Spanish reinsurer rating updates highlight sovereign rating impact and differences between S&P and AM Best

As S&P continues to roll out ratings reflecting its new insurance criteria, those of Spanish reinsurers Nacional Re and Mapfre Re give a specific illustration of the impact of the sovereign rating.

Many market participants have viewed the two reinsurers as fundamentally ‘A’ range security prior to the application of the sovereign impact and the new S&P release reinforces this.

Nacional Re has a final financial strength rating of ‘BBB- ‘ with a negative outlook. But its ‘rating anchor*’ is disclosed as being ‘a-‘; the three notch reduction from the anchor being explicitly driven by the sovereign rating (along with the negative outlook).

Mapfre Re (rated as a core subsidiary of the Mapfre group) has a rating anchor of ‘a’ but a final financial strength rating of ‘BBB+’ with a negative outlook. The two-notch reduction (as opposed to the three applied to Nacional Re) reflects the degree of the Mapfre group’s non-Spanish global exposure.

What is particularly telling about these ratings is that the rating anchors should already include most of the impact of the companies’ credit risk exposure to Spanish sovereign and other debt as well as their exposure to the systemic risk drivers within the Spanish insurance market.

The ratings anchor is made up by combining the ‘Financial Risk Profile’ of the reinsurer with its ‘Business Risk Profile’.  The former includes Capital Adequacy and Risk Position, therefore covering investment risk, while the latter includes the IICRA**.  Therefore In both cases S&P appears to be adding a very material extra degree of sovereign impact. This would include the concentration risk the reinsurers have with Spanish government bonds but, nonetheless, it’s a severe outcome relative to the rating anchors.

By contrast, AM Best’s rating on Nacional Re is A- (stable outlook), the same as the S&P rating anchor but with a stable rather than negative outlook and for Mapfre Re it is A (negative outlook) exactly the same as the S&P rating anchor***.

Given that Best also has country risk and sovereign debt exposure explicitly addressed within its ratings this represents one of the largest differences of rating opinion that we are aware of between the two agencies.

Stuart Shipperlee, Analytical Partner, Litmus Analysis

Technical notes

*The ‘ratings anchor’ is the initial outcome of S&P’s rating review of a re/insurer. It addresses the core elements of financial and business risk analysis but is prior to S&P’s review of the key qualitative aspects of the re/insurer’s management profile; namely the quality of management, governance and its ERM.  These may modify the rating anchor outcome positively or negatively. S&P then may apply a ‘cap’ to the rating based on concerns around either liquidity or sovereign risk. Finally the rating may be adjusted due to group or government support.

**An IICRA (Insurance Industry and Country Risk Assessment) addresses the risks typically faced by insurers operating in specific industries and countries. It covers macro issues from the degree of economic and political risk to the payment culture and rule of law to more micro factors such as barriers to entry.

*** AM Best maps its ‘A’ grade financial strength rating to the level of ‘A+’ or ‘A’ on the capital markets scale used by S&P. However the Issuer Credit Rating (ICR) it also issues on Mapfre confirms that the mapping in this case is to the ‘A’ level.

Is your rating at risk?

Controversial though they can be, financial strength ratings, and particularly those from S&P and AM Best, continue to be central to the transaction process in reinsurance globally and in many primary markets.

The confirmation this week of fundamental changes in S&P’s ratings process is therefore, to borrow a phrase beloved of financial markets mathematicians, a ‘non-trivial’ event.

S&P’s new criteria for rating re/insurers will result in ratings changes – including downgrades. It’s not yet clear how many insurers will be impacted. However, even if a relatively small percentage of ratings change, this could still mean dozens of re/insurers being affected.

In July last year S&P published a ‘request for comment’ (RFC) on the proposed criteria changes. At their seminar later in the year, they reinforced the concepts behind the changes and confirmed that ratings actions, including some downgrades, are highly likely. Shortly afterwards we published a commentary (“S&P insurance rating criteria change means downgrades – and upgrades – are on the way”) noting that “What S&P 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”.

