October 23rd, 2012

Standard & Poor’s Proposed Criteria – Guy Carpenter’s View on Key Ratings Drivers

Posted at 1:00 AM ET

arendal_birgitte_photomatt-gc-portraitBirgitte Arendal, Senior Vice President and Matthew Day, Senior Vice President
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Standard & Poor’s (S&P) proposed insurance rating criteria framework includes significant changes that may adversely impact financial strength ratings of (re)insurers. The new framework is expected to be published and become effective in early 2013. Guy Carpenter has examined the three key proposed criteria changes. In our opinion, these can drive rating changes especially for (re)insurers in the United States and other developed countries with “A” and “AA” range financial strength ratings.

Operating Performance

Operating performance is no longer an independent rating factor, but (re)insurers should not interpret this to mean that it is of reduced importance. Operating performance remains a crucial ratings driver and will be a strong driver within S&P’s proposed criteria.

In the proposal S&P emphasizes the importance of forward-looking operating performance. We view this as a positive development, but we question S&P’s ability to do so adequately because of data limitations. We believe operating performance and peer comparisons will continue to be heavily influenced by a (re)insurer’s past performance. We continue to encourage S&P to increase transparency around peer comparison and prospective operating performance.

S&P’s Risk-Based Capital Model (SPRBC)

We believe S&P’s proposed criteria rely more heavily on its quantitative SPRBC outcome. The “capital & earnings” score is driven by the most recent financial year-end SPRBC including simplified adjustments based on S&P’s view of projected capital management and earnings growth. Under existing criteria SPRBC is only a component of capitalization. We are concerned about this development, as we believe over-reliance on any specific model is dangerous. S&P proposes adjustments to assess “representation of the capital model,” but the adjustment is not bi-directional - only negative when SPRBC redundancy is “A” or better.

According to S&P, capitalization remains an area of ratings strength for most U.S. (re)insurers. Guy Carpenter’s Global Reinsurance Composite capital position remains in an excess capital position. Therefore, capital adequacy may not be a huge driver for most U.S. insurers and global reinsurers, but we believe this could easily change mainly due to looming inflation and reserving risk. In addition, historical low interest rates negatively impact capital model output. This occurs because S&P uses the 10-year Treasury spot rate for discounting reserves, which was lower at year-end 2011 versus 2010. The largest impact is on casualty (re)insurers with longer reserving tails.

Enterprise Risk Management (ERM)

S&P’s ERM criteria also remain largely unchanged, but we believe ERM will have a heightened influence on ratings, especially for (re)insurers with complex risks. An ERM assessment of “Adequate” or “Weak” could lower a (re)insurer’s rating by 1 to 7 notches depending on S&P’s view of company’s management and corporate strategy.

Guy Carpenter is actively engaged in helping our clients navigate these changes to help them achieve their ratings and capital management objectives successfully.

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Guy Carpenter & Company, LLC provides this material for general information only. The information contained herein is based on sources we believe reliable, but we do not guarantee its accuracy, and it should be understood to be general insurance/reinsurance information only. Guy Carpenter & Company, LLC makes no representations or warranties, express or implied. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. 

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