An Introduction To the A.M. Best Rating Process For Life, Health and HMO Insurers

Transcription

1 An Introduction To the A.M. Best Rating Process For Life, Health and HMO Insurers Speakers review the process of obtaining a rating, what information is required and those ratings are developed and maintained. Tina Bukow-Truman Andrew Edelsberg Mike Hoppes TINA BUKOW-TRUMAN: Good afternoon everyone. Thanks very much for joining us today. You have logged on to A.M. Best s webinar titled An Introduction to the A.M. Best Rating Process. I am Tina Bukow-Truman. I am the senior business development manager responsible for both Property/Casualty and Life/Health divisions in the U.S., Canada and the Caribbean. Today you will be hearing from Michael Hoppes and Andrew Edelsberg. Andrew is a vice president in the Life/Health ratings division. He manages an analytic team that provides rating coverage for a diverse group of domestic Life/Health insurers. His team s portfolio includes both mutual and stock Life/Health companies, including major writers of individual life and annuity, group life and annuity, disability income, credit life, dental, long term care, supplemental health and related financial services products. You may recognize Andrew as he frequently speaks at conferences and participates on various industry panels on behalf of A.M. Best. Mike is the business development manager responsible for Life/Health and HMO insurers as well as hospitals and healthcare systems. Mike is generally the first person a company speaks with when they are interested in learning about the rating process as well as when a company wishes to enter the process. You may also recognize Mike from the conference circuit as he attends many industry events. While I explain the purpose of today s webinar, please take a brief moment to read our disclaimer. This disclaimer explains what our financial strength ratings are and, more importantly, what they are not intended to be. The intent of today s webinar is to help the industry better understand the inner workings of the rating process. Inquiries about being rated have increased of late and we felt a webinar of this nature would be both timely and informative. Today s format is meant to be casual and we welcome your questions. You do have the ability to submit questions and we encourage you to do that. We have quite a bit to get to so let s start with what we re going to speak about today. Today you will hear from both Andrew and Mike. They will discuss the overview of A.M. Best, uses of Best s ratings, the actual rating process, the major components of the interactive rating, rating methodology for life, health and HMOs, the role of BCAR, which is Best s Capital Adequacy Ratio model. We will have time for Q&A. I will now turn it over to Mike Hoppes and he can begin the presentation. MIKE HOPPES: Thank you, Tina. A.M. Best has been in business for over 110 years. We re a worldwide rating agency and issuer of life and health insurance ratings. Just a brief overview of our timeline: we began rating life and health insurers in 1928 and in 1995 rated our first HMO. We began rating new company formations in We started rating healthcare systems in 2007 publicly. That s important for HMOs that are provider-owned. Some things I wanted to touch on that make A.M. Best unique: we are the only rating agency also focused on smaller issuers. We rate companies in virtually all segments, which give us a unique perspective. For example

2 we rate life and annuity companies, fraternals, small and large mutuals, small and large stocks, health companies, HMOs and credit insurers. Our products contain information on thousands of issuers and our Website gets millions of hits. Our ratings are available to the public via A.M. Best s Website and through a number of data providers and news vendors. Best s ratings are released in several publications available in print and/or digital format, such as Best s Insurance Reports and Best s Key Rating Guide. BUKOW-TRUMAN: I think it s probably fair to note that across all industries within our rating association that greater transparency is definitely an overriding theme. We hear that on all sides. The other thing that I did want to note as well, there was a recent press release on April 16th that noted the actual hits to our Website. In this year, 2010, there were 21 million page views in the first 100 days and the majority of those hits to the website were actually for financial strength ratings so it s incredible the reach that our ratings have. HOPPES: This slide shows the various users of our ratings. Some highlights that this audience might appreciate include agents, brokers, policyholders, reinsurers and government