OLDWICK, N.J.–(BUSINESS WIRE)–AM Best analysis of the U.S. life/annuity (L/A) industry under the rating agency’s Best’s Credit Rating Methodology highlights how volatility has a significant impact on a L/A company’s balance sheet strength and operating performance, the first two building blocks in AM Best’s ratings process.

The new Best’s Special Report, “Life/Annuity Benchmarking: Higher-Rated Companies Better Able to Withstand Volatility,” also shows how adequate and stable levels of capitalization are relevant to the strength of a company’s balance sheet. A high ratio of capital and surplus (C&S) to liabilities implies that the rating unit has a lot more capital cushion to absorb during periods of stress. Higher-assessed companies also are able to grow surplus more quickly than rating units with a weaker assessment.

AM Best uses a variety of benchmarking techniques to view companies from different perspectives and angles, allowing for comparisons of absolute results and volatility levels across the industry. The primary quantitative tool used to evaluate balance sheet strength is Best’s Capital Adequacy Ratio (BCAR); however, AM Best takes all of the balance sheet components into consideration, as the BCAR itself is not the sole determinant of the balance sheet strength assessment.

As highlighted in the report, the balance sheet strength assessments of a little more than half the rating units are equal to their BCAR assessments. Meanwhile, the balance sheet strength assessments of 43% of entities are lower than their BCAR assessment, reflecting significant drag from components of the balance sheet strength other than the BCAR score, or from a relatively weaker parent organization.

Along with balance sheet strength, the key pillars AM Best uses in its credit analysis are operating performance, business profile and enterprise risk management (ERM). Operating performance in particular is a leading indicator of future balance sheet strength and long-term financial stability, as AM Best assesses the ability of an insurer to generate consistent earnings over time. Companies with an operating performance assessment of marginal or weak reported negative returns over the last 20 years and higher volatility. The combination of anemic returns and greater volatility can act as a drag on ratings. Additionally, companies assessed lower on the operating performance scale have reported an operating loss in a significantly higher number of years than more favorably assessed companies, including an average of nine out of 20 years for companies with an operating performance assessment of weak.

L/A insurers have multiple product lines and business segments, and each business line has a different risk profile and capital requirements, and hence a different target rate of return. Volatility occurs at all levels, but AM Best is primarily concerned with the downside risk volatility seen at weaker rating units, given the negative impact such volatility can have on C&S and overall financial strength.

To access the full copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=308915.

AM Best is a global credit rating agency, news publisher and data analytics provider specializing in the insurance industry. Headquartered in the United States, the company does business in over 100 countries with regional offices in London, Amsterdam, Dubai, Hong Kong, Singapore and Mexico City. For more information, visit www.ambest.com.

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