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www.fitchratings.com March 31, 2011
Property/Casualty Insurers, Reinsurers Global Sector-Specific
Criteria
Non-Life Insurance Rating Methodology
Summary This report outlines the global rating methodology used
by Fitch Ratings to analyze the credit quality and financial
strength of non-life insurance (also known as property/casualty or
general insurance) and reinsurance companies. The methodology
ultimately supports Fitchs assignment of issuer default ratings
(IDRs), insurer financial strength (IFS) ratings, and debt/issue
ratings for these entities. This criteria report is a subsector
report under Fitchs global master criteria report Insurance Rating
Methodology. For a fuller understanding of Fitchs methodology for
rating non-life (re)insurance companies, readers should refer to
this report and other related criteria.
The criteria report identifies factors that are considered by
Fitch in assigning ratings to a particular entity or debt
instrument within the scope of the master criteria referenced. Not
all rating factors in this report may apply to each individual
rating or rating action. Each specific rating action commentary or
rating report will discuss those factors most relevant to the
individual rating action.
This report updates and replaces Fitchs Non-Life Insurance
Rating Methodology dated March 24, 2010.
Scope of Criteria Non-life (re)insurance companies typically
offer protection to property against loss, theft, or damage or
provide financial protection against various liability claims.
Common product lines include motor (auto) insurance, homeowners
(household insurance), and workers compensation (employers
liability). The risk associated with these products largely varies
according to policy limits offered and the predictability of future
claims.
Business is often segmented by the customer base (commercial or
personal insurance products, the nature of protection provided
(property, casualty, liability), the layer of coverage
(primary/reinsurance), and the length of the loss tail (i.e. the
timing of average claims payments). As a general rule, personal
lines insurance tends to exhibit milder market cycle fluctuations
than commercial lines.
Reserve risks tend to be lower for property business given that
it is comparatively easy to establish when loss or damage has
occurred and the scale of loss. Liability business is generally
longer tail given sometimes lengthy court proceedings and the time
that it takes to establish the extent of loss (e.g. healthcare
costs). Some business lines may have greater exposure to
catastrophic risks due to location and weather, such as property
reinsurance and homeowners business in coastal areas.
The report provides the following:
A discussion highlighting the key characteristics of the
operating environment and key risks faced by the non-life
(re)insurance industry.
Key financial ratios and other performance metrics that Fitch
focuses on when rating non-life operating companies.
Analysts
Chicago James Auden +1 312 368-3146
[email protected]
Brian Schneider +1 312 606-2321
[email protected]
London Federico Faccio +44 20 3530 1394
[email protected]
Asia Terrence Wong +852 2263 9920
[email protected]
Latin America Franklin Santarelli +1 212 908-0739
[email protected]
Related Research
Insurance Industry: Global Notching Methodology and Recovery
Analysis, March 31, 2011
Insurance Rating Methodology, March 31, 2011
Fitchs Approach to Rating Insurance Groups, Dec. 14, 2010
Takaful Rating Methodology, Oct. 28, 2010
Rating Hybrid Securities, Dec. 29, 2009
Equity Credit for Hybrids & Other Capital Securities, Dec.
29, 2009
Table of Contents Page
Summary..................................1 Scope of
Criteria.........................1 Ratings Limitations
......................2 Ratings Analysis..........................2
Appendix A ............................. 10 Appendix B
............................. 11 Appendix C
............................. 15
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2 Non-Life Insurance Rating Methodology March 31, 2011
The process for relating the key credit factors that Fitch
reviews for a non-life (re)insurer relative to ratings, for either
a stand-alone insurer or a consolidated group.
Ratings Limitation Ratings of non-life (re)insurers are
primarily based on a review of public information, together with
Fitchs judgments and forecasts. The extent and nature of financial
information for insurance entities varies by country of domicile
based on unique regulatory, accounting, and disclosure practices.
Where management interaction is forthcoming, the information
derived may or may not influence the rating based on Fitchs
judgment with respect to the usefulness of such information. In
certain cases, Fitchs forward-looking views related to risk
exposures or forecasts may dominate a rating conclusion, and such
forward-looking views may be based on factors that are highly
subjective.
Although Fitch may receive nonpublic information from rated
non-life (re)insurance companies, the extent and usefulness of such
nonpublic information can vary widely from issuer to issuer, as
well as over time for a given issuer. Thus, while such information
can be informative, Fitch generally does not rely on nonpublic
information when rating non-life (re)insurers.
Rating Analysis The main rating factors used by Fitch for the
analysis of non-life (re)insurance companies are as follows.
Industry Profile and Operating Environment Fitch believes that
the key risks inherent in the non-life (re)insurance industry are
derived from the cyclicality of year-to-year results; intense
competition in most sectors; challenges in predicting, pricing, and
reserving for losses from products with long reporting and claims
settlement tails; and exposures to large low frequency, high
severity losses such as property catastrophes. Also, certain lines
of business are highly regulated from an availability and rate
perspective, making it hard to exit or adjust prices if operating
results are poor. Further, regulatory capital requirements provide
some barrier to entry and credit protection to policyholders.
While non-life (re)insurance is inherently cyclical relating to
industrywide changes in capital levels (and thus capacity) and
competitive pressure in response to pricing adequacy, as well as
underwriting uncertainty, individual markets, and business lines
may follow unique cycles that are less correlated with the
insurance market in aggregate. For instance, surety and financial
lines underwriting results may be influenced by specific economic
factors more so than broader industry trends. Reinsurance markets
also follow unique cycles driven largely by market competition and
capacity, shifts in demand for coverage, and the impact of losses
from catastrophe events on pricing. As such, Fitch may recognize
the benefits to scale and market share across individual businesses
as a credit positive.
Also favorable to credit fundamentals, non-life (re)insurers
offer a unique product that faces limited competition from outside
of the industry, although competitive advantages are rare and
commodity pricing is the norm for most non-life lines. Further, the
demand for a number of products is supported by third-party
requirements that individuals and companies carry certain types of
insurance. For example, in a number of jurisdictions, auto
third-party coverage is mandatory, a homebuyer must obtain
insurance on the property to secure a mortgage loan, and employers
in many regions around the world are required by law to provide
insurance to protect injured workers.
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Non-Life Insurance Rating Methodology March 31, 2011 3
In general, Fitch believes that insurers selling long-tail
products, such as liability lines, are exposed to greater pricing
and reserving risk than those writing shorter-tail lines. Medical
malpractice and workers compensation are examples of longer-tailed
non-life insurance products. In the U.S., risk inherent to
liability coverage is mitigated somewhat through a claims-made
policy form in some segments, which in contrast to occurrence
coverage, requires an earlier claims notice provision versus an
occurrence policy form. A comparison of risk factors for major
non-life (re)insurance products is included in Appendix A.
The longer period over which actuaries need to predict losses
increases the risk of pricing errors that can result in
underpricing over a several-year period. In such a case, once
inadequacies are detected, the cumulative effect on the balance
sheet can be significant.
