Rating Agency

Study guides: Exam 6C, Exam GI-201, Exam ILA-201I, Exam ILA-201U

A Rating Agency — A.M. Best, S&P, Moody's, DBRS Morningstar and Fitch in the Canadian market — assigns a financial strength rating expressing its opinion of an insurer's ability to meet its policyholder obligations. It is an independent, market-facing assessment that sits alongside the regulator's, and for a commercial insurer it can be as consequential as the MCT ratio.

• What a rating assesses: balance sheet strength (capital adequacy on the agency's own model, reserve adequacy, reinsurance quality, liquidity), operating performance, business profile (scale, diversification, market position), and enterprise risk management.
• How it differs from regulatory assessment. A rating is an opinion aimed at counterparties and is published; supervision is confidential and carries legal powers. Agencies apply their own capital models — Best's BCAR, S&P's capital model — which can differ substantially from the MCT because they are calibrated to different objectives.
• Why it matters commercially. Commercial insureds, brokers and reinsurers often require a minimum rating (A- is a common threshold), so a downgrade below it can remove access to whole segments of business regardless of the insurer's actual solvency. Reinsurers price cedants by rating; lenders price debt by it.
• The downgrade spiral is a ripple effect to model explicitly. A downgrade reduces business, raises reinsurance and funding costs, and weakens the metrics that produced the rating — which is why FCT scenarios should carry a downgrade as a consequence rather than treating the rating as fixed.
• Ratings as an early warning. Agencies act on forward-looking information and often move before regulatory metrics deteriorate, so a negative outlook is a signal worth taking seriously. Against that, they are demonstrably imperfect — the financial crisis is the standard illustration — and they should not substitute for the insurer's own analysis.
• Ratings are voluntary. An insurer can decline to be rated, and many Canadian personal-lines insurers with no commercial counterparty requirement do.

Regulator Satisfied, Agency Not An insurer maintains an MCT ratio of 172\%, comfortably above the 150\% supervisory target, and OSFI has raised no concerns. Its rating agency places it on negative outlook, citing reserve development and business concentration.

How should the Appointed Actuary and the board respond?

Answer Take it seriously rather than dismissing it. The two assessments answer different questions, and disagreement between them is informative.

Why they can differ:

• Different capital models. The agency's model may charge more for reserve risk on this insurer's line mix, or apply a concentration charge the MCT's standardised formula does not.
• Different horizons. The MCT is a point-in-time measure; the agency is forming a forward view, and it has weighted the reserve development trend as a predictor.
• Different tolerances. A rating of A- requires materially more than the minimum a regulator will accept — a regulator asks whether the insurer will fail, an agency asks whether it will pay every claim comfortably.

What the actuary should do. Test whether the agency is right about reserves. A negative outlook citing development is an external party independently reaching the conclusion that the reserving process is biased — the same signal a Canadian Annual Return development exhibit would give. If an actual-versus-expected analysis confirms it, the reserves need strengthening, and the MCT ratio is overstated too.

What the board should do. Model the downgrade as a scenario in FCT: what business is lost if the rating falls below A-, what reinsurance costs, what funding costs. On a commercial book, that consequence can be larger than the reserve deficiency that triggered it.

What neither should do is treat "we exceed the supervisory target" as an answer. The regulator's threshold is a floor for continued operation, not a statement that the insurer is well capitalised — and the agency is measuring something the insurer's customers actually care about.