agencies. BUKOW-TRUMAN: I think really what it depicts is the depth and breadth of the users across the board. Before we start here, Mike, what I want to do is address the divisional split that we have here at A.M. Best. As you can tell there are two folks doing the main presentation. We have Mike Hoppes and we have Andrew Edelsberg. Mike, as I mentioned earlier, is on the business development side. What that means is we handle the beginning stages of a rating in the business development group. We take care of items such as contracts and pricing. We do a lot of the educational work that needs to be done to help folks understand the rating process, what s involved with it, what will happen, etc. Andrew and his group on the ratings side strictly handle the analysis. They take care of all the inner workings, rating dissemination, all of the information that goes into the actual rating. On the ratings side, they don t cross the line with business development. They re not privy to the contract information or fees that we charge companies how we charge them, when we charge them. I think it was fair to note that before you got started, Mike. HOPPES: One of the most frequent questions that we get is how much is it going to cost? Well, with Andrew here I m not going to get into specifics but there are some factors that are taken into account. For established life and health companies, the size and complexity are the biggest factors. For startup companies we will peruse their business plan, focusing on three to five-year admitted asset and/or direct written premium projections. We use admitted assets to gauge the size of life/annuity companies and direct written premium projections for health companies. For established companies we like to see two previously audited year-end financials for all companies. We like to see the organizational chart because, as Andrew will discuss later, we review the parent. For provider-owned HMOs, that includes the hospital or healthcare system. And we also review other risk-bearing entities in the corporate family. BUKOW-TRUMAN: When Mike speaks to the complexity and the corporate structure that is external, not internal. That means any legal entities owned by the ultimate parent, any affiliates. I always like to stress that because sometimes folks think we mean the internal workings and we ll get an org. chart of senior management. HOPPES: Think Schedule Y from the Annual Statement filing. The next step would be to issue a contract. Once I would calculate and quote a fee, the next step would be to send what we call a Rating Services Agreement ( RSA ). Once that s signed and returned along with the fee payment, that s what triggers the analysis. We hand it off to the analytical team and they will contact the company within a few days. That s when they will dialogue with the company to develop their actual agenda, including any off-chart items. The next slide just gives an idea of the timing of the process. Once the RSA is signed and everything has been handed off, the clock starts ticking when the analyst receives all the required data. Our data requirements are on our website and, of course, they can be sent via . If anyone is interested I can send that to you. The timing is typically eight to ten weeks, usually. It s important to note that we try to be flexible with the timing based on the company s needs and their scheduling requirements. BUKOW-TRUMAN: That works in tandem with the analytic schedule as well. That s really where the flexibility comes in because the company meeting needs to be scheduled. You ll hear more about that from Andrew as well, once he delves into the analytic process. HOPPES: Just to touch on the options that you have, once the initial rating has been disseminated by the Ratings division- you can either accept, decline or you have the option to contest or appeal the rating as well. BUKOW-TRUMAN: You ll hear more about that later in the presentation as well. HOPPES: Just one final note. A.M. Best s Business Development team will be happy to address your boards during a meeting via teleconference if need be. BUKOW-TRUMAN: We find that in the initial stage when companies are coming to us to learn about the process, more often than not they have to take the information that they ve gleaned from us and share it with their boards or their C-suite. What we like to do, and actually what companies take advantage of quite often, is when they have board meetings we offer to call in. We ll give a similar presentation to what we re giving now and allow the board to ask questions as well. Many companies have taken advantage of that. It helps them in their decision making process on whether or not they want to go through the rating process or not.

