CASE STUDY: PROPERTY AND CASUALTY INSURANCE
Financial institutions are complicated by their many definitions of capital: statutory or regulatory capital, economic or risk capital, and accounting or book capital. In the insurance industry, considerable attention is given to financial strength ratings (FSRs). These are credit opinions on the underlying financial strength of insurers in terms of their ability to punctually repay senior policy holder obligations and claims.
FSRs differ from senior unsecured bond ratings in that they are not security-specific, and that insurance companies are often owned by holding companies, which may be the issuers of long-term debt. FSRs incorporate capitalization, profitability, liquidity, market stature, and competitive advantage (underwriting, distribution, cost control, service, innovation).7
Though ratings are less sensitive to financial leverage than core business risk, company size, and other factors, EBIT coverage and book leverage work better in these industries than most. In terms of the statistical power of several Property and Casualty metrics in predicting ratings, the strongest predictive power is achieved with gross underwriting leverage, financial leverage, pretax return on equity, and size.8
Several important factors are not in our model, due to challenges with statutory data quality and timeliness. Others received coefficients of the wrong sign, perhaps due to multicollinearity or for being too small for sufficient sensitivity, ...