OLDWICK, N.J.--(BUSINESS WIRE)--A.M. Best recently examined the rating distribution and associated metrics within rating categories among domestic health insurers and concluded that in many respects, what determines the relative strength or weakness of a company’s operating performance is a combination of its business profile and its ability to effectively execute its strategy and operating profitability, which drives future balance sheet strength and long-term financial stability.
A new Best Special Report, titled, “How Financial Metrics Track With A.M. Best’s Health Rating Categories,” states that the assignment of an interactive rating is derived from an in-depth evaluation of a company’s balance sheet strength, operating performance and business profile, as compared with A.M. Best’s quantitative and qualitative criteria. Additionally, A.M. Best utilizes various benchmarking tools to get a more detailed comparison of the overall performance and volatility of rating units within certain business segments, peer comparisons and rating categories using various financial measures and metrics, providing micro- and macro-level views.
While the number of statutory-health rating units has increased from 65 to 82 from 2011-2014, the rating distribution has been fairly consistent over the last four years, with the majority of insurers in the “Excellent” (issuer credit ratings of “a-” through “a+”) and “Good” (issuer credit ratings of “bbb-” through “bbb+”) categories. The health industry has been highly influenced by the Affordable Care Act (ACA) over the last four years, especially when it pertains to administrative expense ratios. Although as a whole the health industry is producing favorable results, operating trends have been affected by specific aspects of the implementation of ACA provisions. Additionally, macroeconomic factors have created a challenging environment for health insurers to achieve growth in their commercial employer market segment, which had previously been a material driver of earnings for many insurers.
Overall liquidity for all health insurers is relatively high and is fairly consistent among insurers in all rating categories. An overall liquidity ratio of more than 100 is considered good, while the mean for health insurers, regardless of rating category, generally is about 200. The reason this is higher for health insurers is that they keep more cash and short-term investments given the short-tail claim liability period. Additionally, some insurers have increased the liquidity of their portfolios in order to supplement cash flow. Cash flow for insurers participating in health insurance exchanges has been negatively affected by receivables booked in 2014 for the 3Rs (risk adjuster, reinsurance and risk corridors). These receivables can be quite sizable and the timing of the final settlement with the federal government is still unknown. Furthermore, receivable balances may have increased further in 2015 for active health insurance exchange enrollment, which makes liquidity management very important to participating health insurers, especially smaller companies.
The biggest expense for health insurers is medical expenditures. This is measured by the medical loss ratio (MLR), calculated as incurred claims net of reinsurance recoveries and increase in reserves as a percentage of earned premiums. Companies with higher enrollment, which is diversified by market segment and geography, have the ability to absorb short-term unfavorable medical or pharmacy trends and generally report less volatility over time for their MLR.
Consistent profitability is the predominant driver of capital stability. The sustainability of profitable operations and lack of earnings volatility are important characteristics for insurers in the higher rating categories. Insurers in the “Superior” (issuer credit ratings of “aa-” through “aaa”) and “Excellent” categories have significant higher return on operating revenue than insurers in the “Good” and “Fair & Below” (issuer credit ratings of “bb+” and lower) categories.
Operating performance and business profile are viewed by A.M. Best as leading indicators when measuring future balance sheet strength and long-term financial stability. Profitability is the engine that ultimately drives capital growth, and looking into the future enables an assessment to gauge a company’s ability to preserve and/or generate new capital over time.
For the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=242676.
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