Without fresh capital RSA’s S&P rating may be downgraded further to ‘A-‘

On Wednesday 13th November S&P downgraded RSA’s financial strength rating to ‘A’ from ‘A+’ and placed it on credit-watch negative.

Financial strength ratings (FSRs) are those related to policyholder credit risk.

These ratings, and particularly those from S&P and A.M. Best, remain critical carrier selection criteria for many insurance brokers in RSA’s core markets, and for larger and/or more sophisticated commercial lines insurance buyers.  While ‘A-‘ is seen as the benchmark by many brokers (below which they request explicit client approval for using the carrier), for larger commercial lines buyers an ‘A’ rating floor is not uncommon, especially for longer tail lines.

RSA dropped its A.M. Best rating last year , so it is particularly exposed to S&P’s views when it comes to its FSR (Moody’s and Fitch, while less closely followed by insurance market practitioners,  are both currently more sanguine; confirming ‘A’ FSRs with stable outlooks on those group core carriers that they rate).

So what is driving the S&P action specifically and what might the prognosis be?

In fact the downgrade to ‘A’ is not that much of a surprise.  S&P placed the rating on negative outlook back in July.  The primary driver of that was the outcome of S&P’s capital model analysis; RSA currently achieves a level consistent with only a ‘BBB’ FSR.

The ‘A+’ was therefore a long way north of the agency’s base case view of RSA’s capital adequacy. While that final rating level was achieved through both RSA’s ‘very strong’ “Business Risk Profile” and a recognition that the insurer’s own ‘economic capital model’ produces a stronger apparent capital position, the agency explicitly highlighted the need for retained earnings to materially improve the capital adequacy outcome in its analysis (which includes a view of current year and prospective earnings).

Clearly the combination of recent windstorm losses and the Irish motor book reserving problems (impacting both earnings and risk-adjusted capital) have removed that likelihood near term for S&P, hence the downgrade.

However these issues directly or indirectly lead to four further risks to the rating.

Currently the rating gains a one-notch uplift from S&P’s strongly positive view of RSA’s “Enterprise Risk Management (ERM)” process and of the group’s “Management & Governance” in general.

Key factors in the analysis of both of these areas in terms of risk controls, quality of reporting and operational oversight could well be viewed more negatively in the light of recent events leading to removal of the one-notch uplift currently reflected in the ‘A’ rating.

In addition the ‘very strong’ “Business Risk Profile” has been crucial to the rating level and this could be seen as having weakened (performance relative to peers plays a key role in this part of the analysis).

Finally, without retained earnings, improvements in capital adequacy require either injections of equity capital or some ‘de-risking’ of the business.  Current stock market sentiment towards the group seems to make the former unlikely (or at least contentious) and since the latter basically means reducing expected returns on capital employed going forward, shareholders might well not back that either.

From our perspective, without a material equity injection, the risk to the rating is significant. The agency caps the further downside rating risk as ‘one-notch’. That would mean an ‘A-‘ FSR rating for the group’s core carriers.

Of course, were the further downgrade to happen, it would still be a perfectly healthy rating level in theory, and one shared by hundreds of insurers globally.  Moreover RSA have been there before, carrying ‘A’- ratings for several years from both S&P and AM Best following the problems the group faced in the early part of the last decade. But it’s not the credit profile an insurer of RSA’s scale would be looking for or, we would imagine, comfortable with.

Stuart Shipperlee, Analytical Partner, Litmus Analysis

Lloyd’s on the cusp of ‘AA’ range ratings; this could be a game-changer

During the summer both A.M. Best and Fitch assigned ‘positive’ outlooks to their current Lloyd’s market ratings. S&P did so last year.

Translating the A.M. Best rating scale to the one used by S&P and Fitch this means that Lloyd’s is rated ‘A+’ with a positive outlook by all three agencies.

While a subsequent upgrade from any one agency is not a given this suggests (absent a – truly – major loss) that a ‘AA’ range rating from one or more of the agencies is very likely in the not too distant future.

This would be both a notable step in the long-run post R&R transformation of Lloyd’s and also a profound event for the global reinsurance and specialty lines sector.

If the latter point seems like hype, consider this; only eight of the largest 40 reinsurance groups in the world have a major reinsurance carrier rated in the ‘AA’ range by S&P*. Lloyd’s paper would be rated equivalent, or close, to the strongest globally available from professional reinsurers. Yet organisations can transact business via Lloyd’s who could never begin to achieve that rating level independently.

Writing at Lloyd’s for any re/insurance group with an ability to also write via its own carriers is often seen as a ‘trade-off’. The market costs and Franchise Board oversight are seen (by some at least) as negatives, while the licences, (potential) capital efficiencies, distribution and brand are positives. The current rating is an important positive for many – but not all – and not so much that it is the overwhelming factor for much of the market’s capacity.

BUT, if the decision to trade at Lloyd’s also means the ability  to offer ‘AA-‘ paper then it becomes a whole new ball game.

Even very well known ‘A’ or ‘A+’ rated groups (for their non-Lloyd’s carriers) that are active at the market might now say “of-course we can offer you ‘AA-‘ paper via our Lloyd’s platform if you prefer”. We could even finally see some true ‘credit risk’ based pricing spreads emerge. And those not active at the market would be faced with a very different ‘cost/benefit’ scenario about whether to pursue participation.

Of course, we should not confuse this with the idea that a rating is, per se, the only way re/insurers, brokers, or buyers should communicate or evaluate financial strength. At Litmus we have long argued that a balanced set of inputs should be considered. Nonetheless, there’s no avoiding the fact that a ‘AA-‘ rating in the reinsurance market is a very powerful card.

How Lloyd’s might react to any flood of participation interest is itself an issue. The rating agencies have heavily bought into the ‘selectivity’ and oversight of the Franchise Board in getting to the current rating levels (along with the demonstrated robustness of the ‘market level’ capital model). So, from both a ‘market’ and a ‘ratings protection’ perspective the Franchise Board is likely to be very cautious about any ‘upgrade driven’ participation interest.

Nonetheless the market wants risk spread in the world’s growth economies and what better way to get it than by being able to say ‘if you meet our standards you can offer ‘AA-‘ paper to your clients’; a rating level higher than that of the sovereign in most of those markets.

* Source: S&P’s Global Reinsurance Highlights 2013

Stuart Shipperlee, Analytical Partner