Data Adjustments

Data Adjustments

1. The reason for the data adjustments

Accounting practices do not necessarily align with how credit analysts and regulators view various items from the perspective of considering an insurer’s financial condition.

Accordingly, in the BLTR, data adjustments are made to the reported data derived from Best to fit with common credit analytical and regulatory approaches. These are described below.

However, such adjustments should be considered by the user in the context of the company being reviewed. To facilitate this the BLTR presents the ratios impacted (the capital ratios) both before and after the adjustment. The BLTR also displays the details of the adjustments made.

Note that all figures in the BLTR are shown in sterling units. For carriers that do not report in sterling all data is converted using the exchange rates stored within Best’s database. A full list of Best currencies and the associated currency codes has been included in the Appendix at the end of this guide.

2. Adjustments to reported shareholders’ funds (RSF)

Standard credit ratio analysis of an insurer’s risk capital can involve both positive (additions) and negative (deductions) adjustments to the reported shareholders’ funds.

The individual BLTR report outcomes include the following adjustments to form the adjusted shareholders’ funds (ASF).

The benchmark categories shown in the ASF display in the BLTR reflect these adjustments (i.e. the data for each insurer included in the benchmark cohort calculation is adjusted in exactly the same way as for each covered insurer).

a) Deductions from the RSF in creating the adjusted shareholders’ funds (ASF)

i) Goodwill

Many UK brokers will be familiar with the deduction of this intangible asset from regulatory capital, and we do so here in calculating the ASF.

ii) Investments in or loans to non-consolidated group companies

Insurance carriers that are part of a wider group but not themselves the ultimate parent company may sometimes hold equity positions in, or provide loans to, other group companies (which may or may not include the ultimate parent) beyond their own directly owned subsidiaries (if they have any).

Since the amount of RSF this represents may therefore be supporting other group risk taking activity, credit analysts generally deduct this amount from the available risk capital for the insurer. We therefore deduct this amount when calculating the ASF.

If this item materially impacts the BLTR, users may wish to discuss it directly with the insurer. However, we would note that attaching risk capital value to such an intra-group investment/loan would logically also require an overall analysis of the group (since the ability to repay would be a function of the group’s financial health).

In practice the ultimate parent may have made some form of commitment to the insurer’s regulator that some or all an intra-group investment/loan would be repaid if the insurer’s regulatory capital position falls below a given level.

If so this might also be something the user wishes to discuss with the insurer. However, it would again imply a need for an overall view of the group’s financial health. We would also note that repayment commitments given to regulators may not be for the full amount owed/invested and may depend on the legal wording of the commitment.

For example, the commitment might only be to repay that part of an intra-group loan provided by the insurer necessary to continue to meet the insurer’s minimum regulatory capital requirement.

b) Additions to RSF

i) Equalisation reserves

In some jurisdictions insurers are allowed or required to carry additional reserves beyond what they prudently need for future claims in the form of ‘equalisation’ or ‘catastrophe’ reserves.

As these basically fulfil the same economic function as risk capital we add these to the RSF in calculating the ASF.
Since these reserves are simply carried as a safety buffer, we do not include this amount in the ‘reserve’ totals for the ‘reserve leverage’ calculations (see the ‘Ratio Guide’ tab).

The impact of contributions to, or releases from, equalisation reserves are also not included in the combined ratio (underwriting profitability) and operating ratio (operating profitability) calculations.

ii) Market value adjustments (usually positive)

In some jurisdictions the reported “book value” of invested assets may be different (usually lower) than the market value due to the accounting approach. If so the difference is often shown in the notes to the accounts and is captured in a separate data field by Best.

Normal practice for assessing risk capital ratios is to consider these on a “market value” basis and so this amount is added in calculating the ASF and to the investment total for the investment risk ratio.

c) The treatment of deferred acquisition costs

It is quite common to also deduct any deferred acquisition costs (DAC) asset from RSF, or at least some part of it.
However, there is a far less clear analytical basis for this beyond ‘prudence for prudence sake’, and indeed it can be seen as double counting.

That is because DAC typically represents that part of the costs incurred by the insurer to acquire business for which it has not yet economically provided the cover (e.g. broker commissions paid for policies running into the subsequent accounting year). However, in standard accounting the income from that is also not recognised.

Hence disallowing DAC effectively charges the insurer with the full acquisition cost of that part of the policy that is unearned, while not crediting it with the unearned premium.

For reference in most accounting conventions DAC is shown as a balance sheet asset and the unearned premium reserve is a liability.

We therefore do not adjust for DAC in the ASF, but BLTR users should be conscious that it is an intangible asset (the insurer has spent – or committed to spend – the money already) and consider the scale of any DAC relative to the scale of RSF and ASF.

d) Adjustment limiter

It’s possible in any given case that the combined total of goodwill and investments in/loans to non-consolidated group companies could exceed reported shareholders’ funds. If they were no positive adjustments, then the ASF would be a negative number.

Since this would fundamentally distort any ratio using that number we limit the total reduction to reported shareholders’ funds when calculation adjusted shareholders’ funds to 75% of its total.

Nonetheless if and when this occurs the adjustment is still profound and would further emphasise the importance of considering the nature of the reduction in the context of the insurer’s profile.

3. Subordinated debt

In most areas of financial analysis, taking on debt is considered to increase the riskiness of a company’s credit profile. However, for financial institutions – including insurers – certain types of debt can be seen as enhancing the credit profile of the borrower from the perspective of creditors more senior than the lender.

It’s a complex area but in essence the premise for an insurer is that – if debt is issued with very long maturities, has waivers on interest payments if the insurer is losing money, and is very clearly and deeply subordinate to policyholders – then it adds to the long-term capital available to pay policyholder claims.

Given that, rating agencies and regulatory approaches (including Solvency II regulations) typically ‘allow’ various amounts of subordinated (sub) debt to be added to risk capital. The jargon for this is that the debt ‘qualifies’ as risk capital.

But this is a highly ‘case specific’ issue. A study of the terms of any given sub debt transaction, along with the ability of the insurer to very comfortably finance the interest payments, is necessary to decide what – if any – part of it should be viewed as risk capital.

This is clearly beyond what is possible within the BLTR. Nonetheless members should be aware that neither the reported or adjusted capital ratios reflect any credit for what might be considered ‘qualifying’ sub debt.

Appendix

AM Best Currency Codes