3 HOPPES: I just want to give you a definition- A.M. Best s Ratings are based on historical default rates and they are our opinion as to an insurer s financial strength and ability to meet its ongoing obligations to policyholders. What this chart shows is that an Issuer Credit Rating is assigned to the company first and then is translated into the Financial Strength Rating, which is also assigned. Andrew is going to delve deeper into these factors in a few moments, but briefly, the first two tiers on this pyramid, operating performance and balance sheet strength [the bottom two tiers] are primarily the quantitative part of the analysis. As you move up the pyramid that s when you reach our qualitative factors, which include enterprise risk management, business profile and company management. BUKOW-TRUMAN: So the financial strength portion, which is your balance sheet strength and your operating performance, that s your quantitative piece. Your qualitative piece is all the other informational sources that you have and it s those two pieces together that the analyst uses to make their rating recommendation. HOPPES: Now I m going to hand it off to Andrew who will give a little more detail of the actual rating process. ANDREW EDELSBERG: Thanks, Mike. As Tina mentioned at the outset the purpose of this Webinar is to get you comfortable with the rating process. I m not going to go into great detail with regard to our rating methodologies and criteria. Instead I m going to attempt to enhance your understanding of the interactive process we employ and guide you through the key steps. Best s Credit Ratings are independent opinions regarding the creditworthiness of issuers and securities. They are based on a comprehensive quantitative and qualitative evaluation of a company s balance sheet strength, operating performance and business profile and, where appropriate, the specific nature and details of a security. We employ both a top-down and bottom-up approach. I do want to stress that since our ratings are independent opinions they are not a warranty of a company s financial strength and ability to meet either its obligations to policyholders or its financial obligations. Additionally, a review of the organization s Enterprise Risk Management (ERM) framework is an integral part of the rating analysis and discussions with all rated companies. A.M. Best believes that risk management is the common thread which links balance sheet strength, operating performance and business profile and has always been core to our ratings. Of course, risk management is certainly not new to the insurance industry. What s new is the E in ERM, which represents the development of an enterprise-wide view of risk through which insurers consistently can identify, quantify and manage risk on a more holistic basis. ERM is still a developing discipline. Many insurers have invested substantially to build ERM programs, although others did continue to manage on a silo basis. Clearly not all insurers weathered the crisis equally. We believe those who truly embraced ERM and employ and integrated process fared better. Still, it is safe to say that almost all companies are reviewing their practices to proactively increase transparency, better align capital allocation with potential tail risk and employ a more appropriate approach to setting risk tolerances. I ll complete my remarks with a brief discussion regarding our ratings scale and outlooks. A.M. Best assigns various types of credit ratings, financial strength ratings, issuer credit ratings and debt ratings, to organizations of all different shapes and sizes, from single legal-entity organizations to complex multi-national organizations with diversified insurance and non-insurance operations. Also multiple intermediate holding companies, and they re all under a publicly-traded or privately held ultimate holding company. Our fundamental rating approach with the assignment of any Best s rating is to examine an organization from both the top-down and the bottom-up. As a result, the analysis performed incorporates an assessment of the material sources of risk to the rated entity. The top-down analysis includes the exposure to risk generated by the activities at the parent holding company such as the potential strain on the operating entity from debt servicing requirements related to the parent s borrowings as well as the benefits of earnings diversification that may come from being a member of a diversified organization. For non-rated subsidiaries, A.M. Best performs a detailed internal analysis of their risk profile and the resulting effect on the rated entities within the group, including A.M. Best s judgment as to the exposure of that entity to debt or other borrowings at the holding company level. The bottom-up analysis focuses on an assessment of the risks generated directly by the operations of the rated entity itself as well as any other rated affiliates. For insurers this analysis includes an assessment of underwriting, credit, interest rate, market and other risks at the operating company level. The primary objective of this overall approach is to gain a broad understanding of the potential impact on the current and future balance sheet of the rated operating entity both from its own operations and those of its parent and affiliates in support of the assignment of an issuer credit rating on the rated operating entity, which is referred to as an operating company ICR. As Mike mentioned earlier, the ICR is then translated to the FSR. The foundation of Best s interactive credit rating process is an ongoing dialogue with the rated company s management. Each interactively rated entity is assigned to a primary analyst who is supervised by a team leader. The primary analyst is charged with managing the ongoing relationship with company management and performing the fundamental credit analysis prescribed in our rating criteria. It is the primary analyst s responsibility to monitor the financial and nonfinancial results as well as significant developments for each entity in his/her portfolio. A

