A.M. Best Rating Methodology: Analyzing Finance Companies.

OLDWICK, N.J. -- Based on the growing trend toward convergence of the financial services and insurance industries, A.M. Best Co. has released the second in the series of special reports discussing its approach to analyzing non-insurance financial services affiliates of rated insurance companies.

A.M. Best's latest rating methodology, Analyzing Finance Companies, provides the analytical framework for assessing finance companies and highlights special issues particular to the industry. Such evaluations typically are performed in the course of assigning a Best's financial strength rating (FSR) and an issuer credit rating (ICR) to insurance entities within an organization.

FSRs and ICRs are assigned to an operating insurance company based on the assessment of the entity's financial strength, operating characteristics and business profile.

The assignment of an ICR to a holding company of an operating insurer or non-insurance entity reflects an analysis of the impact of the creditworthiness of the various insurance and non-insurance subsidiaries on the parent's credit profile.

This includes consideration of the risks associated with the holding company being a discrete legal entity and the impact of the subordination of holding company creditors to the operating company's policyholders. The FSR/ICR of an operating entity reflects A.M. Best's analysis of the extent to which the operating company is supporting debt or other obligations of a holding company, and vice versa. For non-insurance finance entities, A.M. Best performs a detailed internal analysis of their risk profile and the resulting effect on rated entities within the group.

There are two main segments within this industry: commercial finance and consumer finance. Some of the unique factors include:

--The lack of regulatory oversight of the industry creates a wider variation in reporting standards by finance companies than by other regulated financial institutions.

--Without access to low-interest funding sources, such as deposits or similar funds available to banks or insurance firms, finance companies rely more on capital markets and institutional sources of financing.

--Commercial finance companies provide alternative non-bank financing to commercial entities based on the value of the financed asset(s).

--Unlike the commercial finance segment, the consumer finance industry is highly fragmented, with many companies offering essentially the same commoditized products to consumers.

--The consumer finance companies deal with a large volume of small receivables, with more standardized product features (repayment schedules, interest rate indexing standards, and other features pursuant to consumer protection guidelines as may exist in many countries).

--Commercial finance companies are subject to the cyclical forces specific to their respective product niches, from new competitive factors drawn into a niche by high margins, to the larger economic conditions affecting borrowers' capital spending or receivable turnover.

Key firm specific issues are assessed for finance entities, including the competitive environment, management and strategy, funding and liquidity, financial and operating leverage, capital adequacy, earnings sources and stability and risk management. Each element considered fits comfortably within the traditional A.M. Best insurer rating analysis framework of balance sheet strength, operating performance and business profile.

Taken together, these factors result in a determination as to whether the given finance activities add to or potentially detract from the financial strength and flexibility of the respective A.M. Best rated companies.

For more information on A.M. Best's rating methodologies or to download a copy of this methodology report, visit http://www.ambest.com/ratings/methodology.asp.

A.M. Best Co., established in 1899, is the world's oldest and most authoritative insurance rating and information source. For more information, visit A.M. Best's Web site at http://www.ambest.com.