This week, having taken on board feedback to the RFC , S&P published the new criteria. They have stressed that they “expect that a significant majority of our ratings will not change as a result of the publication of these criteria”. Which therefore means a minority will change; although there is a somewhat more upbeat note than previously stressing that “preliminary results suggest that positive rating actions will likely slightly outweigh negative rating actions”.

Our initial observations and conclusions are:

• Whilst there are likely to be more positive than negative actions, and the ‘significant majority’ will not change, given the breadth of S&P’s coverage of insurers we could still see a meaningful number of downgrades.

• Ratings on over 2000 insurers have been put ‘under observation’ following the introduction of the new criteria, but this does not mean most ratings will change. Indeed, S&P has stressed that only a minority will. (The ’under observation’ status is a regulatory requirement when introducing new criteria – so no need for panic!)

• S&P’s language does allow for some two notch (or more) rating changes although the implication is that this will be unusual.

• For the minority of  re/insurers downgraded a one or even two notch downgrade may not have a great impact on their daily operations. But given the extensive use of ratings triggers and the binary usage of ratings in insurance markets, those on the cusp of ‘ratings cliffs’ could see a major impact.

• Our experience and S&P’s comments suggests they have been testing the criteria thoroughly since the RFC  via running it in parallel to the existing criteria in order to ascertain the impact.

• Their target is likely to have been to minimise the impact of the criteria change. However the process will have identified ‘outliers’- insurers who appear to be either better or worse under the new criteria.

• Some, though not necessarily all, of these ‘outliers’ are likely to have seen an increase in the depth of the analytical interest they have received from S&P over the past 9 months. Anyone who has seen such an increase should be particularly alert to the fact that either an upgrade or a downgrade could be on the horizon and consider giving very detailed attention to the questions they are being asked.

Among the key technical aspects of the changes taking place we would highlight that –

• There is some additional flexibility to assign ratings higher than the sovereign given a tightly defined set of circumstances.

• The new ‘Insurance Industry and Country Risk Assessments’ (“IICRA”) could prove to be an important driver of ratings changes in the future – a change to one IICRA could impact numerous insurers at once.

• Nevertheless the IICRA’s show a positive endorsement of certain sectors – for example the P&I Sector, where reading the historical rationales it wouldn’t be difficult to conclude that the S&P view of the industry might have been worse than the ‘Intermediate Risk’ now assigned by S&P. This puts the sector on a par with the UK, Belgium or Global P&C reinsurance.

• Full IICRA reports will be published after revised ratings.

• Public Information based ratings (‘pi’s’) will also be impacted, although they will be reviewed at a later stage.

• All research updates will be re-worded based on new criteria – this increased transparency should help insurers determine where to focus discussions with S&P.

Among the more detailed amendments following the RFC are; the elimination of the controversial fixed charge cover test and more emphasis on analytical judgement/prudential assessment versus strict reliance on mechanical cut-offs.

S&P have also removed the prescriptive approach to assessment of operating underperformance & outperformance; this perhaps implies that they have found it too challenging to identify truly coherent peer groups. In addition some other tables containing scoring metrics for geographical diversification, financial flexibility and liquidity have also not made it into the final criteria. S&P have thus avoided tying themselves into the straitjacket that the original proposal could have lead to.

Even if it does appear that S&P may have achieved its goal of ensuring that the new criteria enhance the transparency of its ratings, this new criteria is one of the most important changes to the approach a rating agency has taken to the insurance industry.

Links –

Standard & Poor’s –

Insurers: Rating Methodology–Shows how eight rating factors determine the stand-alone credit profile (SACP) or group credit profile (GCP).

Group Rating Methodology–Discusses external support from a subsidiary’s parent group, depending on how we classify the subsidiary within five specified “group status” categories, and how ICRs and FSRs are assigned to operating and holding companies within a group.

Criteria | Insurance | General: Enterprise Risk Management–Examines how enterprise risk management (ERM)is scored using five subfactors.

Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers–Looks at how the descriptor for the insurer’s liquidity determined in the rating methodology combines with its long-term rating to determine its short-term rating.