However, short-tail property lines such as homeowners insurance
and property catastrophe reinsurance are exposed to potentially
large losses from natural catastrophes, such as windstorms,
hurricanes, or earthquakes. In these cases, insurers must rely on
simulation models or other estimation techniques to judge exposures
that are subject to significant estimation errors and can be
subjected to near-term earnings and capital volatility risk and
liquidity risk.
Companies operating in the reinsurance market face several
unique challenges tied to greater distance from the underlying risk
exposure, and are therefore dependent to a degree on the
underwriting and claims data and expertise of the ceding company,
particularly on proportional accounts. Reinsurers also have to
often collateralize at least a portion of their ceding company
obligations via trust accounts or bank letters of credit, which can
increase liquidity risk. Additionally, the willingness of
reinsurers institutional client base to accept new reinsurers that
are deemed to have acceptable capital levels, especially for
short-duration property-exposed reinsurance business, reduces entry
barriers in the reinsurance market. Fitch views the credit-negative
aspects of these characteristics to be partially offset by the less
restrictive premium rate and policy form regulations reinsurers
face.
Generally, Fitch sets ratings for non-life insurers at levels
that would be expected to remain stable while the insurer
experiences customary variability associated with normal pricing
and economic cycles. Sudden and swift downward ratings migration
can occur for non-life ratings, and would typically be caused by
sudden reserve increases or catastrophic losses.
Company Profile and Risk Management A non-life (re)insurers
business mix, scale, and competitive market position within its
chosen markets are important factors in considering the underlying
company risk profile. Thus, individual insurers profit potential
and capital volatility will differ significantly based on the
composition, size, and positioning of the underlying portfolio by
segment and geography. Diversification across products and
geographies are typically credit positives while Fitch recognizes
that even apparently diversified portfolios can become more
correlated under extreme conditions.
A non-life (re)insurers ability to manage underwriting risk
within a broader risk management framework is a key driver of
future success. In conducting its review, Fitch recognizes the need
for sophisticated underwriting processes can vary dramatically by
line of business. Subject to data and information availability,
factors that may be considered in assessing underwriting risk
include:
Underwriting expertise in each line of business.
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4 Non-Life Insurance Rating Methodology March 31, 2011
Policy limits and retentions offered by segment.
Management of undue risk aggregates and concentrations.
Exposure to large losses such as property catastrophes.
Claims management and expertise.
Financial Profile Fitch will vary the weightings of the
different financial profile factors depending on the circumstances
of the individual non-life company. Typically, the most important
financial profile areas for non-life (re)insurance companies are
linked and include capitalization, reserve adequacy, investment and
asset risk, and financial performance and earnings evaluation. For
example, Fitchs evaluation of capital adequacy and profitability
are closely tied to its assessment of reserve adequacy.
Under-reserving promotes an overstatement of both historical
profits (often over a multiyear period) and capitalization.
Some of the main elements that are typically reviewed are as
follows.
Capitalization Analysis of a non-life (re)insurers
capitalization focuses on consideration of the adequacy of capital
to absorb losses tied to key risk elements, particularly
underwriting and liability exposures. In all jurisdictions
globally, capital adequacy for non-life (re)insurers is first
evaluated using nonrisk-adjusted leverage ratios that measure
capital levels in relation to a companys notional risk exposures.
These include ratios such as net premium written to capital and
loss reserves to capital, which measure an insurers exposure to the
risk of pricing and reserving errors, respectively.
In addition, in most jurisdictions, Fitch evaluates regulatory
capital standards such as the solvency discipline in Europe and the
NAIC risk-based capital ratio in the U.S.
In some cases, Fitch will additionally evaluate capital using
its own proprietary risk-based models or tools. Since 2007, for
most U.S. non-life insurers and select European insurers, Fitch has
used its internal stochastic risk-based capital model called Prism.
The model is designed to capture key risks faced by a non-life
insurer, including underwriting risk, reserve risk, catastrophe
exposures, asset risk, and credit risk, analyzing and integrating
these components on a fully aggregated basis while also allowing
for recognition of reasonable, economic risk diversification.
For European and Asian non-life insurers, Fitch uses its
factor-based internal calculation to assess companies capital
adequacy and resilience to material shocks regarding market
risk.
Finally, in select cases when such information is made
available, Fitch will assess capital adequacy in conjunction with
results offered by insurers internal capital models. However,
typically due to limitations in the robustness of the information
available to Fitch on such models, and difficulties with respect
comparisons among insurers and relative to Fitchs guidelines,
results of insurers internal models typically have little bearing
on Fitchs overall capital assessment.
Fitch considers both risk and nonrisk-based capital analytical
tools and ratios in its capital evaluation, and judgmentally
determines which measures are most appropriate for an individual
insurer.
Fitch also takes into account a qualitative assessment of the
ability of a non-life (re)insurer to replenish capital following a
large loss, particularly in light of potentially restricted capital
market access during a challenging financial market and
economic
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Non-Life Insurance Rating Methodology March 31, 2011 5
environment. This is especially true for reinsurers exposed to
shock losses, such as property catastrophe reinsurers whose
business models assume an ability to reload capital after a major
catastrophe loss event. In such cases, Fitch considers specific
elements, including the reinsurers track record in raising capital,
their perception of capital market investors, and the likelihood
they may be able to raise capital on reasonable terms if their
capital base were to be hit by an outsized catastrophe event.
Reserve Adequacy Loss reserve adequacy is a critical part of
analyzing a non-life (re)insurer, but it is also one of the most
challenging areas of analysis and one most susceptible to
variability in results. A demonstrated ability to maintain an
adequate reserve position is a crucial characteristic for a highly
rated insurer.
The greatest challenge in assessing loss reserve adequacy is
that the data available to conduct the review whether information
available from statutory filings (such as Schedule P for U.S.
insurers or FSA returns in the U.K.), or tables available from
management as used for internal analysis may be both limited in
availability and difficult to interpret. Even when significant
amounts of data are available, trends observed from this data can
be influenced by a multitude of factors, including changes in
business mix, acquisitions or dispositions, underwriting and claims
practices, reinsurance arrangements, and economic inflation, making
the ability to draw solid conclusions very challenging.
Typically, publicly available supplemental data to support
reserve analysis is most robust in the U.S. within regulatory
filings. Non-U.S. publicly traded companies also typically provide
a reasonable level of supplemental information to support a reserve
analysis. In cases when supplemental data is limited, Fitch relies
more on basic ratio analysis, such as trends in reserves to
premiums or growth in reserves relative to growth in premium to
assess reserve adequacy. In some cases, Fitch may also receive
nonpublic reserve reports and data from companies it rates.
To the extent that sufficient detail is available, Fitchs
reserve methodology utilizes loss development factors on a paid
loss and case incurred basis (preferably on a line-by-line basis)
to estimate ultimate accident year losses. Fitch will then stress
test the relevant financial ratios, particularly for capital
adequacy, based on the estimated reserve deficiency/redundancy.
