Executive Summary
The Determinants of Credit Ratings in the United Kingdom
Insurance Industry
Academic researchers have devoted a considerable amount of attention to the activities of
credit rating agencies over the past 20 years, focusing in particular on the agencies’ potential role
in overseeing corporate financial strength and promoting the efficient operation of financial
markets. Examinations of credit rating practices has recently extended to the insurance industry,
where the complex technical nature of market transactions leads to policyholders, investors and
others facing particularly acute information asymmetries at the point-of-sale. Published credit
ratings are therefore seen as helping to alleviate imperfections in insurance markets by providing a
third party opinion on the adequacy of an insurer’s financial health and the likelihood of it meeting
obligations to policyholders and others in the future. Although the United Kingdom (UK)
insurance market is now one of the five largest in the world, relatively little is known about the
practices of the major firms and policy-makers which influence its operations. In particular, whilst
the determinants of rating agencies’ assessments of United States (US) insurers is well
documented, published studies have yet to provide comprehensive evidence about insurance
company ratings in the UK. This study attempts to fill this gap by examining the ratings awarded
by two of the world’s leading agencies – A.M. Best and Standard and Poor (S&P) – and
establishing the extent to which organizational variables can help predict: (i) insurance firms’
decision to be rated; and (ii) the assigned ratings themselves.
Our sample of UK data comprises ratings made by A.M. Best and S&P over the period
1993-1997 for both life and property-liability insurers. The panel data we use is ordinal in nature
and is therefore analysed using an ordered probit model. However, because neither A.M. Best or
S&P rate the full population of UK insurance firms our data set is potentially subject to selfselection
bias and we therefore extend the model to correct for such problems. In particular, the
paper examines the effect of eight firm-specific variables (namely, capital adequacy, profitability,
liquidity, growth, size, mutual/stockowner status, reinsurance level, and short/long-term nature of
business) on the ratings awarded by the two agencies, as well as on insurance firms’ decisions to
volunteer for the ratings in the first place.
In general terms, our evidence concurs with earlier US findings, and suggests that
although the decision to be rated by either of the agencies is largely influenced by a common set
of factors, the determinants of the ratings themselves appear to differ. Specifically, our first main
finding is that insurers’ decisions to be rated by either A.M. Best or S&P is positively related to
surplus growth, profitability and leverage. Second, while we find that A.M. Best’s ratings are
positively linked to profitability and liquidity, as well as being generally higher for mutual insurers,
the findings for S&P differ substantially. Although liquidity again exerted a positive influence on
assigned ratings, the only other statistically significant variable was financial leverage, which had a
negative sign.
We believe that the results of our research are of potential importance for companies
operating in insurance markets as well as for policy-makers, brokers and others. For example, the
evidence that mutual insurers are generally assigned higher ratings than stock insurers suggests
that certain publicly-traded insurers, in particular new entrants, might not possess sound financial
strength and may require closer regulatory scrutiny than other, more established, insurance firms.
In addition, the finding that liquidity has a significantly positive effect on ratings assigned by two
of the world’s leading credit agencies should provide a measure of confidence about the
robustness of the ratings to industry regulators, policyholders and investors in the UK. This could
imply that external ratings might eventually play a role in substituting for costly industry
regulation. The study concludes that although the factors influencing the decision to be rated by
A.M. Best or S&P are broadly the same, a degree of variability exists in the variables which
influence the actual ratings themselves. Insurance company managers should be aware of this
when contemplating whether to seek an independent rating and which agency to choose for the
assessment. We therefore believe that this study fills an important gap in the literature about key
players in the important UK insurance market and provides a basis for the conduct of future
research