A.M. Best Ratings Outlooks and Financial Strength Ratings Changes

The assessment of an insurer’s ability to pay future claims often relies in part on the use of financial strength ratings (FSRs), which offer insight into the risk of insurer insolvency. In order to communicate the potential for future changes to FSRs, ratings organizations often supplement these ratings with outlooks. While these outlooks should be of great interest to various stakeholders, very limited research exists examining whether outlooks actually predict future changes in ratings and thus serve as additional sources of information that could be used when assessing insurers. In this study we examine the predictive power of A.M. Best ratings outlooks on future changes to FSRs. Our results suggest that ratings outlooks do provide valuable information and that both prior years’ outlooks and changes in prior years’ outlooks are useful in predicting future ratings changes. Our results also indicate that following an outlook change, the probability of an FSR change diminishes over time. Finally, we show that while outlooks do provide valuable information, investors do not appear to respond to changes in outlooks. Our findings imply that ratings outlooks should be given greater consideration by consumers, investors, insurance intermediaries, and regulators when evaluating insurers as they do provide valuable insight into the future direction of the firm’s financial strength rating.