January 26th, 2010

Ratings outlook stable

Posted at 10:00 AM ET

Rating activity by Standard & Poor’s and A.M. Best remained low in 2009 as reinsurers rebounded from 2008 losses and pulled in strong results. Two of the four downgrades of leading global reinsurance groups during the year, Swiss Re and Transatlantic Re, were directly related to the prior year’s difficulties. The other two downgrades were reportedly driven by acquisition (IPCRe) and profitability issues (Everest Re).

ratings-chartbig

These four downgrades were accompanied by four upgrades, three of which were driven by recent strong results and solid balance sheets. Paris Re saw its S&P rating increase from A- to A+ primarily due to its acquisition by PartnerRe, one of the few remaining AA-level reinsurance credits. Additionally, S&P assigned new ratings to Max Bermuda (A-) and Platinum Underwriters (A).

2009 Rating Actions on Leading Global Reinsurance Groups

A.M. Best

 

 

 

S&P

 

 

 

Rating Changes

Previous

Direction

Current

Rating Changes

Previous

Direction

Current

IPCRe Limited

Au

A-

Axis

A

A+

Swiss Re

A+

A

Catlin

A-

A

 

 

 

 

Everest Re

AA-CW

A+

 

 

 

 

IPCRe Limited

A-

NR

 

 

 

 

Paris Re

A-

A+

 

 

 

 

Scor

A-

A

 

 

 

 

Swiss Re

AA-

A+

 

 

 

 

Transatlantic Re

AA-

A+

Note: Reflects most recent rating change in 2009; ratings and outlooks as of 27 December 2009

Red: negative outlook / action; Green = positive outlook / action; Black = stable outlook

As in 2008, outlook changes exceeded actual rating changes in 2009. Notable changes included S&P’s assignment of a negative outlook to Hannover Re’s AA- ratings and all four major international rating agencies’ assignment of negative outlooks to the ratings of Berkshire Hathaway’s reinsurance subsidiaries.

 
Limited regulation
Blamed for lax standards and potential conflicts of interest that led to the assignment of top ratings to billions of dollars of bonds that became worthless in the subprime crisis, rating agencies are easy targets for reform-minded legislators. In spite of this, the rating agencies escaped 2009 without any material threat to the way they do business.

The regulations that were passed and are now under consideration concern only improvements in oversight, additional disclosure rules, and changes that may make it easier to bring lawsuits against the rating agencies. While litigation may eventually induce reforms that change the industry, little else currently threatens to end the potential conflicts of interest inherent in the issuer-pays rating agency model and the financial system’s deep-seated reliance on ratings.

Perhaps the most significant change in the use of ratings so far was the NAIC’s November 2009 decision to use PIMCO, rather than the issuer ratings, to assess the risk of residential mortgage-backed securities held by U.S. (re)insurers.

Value of ratings - limited role in counterparty credit risk management
Ratings are not without value. Indeed, while the predominant ratings business model remains flawed, the major rating agencies have significantly improved the quality of their Insurance Financial Strength Ratings over the last decade. Ratings are not guarantees of solvency or performance, but strong and stable ratings are appropriately used as initial criteria for entry into the prime reinsurance market. It is only intuitive that a counterparty that cannot successfully endure the relative rigor of a rating review is not likely to pass the muster of wind and time.

Even with strong ratings, however, no single counterparty should be accepted without a comprehensive review of its business, resources and people. Equally important is cedants’ diligence in remaining informed about the counterparty’s current status and health. A team of savvy and critically minded staff should be charged with this task. This team has to rely on comprehensive, well-structured data-presupposing strong back-office management (with support from a trusted intermediary). This team should report directly to the Chief Risk Officer or the board of directors, tying ceded reinsurance with premium debtor and investment credit risk monitoring.

Internal security guidelines consisting of quantitative and qualitative factors should be constantly assessed to determine if they are ideal given market conditions and the nature of underlying risks. Indicators of counterparty stress that could be addressed in guidelines include the level of losses / exposures versus capitalization, delays in settlements, increasing financial and operational leverage, and significant deterioration in market measures such as share price and widening credit default swap spreads.

Stress tests should also be included in a robust process of analysis, including systemic crises such as major catastrophe losses, asset market turmoil and a closed retro market. A sample scenario that would approximate the conditions faced by many individual reinsurers in 2008 would reduce panel members’ capital by the 1 in 250 year net aggregate PML, write down equity and structured fixed income investments by 30-40 percent and remove retrocession-supported capacity.

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