2001 CAS ANNUAL 2001 CAS ANNUAL MEETINGMEETING
The Rating Agency’s View
Eric Simpson, Moderator (SVP & CFO – DICO, American Re)Matt Mosher, Panelist (GVP – P/C, A.M. Best Company)Karen Davies, Panelist (Senior Analyst, Moody’s Investors Service)
Post – WTC Issues for the Post – WTC Issues for the P/C Insurance Industry P/C Insurance Industry
Industry Capacity to Absorb Mega Terrorist Losses and Ongoing Cat, Reserve, & Investment Risks
Ultimate WTC Losses & Likely Market Implications
Analytical Approach for Identifying & Downgrading Weakened (Re) insurers
Market Outlooks for Product Lines/Sectors Most Affected by WTC Disaster
Post – WTC Issues for Post – WTC Issues for the the
P/C Insurance IndustryP/C Insurance Industry Key Drivers of a Company’s Rating;
Significant Changes in Rating Criteria Impact on Rating Agency Capital Adequacy &
Earnings Analysis Additional Risk Management Considerations
Posed By Rating Agencies Implications to VAR & DFA Modeling
CASUALTY ACTUARIAL SOCIETYCASUALTY ACTUARIAL SOCIETY
The Rating Agency’s View
Annual Meeting Annual Meeting
Matthew C. MosherGroup Vice PresidentA.M. Best Company
Vulnerable Ratings
Secure Ratings
B, B- FairC++, C+ MarginalC, C- WeakD PoorE Under Regulatory SupervisionF In Liquidation
A++, A+ SuperiorA, A- ExcellentB++, B+ Very Good
Best's Rating CategoriesBest's Rating Categories
Financial Strength
Best’s Rating ComponentsBest’s Rating Components
Balance-SheetBalance-Sheet StrengthStrength
OperatingOperating PerformancePerformance
BusinessBusiness ProfileProfile
Best’s Rating ComponentsBest’s Rating Components
Capital is the cornerstone of any viable insurance organization and the bedrock of any secure Best’s Rating. Balance sheet strength is a key factor delineating Vulnerable from Secure companies.
Balance-SheetBalance-Sheet StrengthStrength
Balance Sheet StrengthBalance Sheet StrengthRating EvaluationRating Evaluation
Leverage / capitalization Capital structure / holding company Quality & appropriateness of reinsurance
program Adequacy of loss reserves Quality and diversification of assets Liquidity Risk-adjusted capital (BCAR)
CapitalizatioCapitalizationn
Equity Value of Reserves for: Equity Value of Reserves for: Catastrophe, Loss, Asset Catastrophe, Loss, Asset
Revaluation & OthersRevaluation & Others
Retained EarningsRetained EarningsCapital IncreaseCapital IncreaseCapital InjectionCapital Injection
Liability GuarantyLiability GuarantyStop Loss Stop Loss
Surplus Relief Surplus Relief Net Worth GuarantyNet Worth Guaranty
RevolvingRevolvingCredit LineCredit Line
Balance Sheet StrengthBalance Sheet StrengthCapitalization InflowsCapitalization Inflows
Best’s Rating ComponentsBest’s Rating Components
Demonstrated profitability combined with capital strength are fundamental to long-term financial strength, and therefore to policyholder security.
OperatingOperating PerformancePerformance
Operating PerformanceOperating PerformanceRating EvaluationRating Evaluation
Profitability Revenue composition Management experience & objectives Ability to meet plan
Best’s Rating ComponentsBest’s Rating Components
The ability to maintain distinct competitive advantages drives current and future operating performance and determines long-term financial strength and policyholders’ security.
BusinessBusiness ProfileProfile
Business ProfileBusiness ProfileRating EvaluationRating Evaluation
Market risk Competitive market position Spread of risk Event risk Regulatory risk
Business ProfileBusiness ProfileCompetitive PositionCompetitive Position
Position in its chosen markets relative to direct competitors Advantage or barrier to continued growth Influences ability to respond to:
Market challenges Economic volatility Regulatory change
Influences ability to compete effectively long term Relationship with distributors Diversity of business among different distributors
A.M. Best Rating PerspectiveA.M. Best Rating Perspective
Balance-sheet strength holds the highest weight across all rating levels; however, as the rating levels increase so does the emphasis on operating performance and business profile.
Balance SheetBalance Sheet StrengthStrength
OperatingOperating PerformancePerformance
BusinessBusiness ProfileProfile
Enterprise Financial StrengthEnterprise Financial Strength
Operating PerformanceOperating Performance
Distribution/Distribution/CustomerCustomer
MeasurementMeasurement
ManagementManagement
Business Profile Business Profile
Rating ConsiderationsRating ConsiderationsSuccess FactorsSuccess Factors
Best’s WTC Rating PerspectiveBest’s WTC Rating Perspective
Rating actions to date mostly one notch adjustments. Phase one—stress test.
Emphasis on capital. Beyond phase one.
Continue to assess companies with direct & indirect exposure. Identify those companies with less obvious exposures. Emphasis on additional factors.
E.G., liquidity, cash flow, earnings capacity. Assess impact of deepening economic crisis on individual companies’ balance
sheet.
Best’s WTC Rating PerspectiveBest’s WTC Rating Perspective
Despite losses, rating actions have been minimal because of excess capital cushion… which no longer exists. Slippage into vulnerable category not likely. Third-quarter results.
Overall, industry will meet its obligations. Caveat—no additional terrorist attacks or major cats.
As in any crisis, opportunities exist for those insurers that can differentiate themselves from the competition. Regardless of scale.
Additional ObservationsAdditional Observations
Events of September 11 changed the insurance industry fundamentally.
