Aon Benfield Analytics
Overview of S&P’s Request for
Comment:
“Insurers: Rating Methodology”
July 2012
port Document Title
Sub-Title of Report Document
Date
General Overview
On July 9, 2012, Standard & Poor’s (S&P) released a Request for Comment (RFC) that corresponds to
their new set of proposed criteria for rating insurance companies. This also includes a document on the
anticipated changes to their rating methodology as well as an online tutorial on the new framework and
the recommended underlying changes. S&P has set a deadline of September 9, 2012 for comments and
responses from the industry before they finalize the new criteria, with the stated goal of implementation in
late 2012 or early 2013. Additionally, before implementation S&P plans to issue a report summarizing the
comments they have received.
S&P has advised that the updated methodology is part of a company-wide criteria revision focused on
increased transparency. For reference, S&P went through a similar process for financial institutions in
2011 where they published the final updated criteria on November 9, 2011. S&P subsequently issued a
press release stating it reviewed the ratings on the largest financial institutions by applying its new ratings
criteria twenty days later. In respect of the proposed insurer update, S&P has stated that based on their
testing they expect that the majority of ratings will remain unchanged or move by no more than one notch
after implementation, and that any change to the overall distribution of ratings is expected to be modest.
This paper summarizes the new model framework that S&P is proposing, compares it against the current
methodology, details key aspects with regards to their new criteria, and provides key questions that S&P
is looking for feedback on. We intend that this document can be utilized as a general overview and
reference on S&P’s proposed methodology. For the full RFC, please go to:
http://www.standardandpoors.com/insurancecriteria
S&P has cited the following reasons for transitioning to new criteria for rating global insurance companies.
Transparency
Recently S&P’s sovereign and bank ratings criteria has been enhanced to increase
transparency for users. S&P is continuing this focus by updating the global insurance company
rating methodology.
Specificity
Increasing the specificity of the ratings factors and sub-factors. This expands beyond the scope
of capital adequacy into all aspects on S&P’s rating framework.
Forward
Looking
Nature
Forming a global framework for rating insurance companies that is more forward looking and
increases comparability; providing consistent analysis for all global insurers.
Centralizing
Various
Criteria
Centralizing the insurance criteria framework in one single criteria document. The proposed
framework combines various criteria and will at least partially supersede certain existing criteria.
The new S&P framework is based on the analysis of the Business and Financial Risk Profiles of each
insurance company. These two main areas are the "anchor" of the new rating framework. S&P is utilizing
a matrix view to compare each insurance company’s risk profile, and will implement certain thresholds
and caps to determine the final ratings, which will be described in more detail below. The analysis will
focus on current year results as well as the upcoming two years of anticipated performance. While a
prospective approach is not new for S&P, the proposed criteria more formally introduces a consistent
forward looking methodology.
Overview of S&P’s RFC: “Insurers: Rating Methodology”
1
The proposed criteria apply to all insurers in the business of life, health, and property / casualty
insurance, and reinsurance. The criteria exclude ratings on bond insurers, insurance brokers, insurers
that are starting up or are in run-off, and mortgage and title insurers. Additionally, public information (pi)
ratings are out of the scope of the RFC.
The New S&P Framework can be summarized broadly in the following chart.
The proposed criteria determine an
operating company’s insurer rating
using five key steps:
1. Evaluate Business Risk Profile
2. Evaluate Financial Risk Profile
3. Derive Rating Anchor from
combination of 1 and 2
4. Apply Modifiers and Caps
5. Determine Group or
Government Support, if any
The aim is to clearly and in
considerable detail specify the
factors and sub-factors of the
analysis and to show how they
combine into rating outcomes.
A key aspect of the rating matrix
in the proposed criteria is geared
towards enhancing transparency.
The criteria provide detailed
quantitative and qualitative
components of how rating factors
(and sub-factors) are measured
and integrated within the rating
matrix to derive a rating. On the
right is our view of where the rating
components of S&P’s current
rating framework flow into the
proposed criteria.
New factors in the proposed criteria
not explicitly addressed in the
current rating criteria include the
impact of Industry and Country
Risks, analysis of prospective capital
adequacy and risk position. S&P’s
assessment of ERM and its capital
adequacy model are unaffected by
the proposed criteria.
Aon Benfield Mapping of S&P Rating Criteria: Current vs. Proposed
Current Rating Components*
Proposed Rating Matrix
Industry Risk
Operating Performance
Business Position

Business Risk Profile (Anchor)
Operating Performance
Investments
Capitalization
Financial Flexibility

Financial Risk Profile (Anchor)
Management & Corporate Strategy
Enterprise Risk Management

