How to avoid a rating downgrade
If that’s not clear, then they presume
that, one way or another, even a strong
current capital position will be eroded.
“The agencies can look through shortterm
pain as long as the medium to longterm
outlook is positive, but that requires
a compelling rationale for that positive
future,” Shipperlee added.
“In our experience, rated insurers and
reinsurers often have a much better story to
tell than they currently make to the agencies.
In part this is because, until a problem with
their rating occurs, they simply don’t realise
how important it is.
“Changing a negative mindset at a rating
agency is much harder than avoiding it in
the first place. The ‘how and why’ of their
business strengths should be an absolute
focus of any rated re/insurer’s agency
communications,” he concluded. n
Despite the importance to reinsurers,
and cedants in many cases, of
achieving and maintaining a desirable
financial strength rating, many companies
still fail to grasp the complexity of rating
agencies’ methodology—and some face
downgrades as a result.
That is the view of Stuart Shipperlee,
head of analytics at Litmus Analysis,
speaking to Monte Carlo Today.
“All too often companies are surprised,
shocked and angry when faced with the risk
of a rating downgrade,” he said.
“There can be many causes of the
disconnect between the agencies and rated
companies but one big one is the tendency of
rated companies to assume the rating process
is dominated by the capital analysis. It is not.”
Shipperlee explained that capital
is indeed crucial, and weak capital is a
fundamental limiting factor—whatever the
other qualities of a rated re/insurer’s profile.
“But even the strongest capital position does not inherently lead to a
high rating. Nor does it eradicate rating downgrade risk,” he said.
S&P’s rating criteria and the new rating methodology AM Best is
about to formally adopt both make this explicit, Shipperlee stressed. “Even
excluding any impact from factors that can be absolute rating constraints
(such as lack of liquidity, sovereign risk and any concern about corporate
governance), ratings from either agency can be profoundly lower than the
capital analysis, in isolation, might suggest.”
He noted that in S&P’s case a capital model outcome above the ‘aaa’
level can still lead to a ‘rating anchor’ of ‘bb-’. Similarly, the strongest
category of outcome in AM Best’s new Best’s Capital Adequacy Ratio
(BCAR) can, by the time operating performance and business profile
have been considered, lead to an indicative rating level of ‘bb+’, with
considerable further downside if enterprise risk management is viewed
“Of course, the kind of profile to which this would happen would
be unusual. But that’s not really the point. Most internationally active
reinsurers still feel the need for a rating of at least A-. It doesn’t take
too much negativity in the non-capital part of a rating analysis to start
putting an ‘A range’ rating at risk,” he said.
He argues that the reason for that is straightforward: ratings are
prospective; it is future capital adequacy that really matters. And that,
the agencies consider, is materially a function of future retained earnings.
“Hence, everything that can be considered to drive the level and
volatility of those is fundamental to ratings,” he said.
“Numerous things come into that but the mindset of the rating
committees at the agencies when considering these is also crucial. For the
reinsurance industry that can be summed up as ‘it’s a difficult business
with a high tendency to irrational price-based competition. So exactly
how and why will this reinsurer succeed?’.”
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www.intelligentinsurer.com | www.bermudareinsurancemagazine.com DAY 4: Wednesday September 13 2017 | MONTE CARLO TODAY | 25