What it means
The agency has been rating insurance companies since the end of the nineteenth century, and that narrow focus is the point of it. Where general purpose agencies rate governments, banks and corporates, AM Best concentrates on insurers, reinsurers and the structures around them.
The result is a methodology built specifically around reserves, reinsurance programmes and the way insurance losses actually behave. Two ratings do most of the work.
The Financial Strength Rating is an opinion on an insurer's ability to meet its obligations to policyholders, while the Issuer Credit Rating is an opinion on its ability to meet senior financial obligations generally, which is closer to a conventional credit rating. A rating is paired with an outlook and can be placed under review when something material happens.
The letter scale is grouped into descriptive categories. A++ and A+ are labelled Superior, A and A- are Excellent, B++ and B+ are Good, and the scale continues down through Fair, Marginal, Weak and Poor, with further categories for insurers that are under regulatory supervision, in liquidation or whose rating has been suspended.
Most buyers in practice set a floor of A- and will not place cover below it. Underneath the letter sits a capital model known as Best's Capital Adequacy Ratio, usually shortened to BCAR.
It compares the capital an insurer actually has with the capital it would need to absorb losses at several levels of severity, and the results at the harsher confidence levels drive the balance sheet strength assessment. A strong BCAR does not by itself produce a high rating, because the agency also weighs operating performance, business profile and enterprise risk management.
For a business buying insurance rather than selling it, these ratings carry contractual weight. Lenders, landlords and large customers routinely require cover to be placed with an insurer rated at or above a stated level, and a downgrade can oblige a company to move its policies mid-term.
Finance teams therefore check the rating of the insurer, not only the price of the premium.
In practice
Real-world examples.
Example
A logistics company signs a warehouse lease requiring all property cover to be placed with an insurer rated A- or better. When its existing insurer is downgraded to B++, the broker is instructed to remarket the policy at renewal to stay compliant with the lease.
Example
A captive insurer set up by a mining group seeks its first rating so that it can write cover directly for group subsidiaries. The agency focuses on the strength of the parent, the quality of the reinsurance programme and the capital held, and assigns a rating in the Excellent category with a stable outlook.
Example
A pension scheme buying a bulk annuity compares three providers on price and on financial strength. The cheapest quote comes from the lowest rated insurer, and the trustees document their decision to pay around 2% more for a provider rated in the Superior category, because the obligation lasts for decades.
Formula
Calculation
Best's Capital Adequacy Ratio = (available capital - net required capital) / available capital, expressed as a percentage.
Suppose an insurer reports available capital of $500,000,000 and, at the harshest confidence level in the model, net required capital of $350,000,000.
Available capital - net required capital = $500,000,000 - $350,000,000 = $150,000,000.
BCAR = $150,000,000 / $500,000,000 = 0.30, or 30%.
A positive result means capital exceeds the modelled requirement at that severity, and a larger percentage indicates more cushion. If the same insurer wrote more business and net required capital rose to $425,000,000, the ratio would fall to ($500,000,000 - $425,000,000) / $500,000,000 = 15%, which is exactly the kind of drift that prompts a review.Case study
Seen in the real world.
Stonegate Mutual is an invented insurer used purely for this illustrative example. It wrote regional commercial property cover, held a rating in the Excellent category, and grew premiums by nearly 40% in two years by cutting prices to win market share.
Growth consumed capital faster than profits replaced it, and two severe storm seasons exhausted the reinsurance layer the insurer had bought. Its capital adequacy result at the harsher confidence levels fell sharply, the agency placed the rating under review with negative implications, and three large brokers immediately paused new placements because their own panels required a minimum rating. Premium income fell before any downgrade was even published.
In this fictional story Stonegate stabilised by raising $120,000,000 of surplus notes, buying a higher reinsurance limit and withdrawing from its two most exposed coastal counties. The rating was confirmed, but the episode showed how quickly a rating question becomes a revenue question for an insurer.
Watch out
Common mistakes.
- Reading an AM Best letter as though it were on the same scale as a general corporate credit rating, when A++ is the top grade here rather than the triple-A used elsewhere.
- Checking the rating once at inception and never again, even though ratings are reviewed at least annually and can change mid-policy.
- Assuming a Financial Strength Rating covers every entity in an insurance group, when ratings are assigned to specific legal entities and a subsidiary can differ from its parent.
Questions
People also ask.
Why is the name sometimes written with full stops between the letters?
The business has used more than one styling over its long history, and the current form of the name is AM Best.
Does a high rating mean claims will always be paid quickly?
It speaks to financial ability rather than service quality, so claims handling reputation still needs to be assessed separately.
Is an insurance rating relevant to a company that only buys cover?
Very much so, because contracts and lenders often specify a minimum rating, and a failed insurer leaves the policyholder carrying the loss.
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