Size and growth

A lack of scale, rapid growth or significant shrinkage are all regarded as potential risk factors by insurance credit analysts. They are, however, more challenging to apply benchmarks to than the other factors shown in the BLTR.

We have defined five size categories for BLTR users to see at a glance the relative scale of an insurer. But both size and growth should be considered in the specific context of the insurer being reviewed.

Here we explain why analysts care about these factors and some of the issues the BLTR user should keep in mind.

Stand-alone profiles

As described in the Key Analytical Concepts (the “KAC”) guide, BLTR reports reflect the “stand-alone” profile of the named carrier (and any consolidated subsidiaries). The background to that is covered in the KAC.

BLTR users should keep in mind that the apparent size and growth of any covered carrier might be seen differently in the context of its position in a wider group. For example, a small carrier owned by a large group could have the de facto ‘market position’ of its parent.

Size considerations

Broadly, a lack of significant size matters in four ways to an insurer’s credit profile.

  • First it can limit diversification of the sources of risk to capital (assets risks and underwriting risks) as well as the related diversification in earnings.
  • Second it can lead to only a limited ‘market position’. In essence this means an insurer’s pricing power is weaker (with policyholders and brokers) as is its buying power with reinsurers.
  • Third it can be challenging for smaller insurers to have real ‘bench-strength’ in their management teams and/or lead to significant ‘key-person’ risk.
  • Fourth the degree of financial flexibility (access to equity or debt capital if needed) can be limited.

The challenge is that none of these issues is a given (although for the very small they are highly likely unless offset by a wider parent group context).

Nor is there full consistency among the major rating agencies on this issue. S&P does not generally rate smaller insurers above the ‘BBB+’ level (although it does not have a prescribed size-based rating ceiling, the cumulative impact of various size related rating factors tends to lead to this). By contrast A.M. Best looks at size in the specific context of the rest of an insurer’s profile and as a result globally has a significant number of smaller insurers rated ‘A-‘.

Moreover, some of the issues above can play out in larger insurers (albeit for different reasons). We have recently seen an incidence of a larger group having problems with under-reserving at a subsidiary; this could be viewed as having been a problem related to larger scale (both the desire for large market share by local management and the extent to which the group leadership was not easily able to recognise the issues it had in the subsidiary).

More generally a privately-held smaller insurer may well be able to focus on attractive niche markets, where it can specialise. In contrast a large quoted insurer might be under pressure to grow and consider niche markets to be of insufficient scale to justify the costs of specialisation.

For the BLTR user we suggest that a general recognition of size as a risk factor is important but that the issues that derive from a lack of scale are considered in the particular context of their knowledge of the insurer’s operations.

That said, all other things being equal, a smaller insurer would generally be expected to have somewhat stronger key ratios to mitigate the challenges of lack of scale.

The size classifications

The BLTR uses Gross Written Premium (GWP) for the size classifications as follows:
I               Up to £25m
II             >=£25m < £100m
III            >=£100m < £400m
IV            >= £400m < £1,000m
V             > =£1,000m

For carriers that do not report in sterling, the exchange rates stored within A.M. Best’s database are applied. Users should note that movements between size classifications over time could reflect exchange rate changes rather than actual changes in the GWP reported by the insurer (although this would be offset by the extent to which sterling denominated business is a significant part of the insurer’s total GWP).

Growth considerations

In developed insurance markets significant growth is seen as a risk factor by insurance credit analysts due to the challenge of how that is achieved without an insurer ‘buying’ market share via under-pricing. Examples of this include some high profile UK insurers in the past.

However, in some respects the issues of size noted above can apply here in reverse. While it would be difficult for a £1bn GWP carrier to grow at 20% a year in the UK market without competing heavily on price, a £20m GWP carrier focussed on a specialist niche might well be able to do so.

What constitutes ‘significant’ growth is also hard to be definitive about. The rating agency Fitch suggests that 5% annual growth above the market average can be a concern. But this is highly predicated on the exact profile of the insurer.

Obviously issues like claims inflation in a given line of business, the degree of competitive pressure etc. can all come into play. Falling rates might actually disguise aggressive growth (a double concern), whereas a hardening market could imply worrying growth although the insurer is simply able to price the same amount of risk at a higher rate.

A key specific consideration is whether growth (or shrinkage) reflects an acquisition or a divestment. Acquisitions are rarely ‘risk-free’ but a doubling in business volume via the purchase of another healthy carrier is a very different type of growth than a doubling of ‘organic’ scale due to slashing rates.

While material shrinkage is a less obvious concern (the insurer appears to be taking less risk onto its books) the issue is that this may indicate a fundamental problem with the insurer’s business (product attractiveness, claims payment reputation, market concerns around its financial health, domicile reputation etc.). More generally the expense position may become commercially unsustainable if revenues drop too low. Sale or cessation of a poorly performing area of the business, or one viewed as being in an unattractive market going forward, can be a positive (although that depends on the case specific details of any sale).

All the caveats about the consideration of high growth apply similarly to material shrinkage.

As with size therefore the BLTR user should consider this in the context of their knowledge of the specific profile and business model of the insurer.

Become a BIBA member

Membership that gives you more. We help support, protect, represent and promote brokers. Our experienced and dedicated team are here to help you!

Find out more