Many insurers and reinsurers remain blissfully unaware of the potential consequences of changes that rating agency Standard & Poor’s is making to its insurance rating criteria – despite the fact that the adjustment could have serious ramifications for them in 2013.
Most insurers and reinsurers rely heavily on financial strength ratings either to sell their own credibility or in the way they purchase and manage reinsurance programmes. Ratings are used as both a yardstick for the security of ceded reinsurance and to benchmark the likelihood of receiving owned recoverables.
Companies that rely heavily on these ratings should brace themselves for a period of uncertainty next year. A number of upgrades and downgrades are forecast by S&P. In a conference call last week, the rating agency confirmed that rating changes, including some downgrades, are highly likely as a result of its review of insurance rating criteria.
But Stuart Shipperlee, a former analyst at S&P and who is now a partner with Litmus Analysis, a consultancy that specialises in the processes and methodologies that underpin credit ratings, says many companies are unaware of both the process and its potential consequences.
The criteria review was announced in July and S&P has sought feedback from the industry. “They have received over 100 responses and yet there is no avoiding the impression that the market in general is oblivious to the process,” says Shipperlee.
He says that, in part, this is due to the agency trying not to sound alarmist. S&P stresses that much of the process has been around mapping the new criteria to the existing rated universe in order to minimise rating changes. “But there is an inevitable limit to that,” says Shipperlee. “While average rating levels will not move, there will clearly be winners and losers.”
He stresses that this round of rating changes is also very different to anything the industry has seen before. “S&P is not highlighting the fact that the usual suspects of severe cat losses, adverse development on casualty business or drastic reductions in asset values can lead to rating downgrades; that is business as usual. What they are saying is that an insurer or reinsurer with exactly the same profile as it has today could have a lower – or higher – rating by the middle of next year.”
He says that while there is little practical consequence if a AA rated carrier were to move to AA-, it becomes a very different story if the change was from A- to BBB+. Many cedants have policies of only dealing with reinsurers rating above a certain level with the A-/BBB+ the most widely accepted line in the sand. “The ‘A-/BBB+’ rating cliff is a market convention, not something introduced by the rating agencies, and they have no real flexibility to accommodate the consequences of it when making rating decisions,” Shipperlee says.
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Standard and Poor's, credit ratings