ERM - Management (Modifier)
Liquidity

Liquidity (Cap)
* Note: Shown for illustration purposes on a "best fit" basis; Operating Performance is
considered a key component of both Business Risk and Financial Risk profiles; Other
rating components may also fall into multiple places of the proposed rating matrix
Overview of S&P’s RFC: “Insurers: Rating Methodology”
2
Business Risk Profile
The Business Risk Profile (BRP) is intended to assess the risk inherent in an insurer’s operations and the
potential sustainable returns resulting from these operations. The two main drivers of Business Risk are
Insurance Industry Country Risk Assessment and Competitive Position.
Insurance Industry Country Risk Assessment (IICRA): This broadly addresses the market and
segment risk of an insurer—including the sovereign risk. The IICRA score is a weighted blend of S&P’s
analysis of the Country Risk Score and the Industry Risk Score based on a matrix of outcomes provided
by S&P. Insurance companies that operate in a single country/sector would be assigned with that country
or sector’s IICRA score. A weighted average score based on GPW from respective areas/regions is used
for companies that operate in multiple areas or regions. The underlying aspects for determining IICRA are
included in the sub-factors below.
Country Risk Sub-factors




Economic risk
Political risk
Financial system risk
Payment culture and the rule of law
Industry Risk Sub-factors





Return on capital
Product risk
Barriers to entry
Insurance penetration trend
Institutional framework
Competitive Position: S&P looks at a company’s operating performance on numerous levels by
comparing it to the various industry benchmarks, peer studies and distribution channels. The sub-factors
below are assessed using a score of Positive, Neutral, or Negative in each category






Operating performance
Differentiation of brand or reputation
Market share
Level of controlled distribution channels
Geographic distribution
Other diversification
Financial Risk Profile
The Financial Risk Profile (FRP) is viewed as the consequence of decisions that management makes in
the context of its BRP and risk tolerances. The starting point for FRP evaluation is the analysis of capital
and earnings. While analyzing capital and earnings is not new for S&P, combining the analysis into one
seamless component of their methodology is a change to their current approach. Capital and earnings will
be scored on a scale of one to eight, where one is the strongest.
Capital and Earnings: Capital and earnings measurers an insurer’s ability to absorb losses by assessing
capital adequacy prospectively, and is a function of three sub-factors that are scored: (1) regulatory
capital adequacy, (2) capital adequacy based on S&P’s internal model and (3) representativeness of
modeling. This summary does not expand on the regulatory capital adequacy as it appears to be a
standard item that S&P reviews before an in-depth analysis of capital using their proprietary risk based
capital model.
Overview of S&P’s RFC: “Insurers: Rating Methodology”
3
To derive the second capital and earnings sub-factor, capital adequacy, S&P proposes to follow four
steps:
1. Determine total adjusted capital (TAC) and risk based capital (RBC) requirements at various
confidence intervals for the past financial year-end
2. Project the RBC requirement growth or contraction for the next two years. For example, if the RBC
requirement was $12.0M at year-end 2011, and S&P expected 5% business growth, the RBC
requirement at year-end 2012 would be $12.6M.
3. Score earnings quality as “high” or “low”; based on a number of tests to determine earnings volatility.
For example, if S&P’s standard catastrophe charge is greater than annual operating earnings the
score cannot be “high”.
4. Calculate prospective TAC generation and TAC. Earnings quality directly impacts S&P’s calculation
of prospective TAC.
Note that S&P’s capital model is to remain largely unchanged, with some minor adjustments including
removal of concentration and size factor adjustments, as S&P feels those risks are now captured
elsewhere. The last sub-factor of capital and earnings, called Representativeness of Modeling,
determines whether the analysis of prospective capital adequacy has overstated or understated capital
and operating performance. This sub-factor can be scored positive, negative or neutral, and S&P states
most insurers are likely to be scored neutral under the proposed criteria.
Once the capital and earnings score (between one and eight) is determined, it is adjusted by the scores
for risk position and financial flexibility to arrive at the final FRP score.
Risk Position and Financial Flexibility: Risk position assesses material risks that the capital model
does not incorporate, and specific risks that it captures but that could make an insurer’s capital and
related financial ratios significantly more or less volatile. Financial flexibility uses qualitative and
quantitative measures to estimate the balance between an insurer’s sources and uses of external capital
and liquidity over the current and next two years.
Both risk position and financial flexibility are scored strong, adequate, less than adequate or weak, and
are used to adjust the capital and earnings score between minus one and plus two points to arrive at the
overall FRP score. The respective sub-factors used to determine the scoring are:
Risk Position Sub-factors





Exposure to employee benefits obligations
Foreign currency exposure
Investment leverage
Investment portfolio diversification
Additional sources of capital volatility
Overview of S&P’s RFC: “Insurers: Rating Methodology”
Financial Flexibility Sub-factors