The analysis of reserve adequacy involves a blend of both
quantitative and qualitative elements. Accordingly, subject to data
and information availability, Fitchs review also focuses on the
following:
Historical track record in establishing adequate reserves.
Reserve ratio analysis including paid losses, incurred losses,
incurred but not reported (IBNR), and total reserves.
Actuarial studies prepared by the insurers independent
actuaries.
Managements reserving targets relative to the point estimate on
the actuarial range (high, low, middle) or on a certain confidence
interval.
General market and competitive pricing environment, and
propensity of management to carry weaker reserves during down
cycles.
Comparison of company loss development trends relative to
industry and peers.
Use of discounting, financial or finite reinsurance, or
accounting techniques that reduce carried reserves.
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Investment and Asset Risk Non-life (re)insurers tend to be less
aggressive in taking investment-related risks than life insurance
companies given the more prominent risks tied to underwriting
operations. Non-life (re)insurers also utilize less asset leverage
in comparison with life insurer peers. However, despite this
general observation, Fitch notes some non-life companies take on
significant investment and asset risk.
Still there is natural risk exposure in any investment activity
and asset risk can vary considerably across individual insurers. In
Fitchs assessment of asset risk for a non-life (re)insurer, four
key areas are emphasized.
Credit risk.
Interest rate risk.
Market risk.
Liquidity risk.
Non-life (re)insurers bear a varying degree of credit exposure
as organizations make unique choices regarding the trade-off
between yield and default risk in investment decisions, and have
differing investment opportunities in their market of origin. Fitch
considers the mix, composition (government/tax
exempt/corporate/asset-backed), and credit quality of a non-life
(re)insurers fixed-income portfolio. Asset stress testing that
estimates economic losses by asset class in more severe economic
conditions is completed to assess insurers credit exposures.
Non-life (re)insurers are less likely to maintain tight duration
matches between assets and liabilities relative to life
counterparts that manage spread or nonlinked businesses. An asset
duration that is longer relative to liabilities creates an exposure
to a decline in economic value as interest rates increase.
Generally, an asset liability mismatch is not a major concern for
an insurer with adequate cash flow, high-quality investments, and a
buy and hold investment approach. However, in periods of economic
stress brought on by high inflation, insurers with longer duration
mismatches will face greater asset and capital volatility.
A portfolio allocation to equity securities is not uncommon for
a non-life insurer. Equity investments may provide higher long-run
expected returns, but also are significantly more volatile in
interim periods. Fitch stress tests equity investment values to
consider the potential impact on capital from severe market
downturns. Equity investment positions may also include positions
in derivatives, hedge funds, or private equity vehicles.
Concentrations in these types of investments are viewed more
cautiously as they have greater uncertainty in terms of valuation
and liquidity.
At the operating company level, a non-life insurer typically
generates sufficient premium and investment income cash flow to pay
current claims, so the risk of having to liquidate investments at a
disadvantageous point in time is generally low. Liquidity takes on
greater importance in short-tail insurance sectors and in the event
of large catastrophe losses, as well as at the holding company
level.
Fitch evaluates liquidity at the operating company based on the
marketability of investments, as well as the amount of liquid
assets relative to liabilities. The manner in which the company
values its assets on the balance sheet is also closely examined.
Fitch also considers the amount of receivable and other balances,
as well as the impact of very nonliquid assets such as affiliated
holdings or office buildings. For lines exposed to catastrophic
loss, such as property reinsurance, Fitch reviews how an insurer
would potentially generate sufficient liquidity to fund claim costs
at various probable maximum loss levels.
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Non-Life Insurance Rating Methodology March 31, 2011 7
For reinsurance companies, Fitch will also consider how
collateralization requirements for assumed reserves may affect
liquidity and financial flexibility, particularly to the extent
collateralization levels are affected by financial covenants or
rating triggers.
Financial Performance and Earnings Evaluation The evaluation of
underwriting profitability, particularly for non-life (re)insurers
in higher risk lines of business, is the first part of the
financial performance and earnings evaluation review for non-life
(re)insurers. Fitchs goal is to judge the overall health of the
book of business and managements understanding of its risks and
ability to control them.
As a first step in evaluating underwriting risk, Fitch looks at
premium growth trends. Fitch typically views premium growth at
rates greater than the market or peers, especially during periods
of pricing pressure, cautiously from a ratings perspective. Trends
in premium growth can be a leading indicator of future reserving
and pricing problems. In some cases, fast premium growth in a soft
market without being accompanied by an obvious competitive
advantage (to explain why the growth may be healthy) can have a
material adverse impact on a rating.
Other key areas considered include:
Performance versus pricing margins that management may target to
produce a reasonable margin/return, including impact of investment
income on pricing decisions.
Performance relative to market peers.
Volatility of underwriting results over time.
Expense efficiencies and impact of ceding commissions on expense
ratios.
Fitch measures underwriting performance using two common ratios
the loss ratio and the expense ratio. The combination of the loss
and expense ratios is referred to as the combined ratio. A combined
ratio below 100% translates into an underwriting profit and above
100%, it represents an underwriting loss.
To properly interpret these ratios, Fitch considers the companys
business mix, pricing strategy, accounting practices, distribution
approach, and reserving approach. Fitch examines these ratios for
the company as a whole, and by product and market segment when such
information is available. Fitch also looks at underwriting results
both before and after the impact of ceded reinsurance, as well as
on a calendar and accident year basis when such information is
available.
The focus of Fitchs profitability analysis is to understand the
sources of profits and return on capital, the level of profits on
both an absolute and relative basis, and the potential variability
in profitability. Profits for non-life (re)insurers are sourced
from two primary functional areas underwriting and investment
income.
Profits derived from investments can take the form of interest,
dividends, and capital gains, and can vary as to their taxable
nature. The level of investment earnings is dictated by the
investment allocation strategy and the quality of management. Like
underwriting income, investment returns and their volatility are
also correlated with the level of risk assumed.
Fitch measures overall operating profitability (underwriting and
investing) for a non-life (re)insurer by calculating the companys
operating ratio, which is the combined ratio less the investment
income ratio (investment income divided by premiums earned).
Operating margin can be evaluated on a consolidated basis and by
major product and market.
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Non-life (re)insurers strive to strike a balance between
underwriting and investment returns. (Re)insurers with secure
insurer financial strength (IFS) ratings and short-duration
reserves typically maintain high levels of liquid high-quality
investments that are subject to little performance volatility.
While this limits investment yields, such insurers typically target
a loss ratio that enables them to be profitable.
Catastrophe Exposures Fitchs analysis of catastrophe risk for
non-life (re)insurers involves both traditional risk analysis and
in some regions, sophisticated risk modeling, with the ultimate
goal of evaluating various large loss scenarios relative to
capital.
In all regions, the starting point for Fitchs catastrophe risk
analysis is to evaluate business mix, geographic concentration,
premium growth rate, and past results in order to understand the
companys overall catastrophe risk management profile. This review
considers the nature of catastrophe risk on both a marketwide basis
within a jurisdiction, as well as a companys specific share of
market losses.
