Best's Ratings, Financial Ratios and Prior Probabilities in Insolvency Prediction

Abstract

Denenberg [7] hypothesized that Best's financial ratings provided an accurate estimate of those insurers that would not become insolvent. Several researchers, most notably Pinches and Trieschmann, sought to quantify those predictions through the use of multivariate discriminant analysis. The authors of this paper incorporate Best's ratings into the discriminant analysis through a system of dummy variates. Best's ratings are then compared to the results obtained by the use of financial variables. Finally, a two-stage discriminant technique is introduced and its results are shown to be better for predicting insolvency for property-liability firms.