THE SAMPLES Through the use of questionnaire returns from insurance departments and published sources, we identified 101 life and health companies that were liquidated or came under state control during the past decade. We then requested that the insurance departments of the states in which the "insolvent companies were domiciled provide copies of annual stateme.t pages 2 through 15 and Schedule H for the five years preceding insolvency. We received annual statements for 50 of the insolvent companies for periods ranging from one to eight years prior to insolvency. Of the 50 companies, annual statements were available for the full five years for 25 companies; for nine companies we received only the final year's statement. At the same time, we received annual statements for 1971 and 1972 for 85 solvent companies. The solvent company sample was developed by providing the states that had experienced insolvencies with a list of domestic companies of roughly the same size as the insolvents. (This list was drawn at random from Best's Insurance Reports.) We requested each department to remove from the list any company clearly experiencing financial difficulty and to supply annual statements for the remaining companies. Thus, the solvent company sample was screened to eliminate clearly troubled companies and was approximately matched with the insolvent companies in state of domicile (Exhibit I) and premium volume (Exhibit II). In addition, we found the two groups were also similar in product mix (Exhibit III). Of the insolvent companies, 8 percent were mutuals; 6 percent of the solvent companies were mutuals. METHOD OF DETERMINING TEST EFFECTIVENESS The effectiveness of the various tests in discriminating between troubled and sound companies was determined in the following manner: For each test, we selected a series of test values spanning the range of possible values. We then calculated, separately for insolvent and solvent companies, the percentage with results below each of these values. Finally, we plotted these pairs of related percentages graphically. The line formed by the plotted points, such as line A in Exhibit IV on the following page, represents the discriminating effectiveness of the test. The further the line departs from the diagonal line representing equal percentages of insolvents and solvents (line C), the more discriminating the test. Thus, test A in Exhibit IV is more effective than test B; this judgment can be made without regard to any particular cutoff or bench-mark test result. 99-073 078 - 19 If the line thus plotted for a given test curves downward as for both tests A and B in Exhibit IV - it is the lower range of test results that distinguishes troubled companies. If the line curves upward such as line D in Exhibit V the higher range of test results distinguishes troubled companies. Finally, if the line forms an "S" curve as line E in Exhibit V both low and high test results distinguish troubled companies. 4. This chapter presents recommendations on the tests, screening bench marks and report format for the current year. It is divided into four sections: 1. Current tests 2. New tests 3. Static and dynamic approaches 4. Report format. We understand that current plans call for 1973 test results to be calculated and distributed during the second half of 1974, and that implementa tion of the recommended tests for 1974 would be feasible without causing major delays in this schedule. CURRENT TESTS We will review the effectiveness of the current tests which are listed in Exhibit VI in numerical order. The first three tests change in surplus, net gain to total income, and investment yield deal with the company's profitability. As shown in Exhibit VII, these tests are effective in discriminating between troubled and sound companies. On all three tests, insolvent companies are distinguished by low test results. In Exhibit VII, the insolvent companies are taken in the third year prior to insolvency; when the insolvent companies are measured in other years, the results are approximately the same, except that results on the change in surplus test tend to become. less favorable for insolvent companies in their final year. The large dots |