Why the A-/BBB+ boundary?
For most traditional reinsurers a credit rating from one of the main agencies remains a business requirement. And in many markets that rating needs to be A- or higher, at least if the reinsurer is going to be shown the kind of business it really wants.
But this binary use of ratings (A- and better is OK, below A- is not) has never really made sense, according to Stuart Shipperlee, head of analysis at Litmus Analysis.
The credit markets differentiate between investment grade (BBB- and higher) and non-investment grade (‘junk’ or ‘high-yield’, BB+ or lower) but with far less absolute distinction, Shipperlee explained.
“Some bond investors can’t hold paper that carries a lower rating, many might limit the amount they hold, but bond pricing across the BBB-/BB+ boundary suggests at least a reasonable degree of credit market risk/reward coherence,” he said.
“By contrast the reinsurance market treatment of the A-/BBB+ boundary is out of all proportion to its real meaning.”
But, Shipperlee noted, there is another way to think about this.
“That is to focus on the historical frequency with which organisations with a given rating have defaulted. While none of the most globally active agencies in reinsurance (AM Best, Fitch, Moody’s and S&P Global) define their ratings in terms of expected default rates, all publish extensive ‘default studies’ about the histories of these by rating level,” he said.
Default means non-payment of obligations on time and in full as a consequence of financial duress.
