A.M. Best Co., which rates the financial strength of insurance companies, is adding a factor to its method of analysis -- the
likelihood that an insurer could face a policyholder panic with large-scale cash withdrawals.
Guides to insurers' performance and strength published by A.M. Best, an Oldwick, N.J., concern, are used by almost all insurance agents and insurance executives, as well as millions of policyholders.
Best said that recent state takeovers of Mutual Benefit Life Insurance Co., Monarch Life Insurance Co. and First Capital Life Insurance Co. represented a major new development that was confounding its traditional solvency analysis.
All three of these companies were afloat when they were taken over, Best noted, but they had to seek the protective custody of the states to stop withdrawals of cash.
As a result, A.M. Best will begin incorporating into its ratings analysis a "policyholder confidence" factor to measure the potential for a "run on the bank" at any one insurer.
The likelihood that an insurer could face large withdrawals will then be incorporated into the Best's Rating, which is intended to measure an insurer's overall ability to meet financial obligations.
"This factor addresses the unprecedented environment caused by the combined effects of a recession, a national depressed real estate market, a decline in consumer confidence in financial institutions and new legal pressures on pension managers," A.M. Best said in a statement. "In this environment, a solvent company's liquidity problems, which in the past were manageable, can develop into a liquidity crisis."
Standard & Poor's Corp., another leading rating agency, said that it, too, would be incorporating the likelihood of policyholder runs into its analysis.
Alan Levin, a senior insurance specialist at S&P, said that "because of the possibility of this run-on-the-bank scenario, we are asking some fundamental and basic questions" about our rating process. "We have always assumed that life insurers would not have this sort of problem," he said, "because of the structured nature of their liabilities."
Kenneth J.H. Pinkes, who runs the insurance rating operation at Moody's Investors Service, said in an interview that while Moody's, the third major rating agency, was comfortable with its current analytic methods, "there may be a change in the weightings" to give greater emphasis to an insurer's cash and marketable-securities position as well as to possible pressure on those assets.
Critics applauded the change, which they said would benefit consumers, but said the rating agencies should have acted long ago, before the recent runs began, because the factors that make insurers vulnerable to policyholder runs -- giant annuities and guaranteed investment contracts that can be cashed in on short notice -- have existed for years. "It's a case of closing the barn door long after the horse is gone," said Michael Sherman, a San Diego lawyer who is suing the rating agencies in connection with the recent failure of another major insurer, Executive Life.
To arrive at their ratings, the major rating agencies have for years considered an insurer's cash position as well as the amount of securities that an insurer could easily sell in a pinch without having to suffer a loss. In the industry this factor is called an insurer's "liquidity position."
Heretofore, however, the agencies have not given heavy weight to whether an insurer would actually have to begin tapping that cash or selling securities -- that is, whether the insurer would face a policyholder panic. In essence, A.M. Best is trying to assess that situation.
While saying that its "policyholder confidence" factor was only in the development stage -- and thus it did not give details -- people familiar with the situation said that A.M. Best would begin reviewing the terms of insurers' agreements with pension plans to see how quickly such policies could be cashed in and at what penalty to policyholders.