AM Best Downgrades CEA FSR to B++

AM Best, a US Ratings Agency has downgraded the California Earthquake Authority Financial Strength Rating to B++. A B++ Rating is considered “Good.” The CEA’s rating before the downgrade was an A-. This rating is dated as of January 18th, 2023. An A- rating is considered “Excellent.” This is bad news all around.

CEA Former FSR: A-

CEA New FSR: B++

More Information about the 2023 CEA Downgrade:

In a press release, AM Best states: “The rating downgrades are based on the deterioration of CEA’s balance sheet strength over the past year due to a decline in risk-adjusted capitalization as measured by Best’s Capital Adequacy Ratio (BCAR). ” In addition the FSR downgrade, AM Best downgraded their “Long-Term Issuer Credit Rating (Long-Term ICR) to “bbb+”” [Please note that this article will mostly discuss the FSR and not the ICR.]

Best’s Capital Adequacy Ratio could be loosely defined as “an integrated review of a…. composite insurer’s underwriting, financial performance and asset leverage.” Source- AM Best.

AM Best … downgraded the California Earthquake Authority Financial Strength Rating to B++

Additionally the press release states: “The decline in risk-adjusted capitalization was driven by a reduction in CEA’s claims-paying capacity to a modeled 1-in-360-year return period as of Jan. 1, 2023, from a modeled 1-in-400-year return period ….” This “reduction in claims-paying capacity was attributable to the impact of market conditions, which included continued increases in exposure and most recently, reduced reinsurance availability.” The move from a 1 in 360 from a 1 in 400 is considered a less severe earthquake. In other words a Once in a 400 year event is less common than a Once in 360 year event. This may mean that the CEA could/would be unable to deal, now with a Once in a 400 year event.

Best also notes a word of caution “the ultimate effectiveness of these efforts and their impact on its risk-adjusted capitalization and balance sheet strength remain uncertain.”

In March of 2022 – Fitch took ratings action on the CEA from an A to an A-.

Why did AM Best downgrade the CEA?

AM Best’s own press release simply states that the their claims paying capacity was reduced from a 1 in 360 year event to a 1 in 400 year event. They note the impact of market conditions and the insurance market and something called Reinsurance.

Reinsurance, simply stated is insurance for insurers. Many consumers are unaware that this type of insurance product is even out there, and it is. It has been stated that the CEA may be one of the largest purchasers of reinsurance in the world.

Global Property property catastrophe reinsurance rates increased by 37 percent

In recent years, most insurance companies have experienced increased reinsurance costs. McKinsey states that “Global property catastrophe reinsurance rates increased by 37 percent in January 2023 renewals—representing the largest increase since 1992.” These rate increases are creating havoc throughout the personal and commercial insurance markets. This problem is not exclusive the earthquake insurance market nor the CEA. For the California record the increased reinsurance premiums are one reason that the home insurance market is struggling with wildfire risk.

Reinsurance premiums are typically renewed annually and are often referred to as a Treaty. There are three main types of reinsurance forms available in the open market.

Has the CEA Crossed the Ratings Rubicon with this Downgrade?

This part of the post is more opinion, just to be super clear. In property insurance insurers that have a rating of an A- or less are often considered subpar. Some governmental agencies themselves require financial ratings of A- or better. [And a B++ is below that threashold.] In liablity insurance it is common for Personal Umbrella Insurers to require that the underlying policy is rated better than B++.

A B++ rating is a problem in our opinion. Certainly the CEA is aware of this and they are likely doing all they can to change the situation. In their defense they deal with a specific Catastrophic risk in a rather tight geographical area. They are at the mercy of the reinsuance market. They are also, plausibly the victims of their own success. When they entered the EQ Market in California years ago, it was because their was no other solution. Now they have a million homes insured.

The saving grace though for the CEA is the lack of other options. Yes there are Alternatives to the CEA, we have noted that many times here. However these other insurers have a more limited underwriting criteria, in our opinion. And the CEA is the base of the CEA Partnership program that allows home insurers to offer the required EQ offer. At the present moment, no other independent insurer seems interested in offering so many homes millions of Earthquake offers. The CEA is built by a State Insurance Regulation in 1996,

But none of this changes the fact that the largest earthquake insurer in the US has a less than optimal financial strength rating. This could have repurcussions for the future. During future underwriting or pricing model reviews. After a large scale event. What happens if the CEA can’t pay all of its claims? We may discuss that in a future discussion, so check back later.

In summation the downgrading of the CEA financial strength rating is going to be a real challenge moving forward. Consumers may wish to reshop their EQ property policies. Although we hope it does not, it may have a negative impact on consumers purchase quake insurance.

What is a Financial Strength Rating?

AM Best and other rating agencies essentially have three main rating methods with regards to insurers. The Financial Strenght Rating [FSR], The Policyholder Surplus Size [PHS], and the Long-Term Issuer Credit Rating [ICR]. In general the FSR is the most prominient for consumers to be concerned with. The ICR is more related to lendors, not consumers.

Best defines a Financial Strength Rating as “an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contract obligations” An FSR is distinct and different from other types of financial ratings such as the ICR. FSRs are related though to insurers. Other non insurance companies do not have financial strength ratings.

Several of ther rating agencies such as Moodys have their own version of Financial Strength Rating. AM Best though is one of the only rating agencies to specialize in Insurance ratings and is hence the most commonly cited Insurance rater.

Who is the CEA?

The California Earthquake Authority is likley the largest earthquake insurer in the United States. According to their own data the CEA insures over 1.068 Million households. The CEA is based in Sacramento California and ONLY provides Earthquake Insurance through their Partner program alongside participating home insurers. The California Earthquake Authority provides earthquake protection for homeowners, renters, and condo owners through select insurers.

What is a Downgrade?

A downgrade is when a rating goes lower. From a higher grade to a lower grade. Downgrades and Upgrades are usually shared via Press Releases. Typically rating agencies will provide a basis for reasoning as to their decision. To be clear downgrades, upgrades, and ratings are simply “opinions” and should not be considered as fact. Downgrades are almost always considered bad news.

AM Best CEA Press Release here: https://news.ambest.com/presscontent.aspx?altsrc=9&RefNum=32967&URatingId=2239056&_ga=2.23515258.1158084277.1677090833-480448344.1675802871&_gl=117nr7fg_gaNDgwNDQ4MzQ0LjE2NzU4MDI4NzE._ga_VNWYD5N5NL*MTY3NzE3NjcwNS40LjEuMTY3NzE3NjczMi4wLjAuMA. These press releases are notoriously difficult to link to. Please try pasting this into your browser to pull it up for further information.

CEA Downgrade – 2023 CEA Downgrade