solvent company sample (in 1972) and 65 to 75 percent of the insolvents (depending upon the period of time before insolvency) had exceptional values on this test. The insolvents tended to show dramatic increases in premium in the third or fourth year prior to insolvency, with abrupt declines in the final years. The distribution of test results for the solvent and insolvent companies is shown in Exhibit IX. Change in Product Mix (Test 7) Results on the change in product mix test represent the average change in the percentage of total premium from each product line during the year. The product lines are those defined in the gain and loss exhibit on page 5 of the annual statement. To calculate this test result, the percentage of premium from each product line is first determined for the current and prior years. Next, the difference in the percentage of premium between the two years is determined for each product line. Finally, the total of these differences without regard to sign is divided by the number of product lines to determine the change in the percentage of premium for the average product line. Due to the addition of separate columns in the gain and loss exhibit for credit life and credit disability insurance in 1973, the change in product mix test cannot be calculated for that year. For 1972 and prior years, the test result is reached in the manner described above, with ADD and TPD premium included in ordinary life for the calculation. Exceptional values for 1972 and prior years are those greater than or equal to 3.0 percent. Twelve percent of the solvent company sample (in 1972) and 34 to 58 percent of the insolvents (depending upon the year) had exceptional values at this bench mark (Exhibit X). For 1974 and subsequent years, the bench mark for determining exceptional values will be adjusted to 5.0 percent, to reflect the increase in the number of product lines from seven to nine. Change in Asset Mix (Test 8) The change in asset mix test is calculated in the same manner as the change in product mix. The test result represents the average change in Note: Companies with test results equal to the value dividing two categories are included in the lower category. Note: Companies with test results equal to the value dividing two categories are included in the lower category. the percentage of total cash and invested assets for the classes of assets on the first 10 lines in page 2 of the annual statement. Exceptional values on this test are those greater than or equal to 5.0 percent. Ten percent of the solvent company sample (in 1972) and 24 to 47 percent of the insolvents (depending upon the year) had exceptional values on this test. The distribution of test results for these companies is shown in Exhibit XI. Change in Reserving The change in the reserving ratio is the number of percentage points of difference between the reserving ratio for the current and prior years. For each of these years, the reserving ratio is equal to the aggregate increase in reserves for individual life insurance taken as a percentage of renewal and single premium for individual life insurance. Positive test results indicate an increase in this ratio from the prior year; negative results indicate a decrease. Exceptional values are those greater than or equal to 10 percentage points and less than or equal to minus 20 points. These bench marks identified 20 percent of the companies in the solvent sample in 1972 and about 70 percent of the insolvents in each of their last three years (60 percent in the fourth year prior to insolvency). The distribution of test results for these companies is shown in Exhibit XII. 6 2 - PRIORITY COMPANY SYSTEM The priority designation is given to companies with exceptional values on three or more of the nine tests. Companies with less than three exceptional values are treated as nonpriority companies. Of the 50 insolvent companies studied, all but one would have been given the priority designation at some time during their last four years. Since some insolvents would have been priority companies in some years but not others, the percentage of insolvents identified in each of the last four years before insolvency would have been about 88 percent (Exhibit XIII). Only 17 percent of the sample of solvent companies would have received the priority designation in 1972. Overall, between 15 and 20 percent of the companies tested are expected to receive the priority company designation. These are the companies most likely to require special monitoring by the Insurance Department. Their test results should be verified, and further analysis of their annual statements should be performed to determine whether an on-site examination is called for (see Chapter 3 for suggestions on further analysis). Although the intent of the priority company system is to assist Insurance Department personnel in focusing their immediate attention on those companies most likely to be experiencing financial difficulty, not all the priority companies will necessarily be troubled. Some may have taken action to eliminate weaknesses that became apparent during the prior year. It is also possible that unusual accounting methods may make test results appear less favorable than is warranted, or that errors may occur in calculating test results. However, unless a priority company is known to be financially sound, careful analysis and examination of that company would be appropriate. Nonpriority companies are less likely to require in-depth review or on-site examination. However, the fact that a company is not given the priority classification by the Early Warning System should not be taken as a guarantee of continuing financial solidity. The results of individual tests for each nonpriority company should be carefully analysed. If areas of concern are identified, a review of that company's annual statement should be made to determine whether an examination if required. 99-073 0 78 - 23 |