3) standing for the adequacy grade.

An insurer gets the "3" grading class index whenever the indicators (1) and (3) have come to be in excess of the weighted market-average (better than C3) per either of the reporting dates, with the indicator (2) being higher than RUR10 million or indicator (1) and (3) requirements being satisfied at par with Index “2”, but with indicator (2) standing below RUR30 million.

An insurer gets the "4" grading class index whenever the indicators (1) and (3) have come to be in excess of the “low grade level” (the indicator (3) standing higher than C3-0.33*CKO, indicator (1) exceeding the “1% level”) per either of the reporting dates, with the indicator (2) being higher than RUR10 million.

An insurer gets the "5" grading class index whenever at least one of the indicators (1) and (3) has come to be below the “low grade level” per at least one of the reporting dates, with the indicator (2) being higher than RUR10 million or indicator (1) and (3) requirements being satisfied at par with Index “4”, but with indicator (2) standing below RUR10 million.

An insurer gets the "6" grading class index whenever at least one of the indicators (1) and (3) has come to be below the “low grade level” per at least one of the reporting dates, with the indicator (2) staying within RUR10 million.

The research shall be carried out per two reporting dates in order to appropriately capture possible shifts in the given insurer’s business pursuits. As a matter of fact, any insurer’s grading class comes to be reflective of its “worst set” of performance indicators.

Quantifying the incremental component:

An insurer gets the "a" grading class index whenever the following three requirements are satisfied:

Should an insurer fail to meet one of the requirements (1), (2) or (3), it will receive the (b) grading class index.