In many but not all cases, Fitch also reviews the results
generated by non-life (re)insurers internal catastrophe models and
software. Fitch reviews model results at various confidence levels,
including but not limited to 100-year, 250-year, 500-year, and
1,000-year probabilities, and beyond, when possible. Fitch believes
a full evaluation of the extreme ends of tail is useful, in part
recognizing that actual catastrophe events seem to occur at
frequencies greater than implied by many models.
Finally, Fitch has licensed AIR Worldwide Corporations (AIR)
CATRADER natural catastrophe modeling tool for the U.S. and Europe
that models catastrophe risk and, where appropriate and feasible,
produces a loss distribution curve for each insurer that fits its
overall risk exposure.
Modeled catastrophe results are most informative on an annual
aggregate basis (both gross and net of reinsurance) as opposed to a
single-event occurrence basis, thus allowing Fitch to capture the
compounding effects of multiple events in a single year, as well as
the impact of diversifying exposures. Furthermore, Fitchs
catastrophe risk analysis uses a tail value-at-risk (T-VaR) measure
rather than a probable maximum loss (PML) approach where available.
T-VaR is the average of all potential losses from a specific
threshold through the most extreme tail event and not just a
single-point PML return period event.
When available, this more sophisticated, model-based catastrophe
risk methodology can allow for more robust and better
differentiated capital requirements among insurers. However, Fitch
recognizes the potential shortfalls in any model-driven analysis
and also takes care not to become overly reliant on the results of
any one model without also applying judgment in interpretation of
the model outputs.
Reinsurance, Risk Mitigation, and Capital Markets Products In
assessing a non-life insurers use of reinsurance, (or a reinsurers
use of retrocession protection), Fitchs goal is to determine if
capital is adequately protected from large loss exposures and to
judge if the ceding companys overall operating risks have been
reduced or heightened.
Further, Fitch also looks for cases in which financial or finite
reinsurance is being used to hide or delay the reporting of
emerging problems that may ultimately negatively affect performance
or solvency. Finally, Fitch tries to assess whether a company is
becoming excessively reliant on reinsurance to manage down its
gross risk exposures, and to the performance of reinsurance
counterparties (including concentrations of exposure to any given
reinsurers). Availability of reinsurance coverage, particularly
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Non-Life Insurance Rating Methodology March 31, 2011 9
retrocession coverage for reinsurers, is at times less robust,
which provides further motives against over reliance on
reinsurance.
In the traditional sense, reinsurance is used as a defensive
tool to lay off risks that the non-life insurance ceding company
does not want to expose to its earnings or capital. When
reinsurance is used defensively, Fitchs goal is to gain comfort
that:
Sufficient amounts and types of reinsurance are being purchased
to limit net loss exposures given the unique characteristics of the
book.
Reinsurance is available when needed.
The cost of purchasing reinsurance does not excessively drive
down the non-life insurance ceding companys profitability to
inadequate levels and weaken its competitive pricing posture.
The financial strength of reinsurers is strong, limiting the
risk of uncollectible balances due to insolvency of the
reinsurer.
Exposure to possible collection disputes with troubled or
healthy reinsurers is not excessive.
Data available to Fitch to assess each of the above areas can
vary greatly from company to company. In some cases, Fitch receives
detailed information on reinsurance programs, and in other cases
information available to Fitch may be limited to amounts ceded or
recovered from reinsurers and the level of receivables and ceded
reserves.
Non-life insurance companies may also sponsor catastrophe bonds
(cat bonds) in place of, or to supplement, their traditional
property catastrophe reinsurance program. In its analysis, Fitch
considers cat bonds to be defensive reinsurance. This treatment
affects Fitchs analysis in that the protection provided to the
ceding company may not be complete due to basis risk. The use of
catastrophe bonds can also create a need for a non-life insurer to
maintain ongoing market access to support ongoing business
generation, and thus catastrophe bonds are considered a part of
debt leverage in Fitchs total financing and commitment (TFC) ratio
discussed in the agencys global master criteria.
Non-life insurers can also use reinsurance offensively and
potentially add to risk. In such cases, Fitch examines why the
reinsurance approach is being used, and stresses what would happen
if the program was unwound or developed adversely. Examples of
offensive uses of reinsurance include excessive cessions under
quota-share treaties simply to earn ceding commissions and the use
of finite or other financial reinsurance. Typically, purchasers of
finite risk reinsurance are driven less by risk transfer and more
by risk financing objectives (although finite risk transactions
contain elements of both). Finite reinsurance can be used to
improve current period earnings, smooth earnings, and effectively
discount reserves thereby enhancing capital. Fitch typically views
the quality of such capital to be less than that obtained through
the use of other forms of reinsurance.
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10 Non-Life Insurance Rating Methodology March 31, 2011
Appendix A
Risk Characteristics of Non-Life Products
Product Profile
Risk Features
Short-Tail Exposure
Catastrophe Exposure
Long-Tail Exposure
Higher Policy Limits
Heavy Regulation
Personal Lines Motor/Auto X X Homeowners X X X
Commercial Lines Commercial Auto X Property X X Workers Comp X X
X General Liability/Umbrella X X Professional Liability X X
Surety/Financial Lines X X
Reinsurance Property X X X Casualty X X
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Non-Life Insurance Rating Methodology March 31, 2011 11
Appendix B
Financial Ratios and Definitions Discussed below are some of the
key financial ratios used by Fitch in its financial review of
non-life (re)insurance companies.
Financial ratios are evaluated relative to peer performance,
median guidelines by rating category (see Appendix C for additional
details), and expectations developed by Fitch specific to the rated
entity. In many cases, there is information value in the change in
ratio values over time as well as the absolute level. As such,
Fitch typically looks at a time series made up of at least five
years of historical data.
Fitchs ratings are intended to look through the peak and trough
of the normal non-life (re)insurance cycle. Thus, many financial
ratios, particularly those tied to underwriting performance and
profitability will vary based on the stage of the market cycle.
Adverse deviations from normal cyclical variations are typically
viewed as outside of ratings expectations, and could result in
downgrades.
Underwriting Quality and Profitability Loss Ratio measures the
magnitude of incurred losses (including loss adjustment expenses)
for the current calendar year relative to net premiums earned. Loss
and loss adjustment expenses represent the largest expense item for
most non-life (re)insurers.
Variances among insurers can be due to differences in the lines
of business written, the level of rate adequacy, the tail of the
book, pricing strategy with respect to expense/loss ratio mix,
adverse loss items (i.e. catastrophes), and development of prior
years business, and changes in relative loss reserve strength.
Expense Ratio measures the level of underwriting and acquisition
expenses, such as commissions, salaries, and overhead, relative to
net premiums. The denominator will use earned or written premiums
depending on the local accounting convention, and the nature as to
how expenses are incurred to better match costs to volume. In
certain accounting regimes expenses are incurred as paid, and in
others they are incurred as premiums are earned.
