“Function and Fundamentals:” The Story of Demotech Inc.

Demotech Inc. is not a household name, it isn’t A.M. Best or Standard & Poor’s – it also doesn’t want to be. Ratings and actuarial studies often take the brunt of insurance industry clichés: boring, bland, humorless, and faceless. However, ratings are a huge part of our industry and if you’re a carrier, being rated and monitoring your financial stability is an essential duty to your policyholders, the agents and agencies you work with, and the public.

Louisiana Comp Blog spoke with Douglas Powell, Senior Financial Analyst at Demotech Inc. to clear up some of the misconceptions and talk about what Demotech has to offer as a smaller independent rating service. In Powell’s words: “Our focus is on the business model of the entity, not its size.” Read on for the rest of Powell’s take on the issue.

Comp Blog: How would you explain Demotech’s mission as a rating agency?

Powell: First and foremost, we view ourselves as offering a rating service. As the first company to review and rate smaller, independent insurers, Financial Stability Ratings® (FSRs) were developed to highlight the financial stability of well-managed regional and specialty insurers. Keeping with our focus on regional and specialty insurers, Demotech was also the first to review, rate and issue FSRs to health maintenance organizations, public entity liability insurance pools and Title underwriters.

The mission of Demotech, to serve financially stable regional and specialty insurers, continued to grow as we issued FSRs to public entity liability self-insured pools through the development of our Management Audit Process. In many ways the Management Audit Process that we have utilized since 1989 was the precursor to enterprise risk management.

In general, Demotech secures accreditations to level the playing field for insurers that are unrated or underrated by the larger services. This is typically in response to rating requirements imposed by third parties such as Fannie Mae, Freddie Mac, HUD, premium finance companies, umbrella insurance writers and insurance agent’s errors and omissions insurers.

Comp Blog: How did Demotech get its start?

Powell: In 1985, Demotech was founded by Joseph Petrelli and Sharon Romano to serve the financial analysis and actuarial needs of regional and specialty insurers. Demotech began assigning FSRs in 1989 and has been effectively identifying financially stable insurers for nearly twenty-five years. Demotech’s ability to discern financially stable carriers has been documented through a comparison to industry icons as well as extensive independent analysis. Although our success is based on several factors, we believe that two major differences distinguish Demotech: simply, our focus on function and fundamentals.

We view insurance fundamentals and functionality in this sense: if a small insurer has the proper quality and quantity of reinsurance, and we have performed our financial tests and deem the carrier to be stable, we will assign a high Preliminary Financial Stability Rating (PFSR). Reinsurance is an important feature of our review. Other rating services seem to believe that if you cede off the potentially profitable business, you are hurting the profitability of the ceding carrier. In contrast, Demotech believes that insurers should be free to customize their insurance relationships, including reinsurance, in a manner that is consistent with their business model. Smaller insurers, of necessity, must use more reinsurance than larger carriers.

Comp Blog: There are a dozen group self-insurance funds in Louisiana, but only one (LCI Workers’ Comp) with a Demotech rating. Most others have no ratings at all. How would you explain the value of a Demotech rating to companies in Louisiana?

Powell: In general, Demotech secures accreditations to level the playing field for insurers that are unrated or underrated by the larger services. LCI performed its due diligence on Demotech and concluded that it should enter into a relationship. As to the other group self-insurance funds in Louisiana, keep in mind that Demotech’s business model is to review and analyze insurers and work with those that qualify for a PFSR at the A level or above. As only 75 percent of the carriers that we review qualify for an A or better, this results in the rejection of 25 percent of the insurers that contact us.

Similarly, in another Louisiana situation, the Louisiana Department of Insurance has agreed to accept Demotech as a rating service for the purposes of the Insure Louisiana Incentive Program and others. This enables companies to participate in the program and provides a solution for insurers that might otherwise be excluded from the Program.

Comp Blog: Is Demotech planning to do any advertising in Louisiana, such as ads in trade magazines or agency publications?

Powell: In an effort to support our rated clients, we offer an advertising reimbursement if a client includes its assigned FSR in an insurance publication; however, we will not be doing any direct advertising.

Comp Blog: Why is Demotech willing to rate small monoline single-state carriers while large rating agencies like A.M. Best are reluctant to do so?

Powell: We believe that well-managed, properly reinsured, regional P&C insurers can be more financially stable than larger, highly leveraged P&C insurers. Similarly, we believe that the financial stability of regional P&C insurers can be analyzed and measured, and furthermore, can support the assignment of a Stable FSR of A or better.

Comp Blog: According to your 2013 Report to the Insurance Community, Demotech reviewed and rated quarterly over 400 companies last year. How would you characterize Demotech’s growth? Do you see your presence in the insurance rating industry growing?

Powell: Demotech’s client base continues to grow year over year. We see this trend continuing. In response to growth and expansion we have retained a Business Development Manager, Carey Schuett. Mr. Schuett is a graduate of Concordia University in Chicago and has over thirty years of experience in the insurance industry.

Demotech Inc. bills itself as “providing unique solutions to level the playing field” in the insurance industry. The company is set to celebrate its thirtieth anniversary in September 2015 and is located in Columbus, Ohio. Read more information about Demotech and its clients here.

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