4 rating action or review can be considered any time A.M. Best becomes aware of a significant development, regardless of the annual review cycle. Ongoing monitoring and dialogue with management occurs through formal annual rating meetings as well as interim discussions on key trends and emerging issues, as needed. Management meetings afford A.M. Best s analysts the opportunity to review with the company factors that may affect its rating, including strategic goals, financial objectives and management practices. It is during these interactive meetings that a company typically will share information that may be extremely sensitive or proprietary in nature. Lastly, all rating actions are determined by a rating committee made up of the company s lead analyst and team leader, plus a minimum of four members of the Life/ Health ratings division management team. The minimum information required in a Rating Committee package is determined by the Credit Rating Policy Committee. Analytical guidelines are established by the Rating Committee and are designed to generally be consistent across Life, Health and Property/Casualty. BUKOW-TRUMAN: Andrew, do you want to talk a little bit about the voting process? Are you going to get into that a little later? How the vote is done in PRC and why? EDELSBERG: The vote is done in rank order. The analyst will make his or her recommendation, the team leader will vote second and after that it will be based on title. Let s say we typically have seven or nine. We try to have an odd number, although the minimum is six. The analyst and team leader will vote and then the managers, then the assistant vice presidents, then the vice presidents and then the group vice president who is generally the chair. BUKOW-TRUMAN: And it s done in that manner so that no one s vote is swayed by the vote of the hierarchy, if you will. EDELSBERG: Exactly. The next slide is a pictorial presentation of the major aspects of our rating process the five phases being compiling information, performing analysis, determining the ratings, disseminating the ratings and monitoring the ratings. This is an ongoing process as illustrated by the arrow with the core of the process being driven by discussions with the company. Throughout the process, although we employ a team approach, the analyst s role is quite extensive and exhaustive. Once assigned, he or she should always be your first and primary point of contact. The lead analyst will work with you to set up the initial meeting as well as subsequent meetings, which are typically held annually and may be supplemented by conference calls and/or shorter follow-up meetings. Before the annual rating meeting, the lead analyst will review public data and internal A.M. Best data as well as develop an initial assessment of strengths and weaknesses of the organization. A company-specific meeting agenda will be created and provided to the management team well in advance of the meeting so that companies can develop a tailored presentation which covers all the pertinent topics. The next slide is an example of a meeting agenda which I ll get to in a minute. After a productive interactive meeting, we will provide the company with a preliminary timeline to conclude the rating analysis and committee process. We will generally ask for some follow-up information to complete our analysis, which may include information on specific products, financial projections and stress testing results. After the committee arrives at a rating decision, the rating is communicated through a press release. The analyst will also create and update a credit report for each legal entity we rate. Throughout the year there is continuous interaction between the A.M. Best analyst and the rating contact where all relevant information is disclosed to the analyst. Hence it is really important to establish a key rating contact to facilitate the process. This is the agenda I referred to earlier. As the company prepares materials to address the agenda requests, we ask that they include critical company issues, relevant industry issues as well as historical and future company trends. Clearly detailed financial analysis is important not only for A.M. Best to review, but also as a measurement for the level of sophistication in monitoring of the group s own financial performance. How is the company managing its business and what tools does it use for benchmarking, et cetera? It s also helpful to have discussions on products and distribution, especially as the product life cycles have shortened and bells and whistles have increased in use in order to remain competitive. We like to see that companies manage profitability by distribution channel and by product line. Also, business plans and forecasts give us a forward-looking perspective, which is absolutely critical in assessing long-term financial strength. Since the maintenance of a solid balance sheet is so important, detailed discussions of the investment process along with exhibits, investment guidelines and how it fits into the company s ERM framework are key. This ties in certainly with capital management and risk adjusted returns, and duration analysis. So, what kind of information does A.M. Best review? Some believe that A.M. Best only looks at statutory data. Certainly it is key to our bottom-up review and is the financial information that is published in our data products. However, we also review other financial presentations and accounting bases including GAAP, company management reports, embedded value and international accounting standards. Many of these items are requested annually by A.M. Best including audited reports, regulatory filings, the Supplemental Rating Questionnaire, management discussion and analysis and actuarial reserve reports. But I want to stress that the meetings with management are a key source of information. That includes discussions of strategy, reviews of projections, by-line and product earnings, investment guidelines and reinsurance