Variances in expense ratio among insurers can be due to
differences in distribution system costs (agency, direct,
underwriting manager), the nature of the book and varying needs to
underwrite each risk, pricing strategy with respect to expense/loss
ratio mix, level of fixed versus variable costs, cost efficiencies
and productivity, profit sharing and contingent commission
arrangements, and ceding commission levels.
Combined Ratio measures overall underwriting profitability and
is the sum of the loss ratio and expense ratio (including any
policyholder dividends). A combined ratio less than 100% indicates
an underwriting profit. Typically, lower combined ratios are
required for companies writing short-tail lines generating modest
investment income levels, or in which the book is exposed to
periodic catastrophic or other large losses that need to be priced
into income over longer periods of time.
Operating Ratio measures operating profitability, which is the
sum of underwriting and pretax investment income, excluding
realized and unrealized capital gains or losses. The ratio is the
combined ratio less the ratio of investment income to net earned
premiums. Due to the combining of underwriting and investment
earnings, the ratio is fairly comparable across both long- and
short-tail lines of business. Several factors can make comparisons
among companies difficult, including:
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12 Non-Life Insurance Rating Methodology March 31, 2011
Differences in operating leverage and the amount of investment
earnings derived from invested assets supporting policyholders
surplus.
Differences in investment strategies, particularly with respect
to the taxable/tax-exempt mix and allocations to lower
income/higher capital gain producing investments such as common
stocks.
Strong growth in long-tail lines for which reserves and invested
asset balances have not yet accumulated to levels reflective of a
mature book.
Return on Surplus/Equity measures a companys after-tax net
income relative to mean surplus or equity levels, and indicates
both overall profitability and the ability of a companys operations
to grow surplus organically. Variances among companies are
explained by both differences in operating profitability and
differences in net operating and/or financial leverage. For a
profitable company, a less favorable (i.e. higher) leverage
position will result in a more favorable result on this test.
Premium Growth Rate is a useful measure when compared with peer
companies and judged relative to cyclical industry trends.
Companies exhibiting above-average growth rates may be the result
of underpricing their products. Premium growth is also a useful
measure of franchise value, as negative growth can be a sign of an
eroding franchise. The ratio is influenced by both changes in rate
adequacy and changes in volume, so care is taken in interpreting
this ratio.
Cash Flow Ratio measures the level of operating cash inflows
relative to operating cash outflows in a given period. A ratio more
than 100% indicates positive operating cash flow and a ratio less
than 100% indicates operating cash flow is negative. The ratio will
frequently be evaluated both in absolute terms and from the
perspective of a trend. Values greater than 100% are viewed
positively. Companies with positive cash flow are less likely to
need to liquidate assets to pay claims. The cash flow ratio is also
analyzed relative to premium growth, as a fast-growing company or
one that practices cash flow underwriting will have strong cash
flow, but it is unlikely to be sustainable over time.
Investment and Liquidity Non-Investment-Grade Bonds as a
percentage of surplus/equity measures the surplus/equity exposure
to bonds below investment-grade (rated lower than BBB), which carry
above-average credit risks. In some jurisdictions, where the
country ceiling is below the investment-grade level, Fitch measures
the actual exposure to stressed investments as a substitute
measure.
Unaffiliated Common Stocks as a percentage of surplus/equity
measures the surplus/equity exposure to common stock investments.
Since common stocks are both subject to price volatility and are
carried at market values, a high level of common stocks potentially
adds an element of volatility to reported surplus/equity
levels.
Investments in Affiliates as a percentage of surplus/equity
measures the surplus/equity exposure to affiliated investments.
High levels of affiliated investments can reduce liquidity, expose
surplus to fluctuations (if common stock), and potentially signal a
stacking of capital within the organization.
Liquid Assets to Technical Reserves measures the portion of a
companys net policyholder reserves covered by cash and unaffiliated
investment-grade bonds, stocks, and short-term invested asset
balances. Higher values indicate better levels of liquidity.
Investment Yield is calculated as a percentage of mean beginning
and ending cash and investments and accrued investment income. It
is a measurement of investment performance. Acceptable values vary
over time depending on market conditions.
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Non-Life Insurance Rating Methodology March 31, 2011 13
Deviations among companies can be explained by differences in
the taxable/tax-exempt mix, the credit quality and resultant yield
characteristics of the bond portfolio, concentrations in higher
return/lower yielding common stocks, the level of investment
expenses, and the quality of portfolio management.
Loss Reserve Adequacy Reserve Development to Prior-Year Loss
Reserves measures a companys one-year loss reserve development as a
percentage of prior years loss reserves, and indicates the
historical accuracy with which loss reserve levels were set.
Negative numbers indicate redundancies and a more conservative
reserving profile, while positive numbers indicate deficiencies and
a less conservative reserving profile.
Reserve Development to Surplus/Equity measures a companys
one-year loss reserve development as a percentage of prior years
surplus/equity, and indicates the extent surplus/equity was either
under or overstated due to reserving errors.
Reserve Development to Earned Premium measures a companys
one-year loss reserve development as a percentage of net premiums,
and indicates the extent the current calendar year loss ratio was
influenced by development on prior years business.
Ceded Reinsurance Exposures Retention Ratio measures the
percentage of gross premiums written retained after premiums are
ceded to purchase reinsurance protections. The amount of
reinsurance necessary to protect surplus from large losses varies
significantly by line of business and the nature of loss exposures,
as well as the absolute size of an insurers capital base relative
to its single risk and aggregate policy limits. Unusually high or
low retention levels could signal that inadequate reinsurance
protections are in place, or that reinsurance is used for financial
or other reasons beside risk spreading.
Reinsurance Recoverables to Surplus/Equity measures a companys
exposure to credit losses on ceded reinsurance recoverables. The
ratio includes recoverables from all reinsurers. Generally,
recoverables from affiliates, pools, and associations are
considered to carry lower levels of risk. The ratio should also be
interpreted in light of the credit quality of reinsurers, the
stability of the relationship between insurer and reinsurer,
historical collection patterns, and any security held in the form
of letters of credit, trust accounts or funds withheld. Acceptable
levels for this ratio will generally be higher for long-tail
writers and lower for short-tail writers, reflecting natural
differences in the build up of ceded loss reserves.
Capital Adequacy Net Premiums Written to Surplus/Equity
indicates a companys net operating leverage on current business
written, and measures the exposure of surplus/equity to pricing
errors. Acceptable levels of net operating leverage vary by line of
business, with longer-tail lines and catastrophe-prone lines often
requiring lower levels of net underwriting leverage due to their
greater exposure to pricing errors. Since net premiums written are
influenced by both volume and rate adequacy, interpretations must
be made carefully since an adverse decline in rate adequacy could
lead to apparent improvements in this ratio.
Net Leverage indicates a companys net operating leverage on
current business written, as well as liabilities from business
written in current and previous years that have not yet run off.
