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Analyzing finance companies

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METHODOLOGY
A.M. BEST
JUNE 6, 2005
Analyzing Finance Companies est’s Financial Strength Ratings (FSRs) panies rely more on capital markets and insti and Issuer Credit Ratings (ICRs) are tutional sources of financing. Since these are coBnies generally exhibit relatively lower leveragempany based on the assessment of the enti assigned to an operating insurance confidencesensitive sources, finance compa ty’s financial strength, operating characteris and have more prudent liquiditymanagement tics and business profile.The assignment of an policies. Accordingly, the capital structure and ICR to a holding company of an operating access to a variety of funding sources are like insurer or noninsurance entity ref lects an ly to be the prominent factors affecting the analysis of the impact of the creditworthiness creditrisk profile of a finance company. of the various insurance and noninsurance • Commercial finance companies provide subsidiaries on the parent’s credit profile. This includes consideration of the risks associated Summary of the Relationship Between with the holding company being a discrete legal entity and the impact of the subordinaDifferent Ratings for Complex Organizations tion of holding company creditors to the oper ating company’s policyholders. The FSR/ICR ICR of Nonoperating Holding Company of an operating entity reflects A.M. Best Co.’s analysis of the extent to which the operating a) b) a) b) a) b) company is supporting debt or other obliga tions of a holding company, and vice versa. For noninsurance finance entities, A.M. Best per forms a detailed internal analysis of their risk Analysis of profile and the resulting effect on rated entiFSR/ICR ofFSR/ICR of Operating Operating Insurer Operating Insurer ties within the group. Noninsurer The analytical framework outlined for assessing finance companies highlights special a) The ICR of the holding company is derived from the ICRs of the operating companies issues particular to the finance industry. There via A.M. Best's analysis of the degree of impact each operating company has on the are two main segments within this industry:holding company's creditworthiness and any benefits it gains from diversified sources of funds from operations. commercial finance and consumer finance. Unique factors include:b) The FSR/ICRs of the operating companies reflect A.M. Best's analysis of the extent to which each is supporting debt, or other obligations, of the holding company or of • The lack of regulatory oversight of the affiliated companies. industry creates a wider variation in reporting standards by finance companies than by other regulated financial institutions. Among the critical areas of difference in reporting stan This is the second in a series of special reports discussing A.M. Best dards are delinquencies, earnings recognition Co.’s approach to analyzing noninsurance financial services affiliates and lease residual valuation. Information on of rated insurance companies. This series of methodology reports some of these areas only can be obtained reflects the trend toward convergence of the financial services and directly from the finance companies. insurance industries, whereby a number of insurers either are owned • Without access to lowinterest funding by banking or other financial services companies or have affiliated or sources, such as deposits or similar funds avail established subsidiary companies operating in these areas.This report able to banks or insurance firms, finance com describes A.M. Best’s methodology for evaluating the financial health of the finance operations of an enterprise.These evaluations generally Questions regarding A.M. Best Co.'s methodolare performed in the course of assigning a Best’s Financial Strength ogy for evaluating commercial banking operRating (FSR) to insurance entities within an organization. A.M. Best’s ations can be directed to Khanh Vuong, seniorearlier report onAnalyzing Commercial Banking Operationswas financial analyst, in the life/health division atreleased March 28, 2005. A.M. Best Co.
Copyright©2005 by A.M. Best Company, Inc. All rights reserved. No part of this report may be reproduced, stored in a retrieval system or transmitted in any form or by any means; electronic, mechanical, photo copying, recording or otherwise.
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