5 programs. HOPPES: You know, Andrew, one of these terms that we mentioned, Supplemental Rating Questionnaire, I was just wondering if you could explain to the audience what that is. EDELSBERG: Sure. The regulatory filing that companies have to do on a quarterly and annual basis has a lot of detailed information. However, a lot of that information isn t specific by product. It s more general. For example, there s a line of business called ordinary life but it doesn t break it out into traditional whole life or universal life. It talks about individual annuities but it doesn t break it out into fixed annuities or variable annuities. The information that we ask for on an annual basis, the Supplemental Rating Questionnaire, is something that we send out to companies asking them for a little bit more detail, breaking that out so that we can go into deeper detail and with a much finer-toothed comb and really drill into the analysis of the company. BUKOW-TRUMAN: We do get a lot of questions on the business development side about Supplemental Rating Questionnaires, so that s a good point. EDELSBERG: And in addition, I ll talk about it later but our capital adequacy ratio (BCAR) also uses some of that Supplemental Rating Questionnaire information. So it s really important to get a more accurate quantitative view of their capital adequacy using that information. BUKOW-TRUMAN: One other thing I want to mention is that the lists of data items and the meeting agenda is something that you will definitely get when you are just searching about the rating process. When you come in and speak to business development, those are things that we provide to you before you get to the analytic team. This way you re not blindsided. You have a pretty good idea of what s expected by the analysts by the time you get there. EDELSBERG: Now I ll touch on some fundamentals. The fundamentals of assigning an A.M. Best rating are quantified across the three areas: balance sheet strength, operating performance and business profile. Balance sheet strength is the foundation of long-term financial strength and is a key factor in determining whether a company s rating should be secure or vulnerable. Operating performance can contribute to or erode a company s capital position and ultimately policyholder security. Business profile is the most subjective. This is where having analysts that understand a specific market really does help. Business profile represents both qualitative and quantitative core activities that provide a company with a sustainable advantage relative to its competitors. We believe a company needs a defensible business profile to generate sustainable earnings which will enable it to maintain or grow capital and enhance its relative ability to pay policy claims over time. In the rating evaluation, balance sheet strength generally carries the highest weight at any rating level. As the rating level increases towards the Excellent and Superior categories, so does the emphasis on operating performance and business profile. BUKOW-TRUMAN: Andrew, these fundamentals would apply for start-up companies as well, for the most part, correct? I think it s important to mention that we do rate start-up companies off of a business plan and performance, et cetera, and these fundamentals pretty much remain the same whether you have experience behind you or you are a start-up company. EDELSBERG: They do. Of course, for newly established companies you won t have any historical operating performance. However, the balance sheet strength will be evaluated based on how the company is initially capitalized and in what form it is capitalized. The business profile, of course, will largely be due to the experience of the management team and the projected business mix. HOPPES: And we do have a methodology on rating start-up insurance companies, which we can provide upon request as well. EDELSBERG: Let s talk about some of the areas we focus on for balance sheet strength. A key tool in assessing capital sufficiency for each operating company is our risk-adjusted capital model, or BCAR. We also examine the holding company s capital structure, including financial leverage ratios, operating leverage, intangible assets and off-balance-sheet exposure. We do a deep dive into an insurer s investment portfolio to assess the quality and diversification of its assets. This has obviously been an area of high emphasis over the last few years for life insurance companies. We look at the quality and soundness of the organization s reinsurance programs, reserve methodologies and assumptions surrounding these calculations. Given the difficult financial environment, we have also stressed liquidity. We note that most life/health companies moved to cash when markets were frozen, facilitating financial flexibility at a time when accessing capital markets was practically impossible. Our Best s Capital Adequacy Ratio Model, or BCAR, remains the quantitative standard for evaluating rated companies capitalization. It does continue to evolve over time. Although the life/health model is largely proprietary at this point, we do provide updates to the model each year on our website. The model is interactive to allow projections and stress scenarios. Its structure is very similar to the NAIC s risk-based capital formula, which uses statutory data. The data inputs are supplemented by the Supplemental Rating Questionnaire ( SRQ ) data that we ask companies to provide. For minimum capital levels to apply, strong and stable operating results are required. I want to note that more than the absolute ratio itself, the trends in the ratio are key. Moving on to operating performance, A.M. Best looks for managed organic growth, possibly complemented by strategic acquisitions. Diversification and balance