The ratio is calculated by dividing the sum of net premiums written
and total liabilities, less any ceded reserves, by surplus/equity,
and it measures the exposure of surplus/equity to both pricing and
reserving errors. Acceptable levels for this ratio will generally
be higher for long-tail writers and
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14 Non-Life Insurance Rating Methodology March 31, 2011
lower for short-tail writers, reflecting natural differences in
the build up of loss reserves.
Gross Leverage indicates a companys overall gross operating
leverage, combining both net and unaffiliated ceded premium and
liability exposures. The ratio is calculated by dividing the sum of
gross premiums written (direct plus assumed) and gross liabilities
(total liabilities including ceded loss and unearned premium
reserves) by surplus/equity. The ratio measures the exposure of
surplus to pricing errors, reserving errors, and credit losses on
uncollectible reinsurance recoverables. Acceptable levels for this
ratio will generally be higher for long-tail writers and lower for
short-tail writers, reflecting natural differences in the build up
of loss reserves.
Regulatory Capital Ratios are also reviewed in regions where
they are available. These include the NAICs risk-based capital
ratio in the U.S., the minimum continuing capital and surplus
requirements (MCCSR) in Canada, the Solvency I ratio in Europe, and
various solvency margins in other regions. Although, in some
regions, local regulatory capital rules can be limited in scope and
result in greater emphasis on simple leverage measures discussed
above.
Financial Leverage and Coverage Total Financing and Commitment
(TFC) Ratio is a comprehensive measure of debt-related leverage,
making use of a broad definition of debt to include essentially all
financing activities, including traditional financial debt as well
as both recourse and nonrecourse securitizations, letters of credit
facilities with banks provided to third-party beneficiaries
(largely used by alien or offshore reinsurers and so-called
match-funded debt), and debt guarantees and other financing-related
commitments. The ratio is designed to measure the debt, financing,
and capital markets footprint of an organization, and its overall
reliance on ongoing access to funding sources. The measure is
intended to flag those companies that have an above average
reliance on the capital markets for funding, which would trigger
further analysis by Fitch to understand the relative risk of the
companys various funding activities. Perceived high levels of risk
would have a negative impact on ratings.
Adjusted Debt to Total Capital measures the use of financial
leverage within the total capital structure. Financial debt
excludes operational debt, such as obligations issued by
non-insurance finance subsidiaries and it includes solely
insurance-related financial debt provisions. Special care is taken
in assessing the quality of reported equity, taking into
consideration the portion supported by intangible assets such as
goodwill. This ratio is adjusted to account for equity credit for
any hybrid securities, which possess both debt and equity
characteristics, and liquid assets maintained at the holding
company.
Fixed-Charge Coverage Ratios are calculated on both an operating
earnings and cash flow basis to judge economic resources available
to pay interest expense, including the interest portion of rent
expense, and preferred dividends. Where applicable, coverage ratios
are also calculated to reflect dividend restrictions from regulated
entities.
Interest Coverage Ratios are calculated on both an earnings and
cash flow basis to judge economic resources available to pay
interest expense associated with outstanding debt. Where
applicable, coverage ratios are also calculated to reflect dividend
restrictions from regulated entities.
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Non-Life Insurance Rating Methodology March 31, 2011 15
Appendix C
Relating Key Credit Factors to Rating Levels This section
includes a description of how the various key credit factors
discussed earlier in this report, as well as key ratios discussed
in Appendix B, can relate to rating levels. The goal is to give
readers a clearer understanding of how differences in performance
under the various aspects of Fitchs analysis translate into
ratings. For sake of simplicity, the focus of this discussion is on
International-scale ratings in markets that are not constrained by
country ceilings.
It should be noted that the discussion in this Appendix is
illustrative only, and is highly simplified. The setting of ratings
is ultimately highly judgmental and dynamic, as is not based on a
formulaic approach.
Industry Profile and Operating Environment The rating of any
entity is influenced, and potentially constrained by, the risk
profile of its industry and operating environment. As discussed on
pages 23 of this report, pricing cyclicality, intense competition,
actuarial pricing and reserving challenges, catastrophe losses, and
regulatory issues are the key credit factors that affect the core
industry risk profile of all non-life (re)insurers.
Despite these industry risks, a majority of non-life
(re)insurers in Fitchs rated universe (which is weighted more to
larger and midsize companies) have IFS ratings in the AA and A
categories, and holding company IDR and senior debt ratings in the
A and BBB categories. Additionally, a very select number of
non-life (re)insurers are rated as high as AAA for IFS (AA for
debt), and some are rated in the BBB and lower categories for IFS
(non-investment grade for debt). Fitch observes that most insurance
companies in the broader non-life (re)insurance sector manage their
risk profiles with a goal of achieving higher ratings because it is
generally difficult for companies to compete at lower ratings
levels. Key risk mitigants are prudent capital and liquidity
management, as well as conservatism in overall risk management
strategies.
Accordingly, there are no constraints on ratings levels that are
achievable in the non-life (re)Insurance sector based on industry
profile and operating environment alone. This, as well as an
expected concentration of ratings levels in the AA and A
categories, is highlighted in Table 1 below. It should be noted
Table 1 applies to both primary and reinsurance companies, and to
all lines of business.
Interpreting the Rating Range Tables
In the Rating Range tables, the wide band indicates a probable
ratings range within which a majority of companies would be
expected to reside. The narrow band extending out to the arrows
reflects the full range of ratings that could theoretically be
achieved. Accordingly, a smaller number of companies with more
unique circumstances would fall in the ratings range represented by
the area between the arrows and wide band.
When a soft cap exists based on the credit factor being
considered, this is noted in the commentary preceding the
table.
Each column header includes both the IFS rating and the senior
debt rating. The debt ratings are shown one category lower than the
IFS rating, which is the norm when senior debt is issued by a
holding company. See the notching criteria referenced on page 1 of
this report for additional details on the relationship between IFS
and debt ratings.
Table 1: Ratings Range Based on Industry Profile/Operating
Environment
Debt:
IFS: AAA AA A BBB
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16 Non-Life Insurance Rating Methodology March 31, 2011
Company-Specific Traits The following is a discussion of how the
company-specific aspects of an insurers credit profile are related
to ratings levels.
Ownership Implications of ownership are discussed more broadly
in Fitchs global master criteria for insurance companies,
referenced on the first page of this report. For purposes of this
summary, one critical aspect of ownership that can affect the
achievable rating level is mutual versus stock ownership.
Fitch currently does not, nor does it anticipate, assigning AAA
IFS ratings to insurance companies other than those owned under the
mutual form of ownership (and even then, only in rare cases). Fitch
believes that the need to meet shareholder return hurdles, together
with the marginal (if any) competitive advantages of being rated in
the AAA versus AA category for IFS, imply that AAA rating levels
generally do not make economic sense for stock companies in the
non-life sector. Mutual insurers, on the other hand, have greater
incentives to hold excess capital and liquidity positions, or
employ other conservative risk management measures, since returns
on capital are a lower priority.
This difference is illustrated in Table 2 below, which is
intended to simply demonstrate that stock ownership provides for an
effective soft cap on IFS ratings at AA+.
