THE MONITORING PROCESS

(March 2023)

A troubled insurance company’s fate can vary wildly. In most instances, an insurer remains viable for many years. When change comes, it may more likely merge with another insurer or be purchased by a larger company. The norm (and desired situation) is that being placed into receivership is a rarity.

If things are working properly, an insurance company’s performance is watched by, typically, a given state’s insurance regulatory body. In the course of monitoring, an insurer’s weakened position should be identified and corrected.

In general, the process a state goes through with monitoring property and casualty insurers involves the following:

• Collecting annual financial statements from all insurers
• Examining the information and, using some selection basis, running key information through a set of financial tests
• Evaluating information on insurers with financial statements that raise warning signals
• Performing audits on selected companies
• Depending upon audit results:

- Letting the company operate as usual (if audit results are positive)

- Creating a program of corrective action (typically requiring quarterly or monthly, rather than annual, financial reports)

- Following up on corrective action

- If the situation deteriorates, considering more drastic action

• Placing company under conservatorship
• Attempting rehabilitation (if conservatorship does not work or if rehab is selected instead)
• If rehabilitation fails, consider finding the company insolvent
• If applicable, issuing a Final Order of Liquidation
• Liquidating the insurer’s assets and using this to fund insurer’s obligations
• Collecting assessments to fund any shortfall

Here is how a situation may appear:

Monitoring Tools

As already mentioned, state regulators receive insurer financial statements each year. These statements are routinely evaluated against a set of tests. One test standard is the Insurance Regulatory Information System (IRIS) ratios. It consists of 11 (P&C insurers) or 12 (Life insurers) ratios that can be calculated using any insurer’s financial statement data. The ratio results can be compared to established benchmarks that may indicate financial problems. The ratios are:

IRIS Ratios
Ratio	Explanation
Net Premiums Written/Policyholders Surplus	Annual Net Premiums divided by that insurer’s policyholder surplus. Typically, a flag is raised when ratio exceeds 3.00.
Change in Net Premiums Written (NPW)	The change in NP written in the latest year divided by the annual net premium amount from the previous year.
Surplus Aid/Policyholders Surplus	(Ceded Reinsurance Commissions divided by Ceded Reinsurance Premiums) x Unearned Prem. For reinsurance ceded to non-affiliated companies
Two-Year Operating Ratio	Sum of loss ratio and expense ratio, less the net investment ratio measured over two years
Investment Yield	Annual Net Investment Income multiplied by two, divided by the annual average of cash and invested assets.
Percent Change in Policyholders Surplus	The change, expressed as a percentage, between an insurer’s current and previous year’s surplus
Liabilities/Liquid Assets	Total Net Liabilities divided by Total Net Liquid (cash and near cash) assets
Agents’ Balances/Policyholders Surplus	Balance owed by agents (being collected) divided by policyholder surplus
One-Year Reserve Development/Policyholders Surplus	Outstanding Incurred Loss Estimate (minus current year info.) divided by policyholder surplus
Two-Year Reserve Development/Policyholders Surplus	Outstanding Incurred Loss Estimate (minus last two years’ info.) divided by policyholder surplus
Current Estimated Reserve Deficiency/Policyholders Surplus	Current reserve estimate minus actual reserves reported
Gross Premiums Written/Policyholders Surplus	Total of Written premium from business that is written directly as well as from reinsurance issued by affiliates and non-affiliates.

Generally, failure to meet benchmarks of four or more ratios is an indicator that the applicable insurer may be having financial problems. Corrective action then takes place, such as more frequently reporting and evaluating subsequent financial data and/or insurance audits.

Related Article: Monitoring Insolvencies – Risk Based Capital