6 between products and business lines typically provides a more stable earnings stream. We note that the costs of compliance as well as regulatory and accounting issues do continue to increase. Scale plays an increasing role in many markets. Ultimately, A.M. Best needs to determine if an insurer s revenue and earnings are sustainable over time. This dovetails well with business profile, which again is an assessment of a company s long-term defensible competitive advantage and market viability. This is the most subjective aspect of the process as there are not many quantitative measures to support an assessment of business profile. However, the importance of business profile does vary with rating levels and is largely determined by the company s mix of business; its competitive market position; and the depth and experience of its management team. BUKOW-TRUMAN: So I guess it s fair to say as a company s rating increases the components to reach the higher level get more and more stringent as well. EDELSBERG: I would agree with that. Business profile becomes more and more important because a company can have a strong balance sheet at a point in time, but our ratings are supposed to be forward looking. So we re looking at sustainable earnings to support that balance sheet and a sustainable, defensible competitive advantage and market position to ensure that those earnings are consistent over time. Franchise value and the experience of the management team really do talk to that. It s hard to measure. It s largely based on our dialogues with companies and what we learn, what we know about the industry itself and the markets that the companies are in. BUKOW-TRUMAN: I think one of the other questions that we get a lot on the business development side has to do with BCAR. The question is always the same: What BCAR score do I need to get an A- rating? So I think that might be an important thing to address, that BCAR scores don t necessarily correlate or don t at all correlate to your final rating. EDELSBERG: Yes. I could touch on that. We have BCAR guidelines and those are really guidelines. I would say it s more to get your foot in the door. Basically, you can t generally be considered for a certain rating unless you have a minimum level of risk-adjusted capital and that s purely on a quantitative basis. Of course on a qualitative basis there are measures of capital adequacy. A company could have a holding company and could issue a lot of debt, push the debt down to the operating company and the operating company can look very highly capitalized. But you have to also take into consideration the leverage at the holding company and the fact that the operating company has to service that debt. So that s one aspect, of course the other aspect being how important the business profile is. Again, over time a company can look good at one point in time because the balance sheet is a point-in-time measure. It s a snapshot in time. An income statement is a period financial statement and that measures how a company did over a certain period of time. And then the business profile will show how sustainable those earnings are. BUKOW-TRUMAN: That is perfect. Again it proves the point that it s two components together qualitative and quantitative. Not one thing makes up the final rating. EDELSBERG: In summary: balance sheet strength, though recognizing that it s a point-in-time measure, is most important. Sustained, stable operating performance ensures future strength. Well-diversified, strong business profile facilitates consistency and profitability; and depth, experience and stability of management influences profile. Some of the key methodologies we employ are listed here on the next slide. Our holding company methodology starts with top-down analysis, hence a consolidated view of the organization. Here we recognize the benefits of diversification and we look at the sources of cash from regulated and non-regulated affiliates. Our group rating methodology establishes guidelines for a stand-alone insurance company rating to receive enhancement from being part of a larger organization. This review can also result in drag to the stand-alone ratings. There are also segment specific methodologies for banks, health-care systems, captives, title insurers, country risk. There s one related to new company formations, which Mike alluded to, as well as issues related to rating debt securities, such as hybrid credit, financial versus operating leverage and rating commercial paper programs. BUKOW-TRUMAN: Of course we have hospital and health care systems as well. EDELSBERG: Yes. The next slide is an illustration of our financial strength rating scale, which many of you are familiar with. It s the traditional scale to measure financial strength ratings. Currently our issuer credit ratings are translated to this scale. So in committee we don t assign a financial strength rating. We ll do it on the issuer credit rating scale and then translate that over such as shown on the earlier slide. Lastly, I just want to explain the difference between a rating outlook and under-review status with regard to ratings. All long-term financial strength ratings and issuer credit ratings have an accompanying outlook, unless they re under review. Rating outlooks can be positive, negative or stable. They re an indication of potential movement in ratings based on current financial and market trends. The timeframe that applies to a specific long-term rating outlook is typically 12 to 36 months. A rating is placed under review when a recent event, abrupt change in financial condition, a pending transaction or other significant event would cause A.M. Best to re-evaluate a rating. The implications for under-review status can be positive, negative or developing. It s usually resolved within six months. Now I ll pass it over to Mike for some final thoughts. HOPPES: I just wanted to give you some key takeaways. There has been some misinformation floating