Access to sources of external capital and
liquidity
Financial leverage
Fixed-charge coverage
4
Modifiers and Caps
After determining the rating “anchor” by combining the BRP score and the FRP score, the proposed
criteria establish four additional factors to be evaluated. These modifiers and caps apply cumulatively.
A high level review of the four factors is in the below table.
Modifiers
ERM and
Management
Score
Peer
Comparisons
Caps
Liquidity
Score
Fixed Charge
Coverage
Sovereign
Ratings and
T&C
Assessment
The proposed criteria combine two existing rating categories into a single score
ranging from one to five. The importance of ERM is also scored as high or low
depending on the rated entity’s risk profile. The overall score for this rating modifier
is a function of the sub-factor scores of ERM, Management and the importance of
ERM determinations. It should be noted that the proposed criteria do not introduce
any new ERM or Management rating methodology.
The rating anchor can be adjusted by up to one notch in either direction to reflect
the insurer's relative credit standing among peers, either through a holistic analysis
of the eight rating factors (except liquidity) or by identifying below- or aboveaverage vulnerability to event-related risks or sustained, predictable operating and
financial outperformance or underperformance.
The liquidity analysis, and more specifically the proposed liquidity ratio thresholds,
is an enhanced aspect of S&P’s rating methodology. Liquidity is assessed with a
score ranging from one to five and is analyzed absolutely (not relative to peers or
insurers in the same rating category). Liquidity, when analyzed in this section of the
proposed methodology, is a cap to the final rating. Liquidity is a cap instead of a
component of BRP or FRP as S&P views weak liquidity can more likely lead to
default, but strong liquidity does not enhance an insurer’s overall creditworthiness.
This test is another cap to the final rating and provides the following minimum
fixed-charge coverage ratios by credit profile level: aaa: 8x; aa: 5x; a: 3x; bbb: 2x;
bb: 1.5x.
The relevant sovereign ratings and Transfer & Convertibility assessments are
usually a cap, unless the insurer meets certain circumstances (described as rare),
in which the insurer’s rating could exceed the sovereign by a maximum of two
notches. Rating an insurer above the sovereign means that S&P believes the
company’s willingness and ability to service debt is superior to the sovereign and
that there is measurable probability the insurer will not default if the sovereign
does.
Overview of S&P’s RFC: “Insurers: Rating Methodology”
5
Evaluate Group or Government Support
The final steps consider any group support for subsidiaries or extraordinary governmental support for
insurers owned by a government. S&P will assess the status of group members by defining them as
either core, highly strategic, strategically important, moderately strategic or nonstrategic. S&P also
discusses the process of assigning ICRs to non-operating insurance holding companies, operating
holding companies and noninsurance operating companies.
S&P Seeking Responses for Specific Questions
S&P has listed four questions it is seeking market feedback on its proposed criteria:
1. Do the criteria incorporate the key factors affecting an insurer’s creditworthiness? Do you agree with
the main variables for assessing the different factors? If not, what is missing and what is redundant?
2. Are we sufficiently clear and transparent about how we explain the proposed process for assigning
ratings, and standard for evaluating and weighting the proposed rating factors? If not, what areas
would benefit from greater clarity?
3. Do you agree with the way the proposed insurance industry and country risk assessment (IICRA)
score is reached and would affect insurers’ ratings? If not, what alternatives would you propose?
4. Do you agree with the proposed way that liquidity, ERM and management are scored and how they
would affect ratings?
Aon Benfield’s Rating Agency Advisory Group plans to provide written feedback to S&P in regard of this
Request for Comment. Additionally, we can provide assistance in understanding rating agency
requirements and potential changes. Should you or your clients have questions, please do not hesitate to
contact a member of Aon Benfield’s Rating Agency Advisory Group, including:
Overview of S&P’s RFC: “Insurers: Rating Methodology”
6
Contact Information
Global
Kelly Superczynski
Head of Global Rating Agency Advisory
Aon Benfield Analytics
+1 312 381 5351
kelly.superczynski@aonbenfield.com
U.S.
Patrick Matthews
Head of U.S. Rating Agency Advisory
+1 215 751 1591
patrick.matthews@aonbenfield.com
EMEA
Marc Beckers
Head of Aon Benfield Analytics, EMEA
+44 (0)20 7086 0394
marc.beckers@aonbenfield.com
APAC
Rade Musulin
COO, Aon Benfield Analytics, APAC
+61 2 9650 0428
rade.musulin@aonbenfield.com
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Copyright 2012 Aon Benfield Inc.
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Overview of S&P’s RFC: “Insurers: Rating Methodology”
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