An accompanying list of IICRA scores has also been published.

List Of Issuers With Ratings Under Criteria Observation

Litmus Analysis –

S&P insurance rating criteria change means downgrades – and upgrades – are on the way

S&P insurance rating criteria change means downgrades – and upgrades – are on the way

This is an article written by Stuart Shipperlee in November 2012, before this blog existed.  Nevertheless the content is still relevant and presages potential important news later this year.

At its latest seminar this week, S&P confirmed again that rating changes, including some downgrades, are highly likely as a result of its current review of insurance rating criteria.  Yet, despite the central role ratings play in the reinsurance, commercial and specialty lines markets globally, this continues to receive little general market attention.

For most insurance market participants rating criteria is a subject as gripping as watching paint dry, especially in the middle of the renewal season. And the markets have grown used to downgrades over the past decade. But this is very different. 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.

While that might be of little practical consequence if a AA rated carrier were to move to AA-, it would be a very different story if the change was from A- to BBB+. Yet both, in rating terms, are simply ‘one notch’ downgrades.  On the other side of the coin, there could be some who benefit with an upgrade.

Of course the agency is conscious that some rating changes are a lot more significant than others. But it has very little room to recognise that in its actions; if the new criteria suggests a downgrade is needed then that is the path it will have to follow. 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.

The criteria review was announced in July when S&P published its initial proposals and a ‘request for comment’ (RfC).  They have received over 100 responses and yet there is no avoiding the impression that the market in general is oblivious to the process.

In part this is due to the agency trying not to sound alarmist. They stress that they do not see a need to adjust re/insurer rating levels overall. In fact they highlight 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. While the goal of the exercise is partly to enhance transparency, it is also to make insurance ratings more ‘forward looking’ and ‘comparable’.  The latter, by definition, imply rating changes. While average rating levels will not move, there will clearly be winners and losers.

S&P’s seemingly benign comment on this highlights the point. They stress that ‘the significant majority of ratings is expected to remain the same or move by no more than one notch’. So, whatever minority that leaves are expected to move by two notches (or more).  And enough one notch changes are envisaged to mean their comment was not ‘a significant majority of ratings will not move’.  As the process is not finished, and the agency therefore cannot yet know exactly what specific rating actions it will take, perhaps this will change.  But it is clear that rating changes are very much on the cards.

Indeed, while S&P stresses that a rating remains fundamentally an opinion and therefore that it retains flexibility in how it ultimately decides these, the new rating factors being taken into account make changes seemingly inevitable. These include:

• Use of industry/country risk assessments as a central part of the initial (internal) rating view
• Peer comparisons as explicit positive or negative modifiers to the initial rating
• The inclusion of ‘risk position’ as part of the financial risk profile
• The linking of capital analysis to forward looking earnings projections
• Additional elements to their analysis of competitive position, financial flexibility and liquidity.

In fact S&P veteran Rob Jones commented that in his 17 years at the firm this is by far the most substantive change to insurance rating criteria he had seen (and he should know; he previously led the development and introduction of S&P’s European capital model and ERM analysis).

You can’t do that and keep every rating the same. So, if the average is not going to move, some ratings must go up and some must go down.

None of this should come as a surprise. The agency is making a very major effort to proactively communicate what it is doing and solicit feedback. Nor, in our opinion at Litmus, is there anything fundamentally wrong with the analytical logic behind the changes (although we wonder if the ‘peer comparisons’ are possible or necessary in the way seemingly intended).  Timing of the expected roll-out of the new methodology, and of ratings updated to reflect it, is also something S&P is being very transparent about.  Publication of the final criteria is due in the first half of 2013, with updated ratings being published in tranches thereafter, starting with global multiline insurers and reinsurers.

So, whether you are a re/insurer, broker or buyer, come late next summer you may be looking at rating changes that materially impact your day despite the rated company’s profile not having changed.  Just in time for conference season, including, interestingly, the big reinsurance meeting in Monte Carlo!

Stuart Shipperlee, 28 November 2012