7 around that we ve heard. Most importantly, which Tina just touched on a few minutes ago, is the untruth that A.M. Best doesn t rate start-up companies. In fact, A.M. Best does rate start-up companies. We have a methodology addressing how we look at a start-up company compared to a company that s been established. And, of course, we did mention some of those key factors a few minutes ago. Also there are no minimum requirements to be rated. BUKOW-TRUMAN: When you say minimum that s size or premium minimum. HOPPES: Correct. Also as we mentioned, we are available to address boards to answer any questions. The rating is interactive. I think Andrew did a good job of describing the relationship between the team leader and the analyst and the company being rated. You do have access to your analyst all year. You re more than welcome to run scenarios by your analyst and get their feedback on how you think making a certain decision might affect the company s rating in the future. Finally, you do have the right to decline a rating initially when you first come on board. You have a couple of outcomes once the analyst communicates the ratings to you. First of all you can accept the rating, fall into the annual cycle and be formally reviewed at least once a year and billed annually. You can appeal the rating by producing new information relative to the review or you can decline altogether. And if the rating is declined it s as if the rating never happened with the exception of paying the fee. BUKOW-TRUMAN: One of the questions that we get quite frequently is what happens if I m already in the process? I m in the annual process for a few years and I no longer need the rating or I need to come out of that process. What would happen at that point? Andrew, would you want to address how that works? If a company does withdraw they would do it via the analyst so maybe it s best if you address that? EDELSBERG: What we would do is make a final rating determination. We would bring our rating to the rating committee, make a final determination and then we would publicly disseminate that final rating determination. Once that is disseminated, at the same time we would then withdraw the rating and move it to an NR (not rated) issuer credit rating or an NR-4 financial strength rating. NR-4 is just the category for withdrawing the ratings based upon the company s request. BUKOW-TRUMAN: Another question has come in and that is how do you look at health insurers compared to life insurers? I guess what are some of the finer differences between them? EDELSBERG: Well, we have specialists that follow the health companies. We have a health team and we have a life and annuities team. The people that follow that company would know those markets specifically. Health insurance is a bit different from life insurance in that it has shorter tail liabilities, it s annually renewable in some cases and the managing of that product is highly dependent on each of the states and the ability to potentially get rate increases in those specific markets. Life and annuity business is generally consistent on a state-to-state basis, although all insurance companies obviously are state regulated. HOPPES: While we re talking about niche markets, one of the questions that I frequently get is how do we view certain types of companies, like an HMO, that is a not-for-profit? Do they have the same chance of getting an A rating as a for-profit company? EDELSBERG: Yes. Whether you are a small company or a large company, a not-for-profit or for- profit, stock or mutual- they all go through the same process. We look at that particular company relative to its peers. So you re not generally going to look at a large nationwide mutual company and how that compares to a small, not-for-profit, one-state company. Even though they go through the same process, the ratings are relative, and they re not peers. We do extensive peer analysis to make sure that the relative ratings make sense. There s no cap on ratings for smaller companies or for not-for-profits. But looking at those ratios you have to understand that not-for-profits obviously are not in the business to generate earnings, consistently strong earnings. So we have to recognize that. Another example, let s say you have a mutual company that s largely participating policies. They have policyholder dividends. We look at operating income of a mutual company before dividends because dividends are part of the product that are built in to the product. Comparing that to a stock company s profitability, you have to add dividends back to look at it more on an apples to apples basis. It s important how the portfolios are aligned. Our analysts and our team leaders have lots of experience looking at peers and being comfortable with assessing companies with different structures in various markets. BUKOW-TRUMAN: That s actually one of the major benefits of the peer rating committee. Andrew talked about the committee earlier; committee is made up of folks from every segment from every market. So there are analysts from the property/casualty market, from personal lines. On the life/health side there are folks from each industry within life/health so that really nothing is missed. EDELSBERG: There aren t a lot of pure companies. A lot of the companies are diversified organizations. Some of the large life insurance companies are also companies that are leading companies in some of the health product markets, for instance long term care. The top three companies in long-term-care are life and annuity companies. You have to make sure you have the right people at the table. As you said, Tina, in committee we have the head of our group, Ken Frino, who has experience on both the health and the life and annuities side. Then you have other people who have experience on both the life side and the health side to make sure that we have a full understanding and discussion of the product lines and the relative profitability in each of those lines.

