Download Credit analysis of general insurers and Lloyd`s syndicates (slides)

GIRO 2001 Glasgow
Credit Rating Workshop
Simon Harris
October 2001
1
Presentation Overview
• Credit rating overview
• How it is done
• Debt ratings
• Use of models
• Ratings for Lloyd’s
• What about the failures ?!
• Example credit analysis
• Numbers but no formuale !
2
Insurance Financial Strength
Ratings
• Opinion on the insurer’s ability to repay
punctually senior policyholder claims and
obligations (policyholder perspective)
• Globally consistent rating scale
• Between major rating agencies, coverage in
most markets is extensive (NB, PI vs full rating)
• Used to varying degrees by brokers and
internal security panels
3
Rating of debt instruments
• Usually at least one rating required for a new
‘sale’, 2 ratings more common
• Used by professional investors to assess risk
- often guidelines on debt they can hold
• Effectively outsources ‘research’ to agencies,
and gives independent view
• Also important in secondary market
4
The role of the rating agencies
• Independent assessment of financial adequacy..
• ..used by intermediaries, lenders, policyholders
• In standardised markets, of greater importance
• Debt ratings used to support primary and
secondary markets
• Assist generally in transparency, cross-border
awareness
5
How financial strength is
assessed (the ‘black box’)
• ‘PI’ vs full ratings
• Combination of qualitative and quantitative
factors, varies by agency
• Usually a committee decision, with extensive
discussion of the company, peers, industry
• Ratings need to be comparative globally and
across industries
6
Financial strength assessment
- example detail
• Qualitative
– Market position, brand, distribution, ownership
– Management quality, strategy, attitude to risk
• Quantitative
– capitalisation, earnings capacity, reserve
adequacy
– profitability, expense levels, gearing
7
Is a ‘Quant’ model a good idea ?
• Difference between rating agencies
• Actuaries like models…...
• ….but model and ratio analysis is by
definition backwards-focussed, whilst
liabilities can be far into the future
• Management, brand, franchise, distribution
etc. remain key influences on security
8
Rating the Lloyd’s market
• Is a market rating appropriate ? - different
approaches evident
• Are all syndicates the same, in terms of operating
performance, capital support etc..?
• Impact of capital providers’ resources, cash calls,
Central Fund, stop-loss
• A complex business
9
Lloyd’s market rating
A good idea
• Central fund, other
central resources
support market
• Lloyd’s ‘franchise’
applies to all synds
• RBC captures
differences in capital
support and liability
profiles
Not a good idea
• Syndicates have
different capital support
• Some may be ‘nearer’
to CF than others
• Differences in mgt, u/w
performance
• May lead to (long-term)
damage to market
franchise
10
Generic approach to debt rating
• IFSR is starting point..
• ..and expected loss concept drives relationship
between IFSR and debt rating
• Priority of claims in liquidation is key, which until
recently favoured debtholders, EU legislation now
protects all policyholders
• ..so debt tends to be at least one ‘notch’ below IFSR
• ..but subordination, corporate structure may change
this
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Moody’s expected loss graph corporate bonds
30
Zahlungsstörungsquote
(%)
25
20
15
10
5
0
B
Rating
Ba
Baa
A
Aa
Aaa 1
3
5
7
9
11
13
15
17
19
Jahre
12
Credit rating example
• Example company analysis
• Basic concepts of
– subordination
– priority of claim
– interest cover and leverage analysis
• Not a definitive analysis !!
13
Structural Subordination
• Key to many credit / debt ratings
• Policyholder rankings and seniority of claims
in a wind-up situation
• Can be improved by a guarantee
14
Subordination and Notching (1)
• All about cashflows
• ABC Insurance plc
ABC Insurance Group
ABC plc
Holding company
ABC Insurance Holdings
Finance company
ABC Insurance plc
Operating Company
ABC Insurance USA
ABC Insurance UK
– insurance company where
cashflows are generated. Also
benefits from ownership of
operating subsidiaries.
• ABC Insurance Holdings
– dependent on ABC Ins plc for
cashflows
• ABC plc
– dependent on operating
cashflows lower down and also
pays shldr dividends
15
Subordination and Notching (2)
• Aa3/AA- IFSR at ABC Ins plc
ABC Insurance Group
ABC plc
Holding company
ABC Insurance Holdings
Finance company
ABC Insurance plc
Operating Company
ABC Insurance USA
ABC Insurance UK
– implied senior debt of
A1/A+
• Subordination applies to hldg
co’s
– A2/A senior debt at ABC
Ins Hldgs
• Guarantee aids rating
– A1/A+ g’teed (by ABC Ins
plc) debt at ABC plc
16
Subordination and Notching (3)
ABC Insurance Group
• Diversity of earnings
can be a positive for
holding co.
ABC plc
Holding company
Aa1 senior debt ?
XYZ Insurance USA XYZ Insurance UK
Aa3 senior debt
A1 senior debt
XYZ Ins Asia
A2 senior debt
• ‘Two-party pay’ principle
XYZ Asset Mgt
Aa3 senior debt
17
Analysis of Interest Cover
• Cashflows are main focus (default occurrs
through non-payment, not high leverage)
• Focus on realistic earnings level
– what are sustainable earnings ? (mediumterm)
– start point is regulatory earnings
– important to include ‘reasonable’
investment income
• ..compared with interest payments
18
Analysis of Leverage
• Common focus is debt / (debt + equity)
• Debt
– issued debt, other borrowings, hybrid equity
– focus on ‘core debt’ (i.e. not matched
borrowings)
– exchangeable bonds may be excluded
• Equity
– statutory free assets / equity, hybrid equity
19
Impact of debt on IFSR
• Debt at holding company can restrict
IFSR
• As can debt at operating company
• Consolidated approach used to include
all features, in leverag analysis (not
notching)
20
What about the failures ?
• Independent, HIH, (Equitable Life)
• Rating agencies find it difficult dealing with ‘event
risk’, but was that the case here ?
• Reinforces need for qualitative assessment ?
Would / did a model help ?
• Should regulation use rating agencies’ opinions ?
21
Effects of the WTC attacks
• Ratings reviews and downgrades by most
agencies
• ‘Event risk’ that is not normally captured in
ratings..
• …but does this signal a change in view of the
risk profile of the industry generally ?
22
Comparing across industries
• Many re/insurers are
rated Aaa,
compared with e.g.
banks
• Are industry barriers
falling ? (ART ?)
• Is the risk profile
changing ?
• Aaa ratings
(Moody’s)
– Re/insurance
(Allianz, Munich Re,
Swiss Re,
GE/Cologne Re)
– Banks (Lloyds TSB,
Rabobank)
– Corporates (GE,
Pfizer, Shell)
– Sovereigns
23
Final discussion points
• Is the industry as a whole a ‘good’ credit risk ?
• Are brokers / policyholders becoming more or
less credit-sensitive ?
• Do actuaries help with ‘risk’ assessment ?
• Will financial condition reporting improve
analysis by external parties ?
• Is management the ‘real’ risk for most ?
24