Evaluating financial performance of insurance companies using rating transition matrices

Abstract

Financial performance of insurance companies is captured by changes in rating grades. An insurer is susceptible to a rating transition which is a signal depicting current financial conditions. We employ Rating Transition Matrices (RTM) to analyse these transitions. Within this context, credit quality can either improve, remain stable or deteriorate as reflected by a rating upgrade or downgrade. We investigate rating trends and forecast rating transitions for UK insurers. We also provide insights into the effects of the global financial crisis on financial performance of UK insurance companies, as reflected by rating changes. Our analysis shows a significant degree of rating changes, as reflected by rating fluctuations in rating matrices. We conclude that insurers with higher (better) rating grades depict rating stability over the long-run. An unexpected but interested finding shows that insurers with good rating grades are nevertheless susceptible to rating fluctuations. General insurers are more likely to be rated and they demonstrate higher levels of rating grade variations over the period studied. Using comparative rating transition matrices, we find more variations in rating movements in the post-financial crisis period. We also conclude that general insurers reflect less stable rating outlooks compared to life and general insurers.