Company Profile and Risk Management As noted on pages 3 of this
report, company profile and risk management are important factors
in considering a non-life insurers risk profile. In fact, both can
play a dominant role in establishing rating levels.
In the context of this discussion, company profile is primarily
defined by the composition of the insured portfolio, focusing
mainly on business mix, with an emphasis on scale/size and market
positioning. Typically, only larger companies with both significant
scale and major market positioning, can achieve ratings in the AA
and AAA categories for IFS. Midsize companies, or more modestly
positioned or specialized companies, can typically achieve ratings
in the A category. Very small, and/or narrowly focused companies
often achieve ratings no higher than the BBB category. The
relationship between market positioning and scale/size, and ratings
levels, is illustrated in Table 3 below.
Three other credit factors comprising a companys qualitative
risk profile that can materially affect ratings include: risk
management, corporate governance, and financial flexibility. While
the three are clearly distinct ratings considerations, in relating
each to
Table 2: Ratings Range Based on Ownership Form
Debt:
IFS: AAA AA A BBB
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Non-Life Insurance Rating Methodology March 31, 2011 17
ratings levels they share a common characteristic: each is
generally considered neutral to a rating when considered
effective/adequate. When this is the case, it will be the other
aspects of the companys credit profile that drive its rating
level.
When these credit factors are considered generally effective and
adequate but with a modest weakness, then the rating achievable may
be somewhat constrained. Subsequent improvement in these
characteristics may remove prior constraints on ratings.
However, if any of these characteristics are deemed to be weak,
ineffective or inadequate, this could have a material negative
impact on a rating. The impact is illustrated in Table 4 below,
which indicates a soft cap of BB+ for IFS when there is material
concerns.
A final key aspect of a companys profile that can materially
affect the achievable rating is years of operations. Other than on
an exceptional basis, typically, newly formed companies with
limited operating histories will not be able to achieve higher than
the BBB category for IFS ratings and non-investment grade for debt
during their initial years of operation absent formal support. This
is demonstrated in Table 5 on the next page.
Table 3: Ratings Range Based on Market Position and
Size/Scale
Debt:
IFS: AAA AA A BBB
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18 Non-Life Insurance Rating Methodology March 31, 2011
Financial Profile Median Ratios As noted on page 4 of this
report, capitalization, reserve adequacy, investments, and
financial performance play key roles in Fitchs assessment of a
non-life insurers financial profile, as do catastrophe management
and reinsurance. While employing qualitative elements, these
analyses also rely heavily on ratio analysis.
To help make the relationship between ratio performance and
ratings levels more transparent, included below in Table 6 are
median guideline ratios by rating category for a number of the
ratios discussed in Appendix B. These median guidelines represent
targets that Fitch would typically look for as a standard of
performance to meet a rating bogey. For example, for an IFS rating,
Fitchs median guideline for an AA quality combined ratio is 95%,
and for a BBB rating, Fitchs standard is 110%. Thus, if a non-life
insurer achieved a combined ratio of 97%, the agency would say that
the companys underwriting performance, as measured by the combined
ratio, achieved Fitchs AA standard. If the combined ratio was 108%,
the agency would say it met Fitchs BBB standard.
These ratio guidelines were developed based on Fitch judgment,
and are intended to apply globally on the international rating
scale. It should be noted that these are general in nature, are
through the cycle medians, and reflect average results across all
business lines. Ultimately, interpretation of a companys actual
performance relative to these bogeys can be quite challenging,
since it will be influenced by a mix of business and other issues,
such as trend and year-to-year variability of performance; impact
of pricing cycles; and position in cycle at any given measurement
point, stock versus mutual ownership form, long tail versus short
tail focus, country/region, and accounting treatment, including
uses (or not) of reserve discounting. See page 21 for further
discussion of limitations.
Table 5: Ratings Range Based on Years of Operations
Debt:
IFS: AAA AA A BBB
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Non-Life Insurance Rating Methodology March 31, 2011 19
Weighting of Credit Factors in Final Rating In any discussion of
how various credit factors affect ratings, one logical question
would be to ask how the various areas of analysis are ultimately
weighed in arriving at a final rating. In practice, ratings are
derived by Fitch rating committees via judgment based on a review
of all relevant credit factors highlighted in all applicable
criteria reports. Neither Fitch analysts nor rating committees
employ any formal, quantitative weighting mechanism, nor is the
final weighting of the various elements explicitly documented in
committee materials.
Rather, the rating is determined after the committee considers
all of the risk elements deemed material to the rating analysis.
The rational in setting the rating, including identification of key
strengths and weaknesses, expectations, as well as sensitivities of
the rating, are documented in a manner consistent with the
rationale described in published research reports.
With that caveat, Fitch recognizes that readers are nonetheless
interested in better understanding the thought process that may be
employed by a rating committee. Recognizing that interest, below is
a discussion of how a committee may assimilate the various credit
factors in establishing a rating. It must be emphasized that the
discussion below is illustrative only.
Weighing of Qualitative Elements As noted, the following
qualitative credit factors linked to a (re)insurers qualitative
company-specific profile can have a material impact on achievable
ratings levels: ownership (stock versus mutual), market positioning
and scale/size, risk management/governance/financial flexibility,
and years of operations. These qualitative factors, which are
highlighted in Tables 25, have the effect of establishing an
implied rating category. As discussed in the next section of this
Appendix, this is combined with analysis of the financial profile
(and any other relevant information) to arrive at a final
rating.
Table 6: Select Long-Term Median Ratio Guidelines
Insurer Financial Strength
AAA AA A BBB
Underwriting Quality and Profitability (%)
Combined Ratio 80 95 103 110 Operating Ratio 67 82 90 97
Investment and Liquidity (%)
Risky Assetsa to Surplus/Equity 25 50 75 100 Liquid Assets to
Technical Reserves 200 150 125 100
Loss Reserve Adequacy (%)
Long-Term Average Reserve Development to Surplus/Equity (5) (2)
0 5
Ceded Reinsurance Exposure (%)
Reinsurance Recoverables to Surplus/Equity 25 45 65 100
Capital Adequacy (x)
Net Premiums Written to Equity 0.5 1.1 1.8 2.5 Net Leverage 2.0
3.5 5.0 7.0
Financial Leverage and Coverage
Interest Coverage Ratio (x) 18 12 7 3 Adjusted Debt to Total
Capital (%) 5 15% 23 30
aThis ratio is a combination of the non-investment-grade bond,
unaffiliated common stock, and investment in affiliates to
surplus/equity ratios discussed in Appendix B.
Financial Leverage, Coverage, and Notching
While the median financial leverage and interest coverage ratios
in Table 6 give a general indication of reasonable levels for these
ratios by rating category, in practice, leverage and coverage
ratios are often more heavily weighed into Fitchs ratings via ratio
guidelines related to notching between IFS and debt ratings of
operating and holding companies. These are described in detail in
the criteria report, Insurance Industry: Global Notching and
Recovery Analysis, that is referenced on page 1 of this report.