8 BUKOW-TRUMAN: One last note I did want to make is that we will be sending a post-webinar to everyone that has registered and we will be including the slide deck in that . So everyone will have a copy of the slides. I want to thank everyone for joining us. I want to thank Mike and Andrew. I think we covered the inner workings broadly and well enough so that everyone has a good sense of what the rating process is all about. Actually, I think we have three more questions that just popped in. HOPPES: I just want you to know while Tina is reviewing the questions, that we will make the recorded version of this presentation available at the same link, So that s where you will able to access this. We ll send out the PDF version of the slides but you can also access the recorded version there as well. EDELSBERG: Someone asked, how is your rating different from the other rating agencies ratings? This is a good question for me to answer because before I came to A.M. Best I was actually at one of the other major rating agencies. I would say the process is largely similar. The big difference is that we cover the entire insurance industry. We rate the largest companies as well as the smaller companies. We have a more detailed understanding of the different segments the companies participate in because we look at detail at those smaller companies and smaller markets. In addition, the insurance business is largely the only business that we re in. We do have a couple of initiatives with regard to banking and hospitals, et cetera, but for the most part our franchises are life/health ratings and our property/casualty ratings. We ve been in the business 110 years. We have that depth of data, we have that depth of experience. We have a structured finance group that looks at securities linked to insurance obligations. BUKOW-TRUMAN: I have one more question. What macro-economic variables do you take into account for health, such as potential for adverse selection due to high unemployment rates? For example, an increase in COBRA participants. EDELSBERG: Obviously in the current marketplace healthcare reform is going to impact health companies substantially going forward. Any of the specific intricacies that impacts a company, whether it be the economic environment, the regulatory environment, whatever, are all introduced into the rating process. Just like on the life side with regard to what happened in the credit markets where credit spreads widened significantly and there wasn t a market for a lot of the securities they owned. There was a lot of concern that there was limited liquidity in the marketplace and therefore if a lot of the annuity holders were to surrender, that some of these companies would be in trouble. However, we looked deep into these companies. We adjusted their ratings where we needed to and there weren t any material companies that had specific liquidity issues during the financial crisis. We did have to reduce some ratings or to assign negative outlooks to some based on exposure but fortunately there really hasn t been a significant amount of financially impaired companies on the life/health side that ticked up during the financial crisis. BUKOW-TRUMAN: I think that concludes our webinar. No more questions have come in. I hope we ve addressed everything. If we did miss a question we will be certain to address it when we send the post so that we don t miss anything. Okay. Thank you very much for your time everyone. Have a great afternoon and please use the contact information on the screen. If you have any questions feel free to contact Mike Hoppes if you have any business-development type questions or anything technical you can certainly address to Andrew Edelsberg. Thanks so much for your time. Note: we did not get to answer the following question due to time constraints: Q: When you rate HMOs are you looking at NCQA data? A: When we rate HMOs, we use NAIC or DMHC statements (in California) for a large part of our financial evaluation. We do look at NCQA/HEDIS data, when provided, as part of our qualitative analysis. However, NCQA data is not a requirement of the rating process. The Financial Strength Rating opinion addresses the relative ability of an insurer to meet its ongoing insurance obligations. The ratings are not assigned to specific insurance policies or contracts and do not address any other risk, including, but not limited to, an insurer s claims-payment policies or procedures; the ability of the insurer to dispute or deny claims payment on grounds of misrepresentation or fraud; or any specific liability contractually borne by the policy or contract holder. A Financial Strength Rating is not a recommendation to purchase, hold or terminate any insurance policy, contract or any other financial obligation issued by an insurer, nor does it address the suitability of any particular policy or contract for a specific purpose or purchaser. In arriving at a rating decision, A.M. Best relies on third-party audited financial data and/or other information provided to it. While this information is believed to be reliable, A.M. Best does not independently verify the accuracy or reliability of the information. For additional details, see A.M. Best s Terms of Use at Copyright 2010 by A.M. Best Company, Inc. All rights reserved. No part of this report may be reproduced, stored in a retrieval system or transmitted in any form or by any means; electronic, mechanical, photocopying, recording or otherwise.