"Trust but verify" is a good business practice to use on this subject.
Insurance companies and bonding companies have good and bad financial results year-to- year like any other enterprise. The financial ratings or measure of solvency of your insurance company is something in which you should have an interest.
Contractors purchase and maintain insurance to satisfy contract requirements, to protect the assets of their business from weather-related damages, to cover financial damage from lawsuits and to comply with state laws such as workers' compensation for employees.
Contract owners oftentimes will specify a particular financial rating as a minimum acceptable standard for the contractor's insurance or bonding company.
The insurance and bonding industry is regulated and monitored at the state level, typically by an insurance commissioner appointed to ensure that those companies that desire to conduct business in that state are licensed and financially sound.
This financial evaluation of these insurance companies is ongoing and for the protection of policyholders (insureds) and claimants alike.
Insurance companies have some flexibility as to whether they will conduct business in a state, either on an "admitted" or on a "non-admitted" basis. The distinction for the insurance buyer between the two, essentially is the degree of scrutiny the insurance regulator performs regarding the insurance policies in terms of coverage forms (what's covered, what's excluded, definitions, terms and conditions) and the rating (pricing) plans for determining those policies' premium cost to the insurance buyer.
Additionally, "admitted" companies provide claimants a "safety net" in the form of a state guaranty fund (in some states) for claim payments (in some minimum amount) for insureds whose insurance companies go into receivorship or bankruptcy. Insurance companies that are classified "non-admitted," also known as "surplus lines" companies, do not receive the protection of these state guaranty funds.
It is a common industry practice for an insurance agent to specify in their insurance proposals to the insurance buyer whether the insurance company is an admitted or non-admitted status placement. There are additional taxes to be incurred when your insurance company is a non-admitted or surplus lines company.
Construction business owners who purchase insurance and bonds, or who enter into contracts with subcontractors need to ascertain the financial viability of their insurers or of their subcontracting partners.
The financial failure of an insurer can be a devastating event that can occur with extraordinary speed. The financial collapse of the Enron Corporation has been duplicated by a number of well-known insurance companies in recent years, i.e., the Reliance Insurance Company and the Home Insurance Company both of which had their A++ (Excellent) ratings decline to B (Fair), then C (Weak), further to D (Poor), on to E (Under Regulatory Supervision) and ultimately to F (Liquidation).
Having your insurer fall from an A rating to a C status could trigger a breach of contract. The loss of a contract, due to a downgrade in its financial condition, could pale by comparison, with your insurer being declared insolvent. Your company's assets are suddenly at direct risk of financial attack from claimants or plaintiff's attorneys.
Your due diligence on the financial worthiness of your insurance carrier can be obtained from at least six separate credit rating organizations. These organizations are private companies, not government agencies, who scrutinize the insurance companies' financial statements, which are required to be filed with the state insurance regulators. In addition to the review of the financial reports, these credit review analysts also review state examination reports, loss reserve reports prepared by actuaries (which determine the adequacy of declared claims or liabilities owed by the insurers), reports filed in annual reports to stockholders and policyholders, and finally, those financial reports that are filed with the Securities and Exchange Commission for publicly-traded insurance companies.
The credit ratings established by these credit service organizations are available by subscription, or you can engage your agent or broker to research these ratings through their resources.
Contract owners will rarely accept an insurer whose financial strength is less than a B+ and a financial size of less than a VII, which is a net worth of $50 million to $100 million.
For your own protection, contractors should not insure their operations with insurance companies or accept certificates of insurance from subcontractors with ratings less than those previously stated, or an equivalent rating from another credit rating organization.
The other credit rating services in addition to A. M. Best Company Inc. include the following:
- Dun & Bradstreet
- Fitch Ratings
- Moody's Investor Services
- Standard & Poors (S&P)
- Weiss Ratings Inc
Now that you are "armed" with this information regarding ratings, how does this information help you make better business decisions? Consider a couple of best practice initiatives in your use of ratings as a barometer of how well your insurance company is performing and the impact it could have on certain provisions in the contracts you execute.
Refer to the insurance clause or section in your current contract specifications. These clauses can contain problematic issues as regards a mi- term downgrade of an insurer's rating and a resulting mid term cancellation or replacement of coverage due to the minimum financial rating not being met. You might consider an insurance provision that gives the other party to the contract the right to reject an insurer that it deems unacceptable because of poor financial condition or because it is not operating legally. This provides some element of control, while preserving flexibility and not triggering an arbitrary default under this contract provision.
If your other party insists on specifying a minimum rating, a fallback alternative is to have the clause state that the insurer must meet the criterion only on the inception date of the applicable policy. This could avoid being forced into a mid-term cancellation following a downgrade.
You might ask, "How often do downgrades in ratings occur?" One of the rating services, S&P, has historically monitored the number of insurance companies that have received downgrades in their ratings over a five-year period. In 2002, the number of downgrades peaked with 648 insurance companies receiving lower ratings than the year prior. That reflected the impact of the World Trade Center losses on the financial results of the insurance industry and the companies that comprise it.
In 2005, the S&P issued more upgrades than downgrades of insurance companies in the sector for the first time in five years. The industry average for the number of ratings downgrades over the past five years is in the range of 250 to 500 insurance companies receiving downgrades per year.
In addition to determining your insurance company's financial condition, and rating, you should also be aware that your bonding company is subject to the same scrutiny and evaluation-both at the state and federal level.
If you are bonding a federal government project, your surety company has to limit its single project bond capacity to a declared limit established in the U.S. Treasury listing publication known as the Circular 570. This publication is the responsibility of the U.S. Treasury department bureau known as the Financial Management Services (FMS). On July 1 of each year, the Congressional Federal Register publishes and distributes this list of approved companies and their single project bonding capacity.
Like the privately-owned credit organizations, the FMS monitors and reviews the financial status of the surety companies that are authorized to provide bonds for federal projects. This information can be obtained at the FMS website, http://fms.treas.gov/c570.
If federally-funded contracts are a mainstay of the work you pursue, it would be prudent to verify annually that your bonding company can satisfy this government-imposed requirement. In your annual bond meeting with your surety company and bonding agent, this should certainly be an item on your meeting agenda.
In summary, you should at a minimum know the financial ratings of the insurance and bonding companies you are obtaining bonds and insurance from. Your expectation is that they will be around in the future to pay claims incurred by your operations. Additionally, you should monitor the ratings of your subcontractor's insurance providers since they contractually obligate themselves and their insurers to hold you harmless for events caused by their negligence. You would like your subcontractor's insurance companies to respond for claims incurred on your projects, otherwise, it could in all likelihood flow back to your policies and impact your business and your insurers as well.
Construction Business Owner, June 2006