In the noted report, Fitch discussed how financial leverage and
coverage influence the degree of notching between the IDRs of an
operating subsidiary and holding company, as well as their IFS and
debt ratings. For example, Fitch states that it typically views
financial leverage of 16%30% as customary for larger, debt issuers
in the insurance industry, and that typically if financial leverage
were to exceed 30%, the agency would likely expand notching. For
example, typical IDR notching of 1 may be expanded to 2, and
typical IFS to holding company senior debt rating notching of 3 may
be expanded to 4. This tolerance varies by rating category, with
additional details found in the noted report.
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20 Non-Life Insurance Rating Methodology March 31, 2011
The weighting of the various qualitative credit factors is
ultimately based on judgment. While to some degree the weakest
factor may receive the highest weighting, no strict weakest link
theory is employed. It should be noted that the credit factors in
Table 4 can have the affect of hurting, but not helping ratings, as
previously discussed.
To illustrate, assume a non-life (re)insurer with the following
characteristics per Tables 25:
Table 2: Stock company.
Table 3: Moderate market positions, and modest scale/size.
Table 4: Risk management, governance, and financial flexibility
deemed effective.
Table 5: Years of operation of 15.
In this case, the initial implied category for the IFS rating
would be A, with the constraint being driven mainly by the insurers
moderate market positioning and modest scale and size.
Assume also a second non-life insurer below:
Table 2: Stock company.
Table 3: Very small company, book of business limited to
property reinsurance provided in limited number of regions to
limited number of ceding companies.
Table 4: Risk management, governance, and financial flexibility
deemed effective.
Table 5: Years of operation of two.
In this case, the initial implied IFS rating category would be
BBB, driven by both the limited years of operation, as well as the
companys very narrow business focus.
Finally, assume a third company:
Table 2: Mutual company.
Table 3: Large and highly diverse, with several major positions
in several major markets.
Table 4: Risk management, governance, and financial flexibility
deemed effective.
Table 5: Years of operation of 50.
In this case, the highest achievable category implied for the
IFS rating would be AAA, though as previously noted, the typical
range would be AA to A.
Weighing of Quantitative Elements/Financial Ratios Next, Fitch
will illustrate how the qualitative elements can be combined with
the financial analysis to arrive at a final rating. While for
purposes of this illustration the agency shows the order of the
analysis as the qualitative assessment coming first and the
financial analysis coming second, the ordering is not important and
will vary in practice.
Assume a case in which the rating category implied by the
qualitative assessment is A.
Generally, the final notch-specific rating will be established
at the + (plus) end of the category, or even within the next
highest category, if performance on the various financial ratios
exceeds that for the initial implied rating category. Accordingly,
in this
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Non-Life Insurance Rating Methodology March 31, 2011 21
case if a majority of the financial ratios demonstrate A or
higher performance, it is likely the final rating will be
established at A+. If performance was especially strong, the final
rating could potentially be AA or higher.
On the other hand, if ratio performance is below parameters for
the initial implied rating category, the notch-specific rating will
likely be established at the (minus) level in that category, or at
a lower rating category. For example, if the implied rating
category based on the qualitative assessment is A and most ratios
were at A to BBB performance, the notch-specific rating would
likely be A to BBB+. If the ratio performance was typically much
worse than A, at BB, or B, the final notch-specific rating would
likely fall to the BB or B categories.
Extraordinary Weighing of a Credit Factor There may be cases as
well when the committee may give extraordinary weighting to any one
credit factor. For example, assume the implied rating based on
Table 25 attributes is A, and performance on most financial ratios
also falls in the A category. Typically, one would expect a final
rating of A. However, assume in Fitchs analysis of reserve
adequacy, the committee was concerned that reserves may be
materially deficient, and that on a pro forma basis, adjusted for
estimated reserve deficiencies, capital would be negative (implying
technical insolvency). In such a case, Fitch would likely rate the
non-life (re)insurer non-investment grade, giving heavy weighting
to that one risk element given its critical implications.
Any such cases in which one or more credit factors receive
extraordinary weighting in the final rating, it would be
highlighted in Fitchs published rating rationale.
Peer Analysis Another important exercise in establishing ratings
is relative peer analysis. Peer analysis is especially useful after
Fitch has established a fairly large portfolio of ratings across
numerous ratings grades in a given sector, and when ratings levels
are generally stable. In fact, in many cases, relative peer
analysis is a noteworthy aspect of the analysis used by analysts
and rating committees to form conclusions with respect financial
ratio analysis, or review of certain non-financial attributes, such
as market positioning. In such cases, an explicit comparative
analysis of a given non-life (re)insurers ratios to Table 6 medians
may not be performed, since the Table 6 medians would already be
implied in the peer company ratios.
A summary of Fitchs peer analysis is typically included in
long-form company-specific research reports.
Additional Limitations The general limitations of this rating
criteria, as well as non-life (re)insurance ratings generally, are
discussed on page 2 of this report. The following are additional
limitations that apply to this Appendix C:
The impact on ratings of credit factors such as group support
and country ceilings, as well as topics such as notching between
IFS ratings and debt/holding company ratings, and national ratings,
can be found in separate criteria reports referenced on page 1 of
this report, and are not discussed in this Appendix. The Appendix
focuses primarily on investment-grade ratings in developed markets,
and accordingly does not provide significant information on
standards for non-investment-grade ratings or ratings in developing
markets. These exclusions represent limitations of this
Appendix.
The Appendix outlines indicative factors observed or
extrapolated for rated insurers. Though used for development of
global guidelines in developed countries, the
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22 Non-Life Insurance Rating Methodology March 31, 2011
underlying data reviewed was heavily skewed to U.S. companies.
Ratio levels refer to the midpoint of a through-the-cycle range,
and actual observations in any given period are likely to vary from
these, at times significantly. Ratio levels reflect a compilation
of observations across non-life (re)insurers with materially
different books of business. Material differences can exist, at
times, in median ratios for cohorts of insurers with different
books of business. Since these differences are not reflected, that
can limit the interpretative value of the median ratios.
The weighing of credit factors will vary substantially over
time, both for a given insurer and among insurers, based on the
relative current significance agreed upon by the rating committee.
This Appendix gives a high level overview, and is neither
exhaustive in scope nor uniformly applicable. Additional factors
not discussed in this Appendix will influence ratings, at times
materially.
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DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY
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RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE
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Copyright 2011 by Fitch, Inc., Fitch Ratings Ltd. and its
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ratings, Fitch relies on factual information it receives from
issuers and underwriters and from other sources Fitch believes to
be credible. Fitch conducts a reasonable investigation of the
factual information relied upon by it in accordance with its
ratings methodology, and obtains reasonable verification of that
information from independent sources, to the extent such sources
are available for a given security or in a given jurisdiction. The
manner of Fitchs factual investigation and the scope of the
third-party verification it obtains will vary depending on the
nature of the rated security and its issuer, the requirements and
practices in the jurisdiction in which the rated security is
offered and sold and/or the issuer is located, the availability and
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