12 September 2017 Insurance

Turn a positive outlook into an upgrade

Many reinsurers underestimate the obstacles that often still need to be overcome when it comes to turning a positive outlook from a rating agency into an upgrade. But it is still achievable if the rating agency’s methodology and requirements are better understood.

That is the view of Karin Clemens, senior consultant at Litmus Analysis, speaking to Monte Carlo Today.

“Achieving a rating upgrade once the outlook has been changed to positive is often regarded as little more than a formality. However, what could be taken for granted may turn out to be a long-drawn process or might never materialize,” Clemens said.

She stresses that a change to ‘positive’ is good news, but it should not be misunderstood to be a guarantee for a subsequent upgrade. According to S&P a negative or positive outlook implies at least a one-in-three chance of a change to the rating in the next two years if it is investment-grade.

An outlook change means that an agency’s assessment of how future circumstances may evolve have altered, but that there is not yet enough certainty to warrant a change in the rating.

To achieve the goal of an upgrade in the most effective way, Clemens recommends seeing things from the agency’s perspective and managing their expectations.

“First we believe it is important to be aware that, by nature, rating agencies will look at a company differently from management or other stakeholders, such as equity investors. However, when engaging with the agency it is important to address their perspective and to present the information in a format that suits their needs,” she said.

“Critical to this is to understand what their expectations are. Over the years, most rating agencies have become more transparent and disclose in their outlook statement the scenarios under which they could see a rating change. Time is therefore well invested in getting underneath the terminology of the outlook in order to fully comprehend the qualitative and quantitative targets the agency expects to be met for an upgrade.”

Clemens says that through that exercise a reinsurer will sometimes discover that the rating agency’s targets may diverge from their own.

“For example, if you pursue a growth strategy, involving writing business in new markets, a rating committee’s focus will likely be on the risks such a strategy may add rather than the opportunities that may come with it.

“The key focus of your discussions with the analysts should therefore not only be why and how you grow but in particular what makes you profitable. Indeed, addressing the "what and why” of how your specific characteristics will drive the sustainability of future performance/capital is always key to your rating.“

She adds that having a clear message how your enterprise risk management constantly evolves in line with your strategy is also critical. “A demonstration of your ability to effectively control and integrate risk management in your decision making will be essential in making analysts comfortable with your strategy,” she said.

Clemens adds that given that a rating is a prospective view of an insurer’s financial strength, it will be equally important to support the strategy with a credible forecast of earnings, ideally including the key ratios agencies typically use.

“Another key factor is communicating a forward-looking view of your capital adequacy against the backdrop of your strategy,” she said.

Clemens added: “Last, the committee will not look at a rating in isolation, but will compare your company with your peers. Benchmarking with competitors already rated at your current and target level can be a powerful tool in influencing the rating agency.”

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