Many industry trends accelerated, others altered: Market hardening significantly and rapidly, but prospects for
adequate margins unlikely until 2003. Operating performance adversely effected by volatile and
declining financial markets. Commercial Lines’ excess capital cushion is gone. Pace of industry consolidation and global financial services
convergence will slow.
Additional ObservationsAdditional Observations
Price hardening, particularly for reinsurance & commercial lines’ coverages. Aviation most affected. W.C., Property & B.I.—rate increases, reduced capacity,
tighter underwriting standards & changed contract wording. Liability—major questions.
Diminished reinsurance capacity? Re-evaluation of risk definitions. Retro cover contraction or disappearance.
Additional ObservationsAdditional Observations
Pace of convergence & consolidation— Will slow in near term. Expected to pick up pace next year.
Market withdrawals will accelerate. New capital enters
Rating Agency’s ViewRating Agency’s View
CAS Annual MeetingCAS Annual Meeting
November 12, 2001November 12, 2001
Karen DaviesKaren DaviesVP/Senior AnalystVP/Senior Analyst
TopicsTopics
Introduction
Moody’s P&C Insurance Ratings
Credit Risk in P&C Insurance
Update on Impact of Terrorist Attacks
Outlook for Ratings of P&C Insurers
IntroductionIntroduction
Recent events have insurers and reinsurers under a spotlight and under a microscope
Against backdrop of past few years’ market turmoil
Pre Sept 11th issues: industry structure and cycle
Post Sept 11th: PV of opportunity vs. risk state
Power of ratings is growing in all markets
TopicsTopics
Introduction
Moody’s P&C Insurance Ratings
Credit Risk in P&C Insurance
Update on Impact of Terrorist Attacks
Outlook for Ratings of P&C Insurers
Moody’s P&C Insurance Moody’s P&C Insurance RatingsRatings
Nature of Ratings Coverage Nature of Ratings Coverage
Ratings coverage and active relationships with virtually all major market participants
No limits on types of insurers we will rate
Often have a dialogue with firms without public ratings
Indicative ratings / right of refusal
Moody’s P&C Insurance Moody’s P&C Insurance RatingsRatings
Meaning of the Ratings Meaning of the Ratings
Debt and preferred: investor orientation - speak to both default frequency and loss-given-default
Financial strength: policyholder orientation - speak to ability to pay, considering recovery value
Rating horizon, long-term (3-5 years)
Financial strength ratings do not speak directly to likelihood or timing of claim payments
Ability Vs. Willingness
Moody’s P&C Insurance Moody’s P&C Insurance RatingsRatingsDifferentiation Among Rating Differentiation Among Rating AgenciesAgencies
Moody’s debt and IFS ratings are intended to be consistent with each other and with other sectors
Rating definitions are different (A A A)
Quantitative benchmarks are different (Moody’s E(L) table based on 90+ years of historical data)
Recent spate of insurer defaults: No one company ever had investment grade debt rating
TopicsTopics
Introduction
Moody’s P&C Insurance Ratings
Credit Risk in P&C Insurance
Update on Impact of Terrorist Attacks
Outlook for Ratings of P&C Insurers
Credit Risk in P&C InsuranceCredit Risk in P&C InsuranceState of the Market Pre 9-11State of the Market Pre 9-11
Years of intense competition, soft pricing broadening coverages eroded financial health
Earnings weak, propped up by finite risk covers
Balance sheets weakening, reserve deficiencies, more aggressive investments
Legitimate turnaround in pricing had begun in commercial lines, reinsurance
Credit Risk in P&C InsuranceCredit Risk in P&C Insurance Key Credit Risks - Primary Insurers Key Credit Risks - Primary Insurers
Financial statements are unreliable indicators of financial health and economic performance
“Hidden” leverage: e.g., reserves and reinsurance exposure, as well as high excess business
Incentives exist for weak firms to expand instead of contract, inviting spectacular reversals of fortune
Because a firm’s position is clear only in retrospect, market perception can sustain or cripple
Credit Risk in P&C InsuranceCredit Risk in P&C InsuranceKey Credit Risks - ReinsurersKey Credit Risks - Reinsurers
All comments about primary insurers apply, but to a greater degree
As a derivative market, reinsurers face less stable demand function, more capital market competition
Credit Risk in P&C InsuranceCredit Risk in P&C Insurance Recent Reversals of Fortune Recent Reversals of Fortune
New Cap Re
ReAC
Reliance
Frontier
Superior National
HIH
Independent
TopicsTopics
Introduction
Moody’s P&C Insurance Ratings
Credit Risk in P&C Insurance
Update on Impact of Terrorist Attacks
Outlook for Ratings of P&C Insurers
Update: Impact of Terrorist Update: Impact of Terrorist AttacksAttacks
General ObservationsGeneral Observations Unprecedented event in terms of coverages that will
respond and total size of the loss
Magnitude of the industry loss will vary depending on resolution of a number of uncertainties
Huge gap between estimates of industry loss and aggregation of ground-up company reports (2-3x)
Large gap between gross and net loss estimates raise issues of reinsurance recoverable, liquidity
Update: Impact of Terrorist Update: Impact of Terrorist AttacksAttacks
Ratings Placed Under Review Ratings Placed Under Review ACE American Re Chubb Copenhagen Re CNA Hartford (debt) Hannover Re Legion Liberty Mutual
Syn #2488 Syn #2020 Syn #2001 Syn #1007 Syn #1212 Markel Munich Re Partner Re PMA
PXRE Royal & Sun St.. Paul Swiss Re Trenwick XL Zurich Zurich Re
Update: Impact of Terrorist Update: Impact of Terrorist AttacksAttacks
Focus of Rating Reviews Focus of Rating Reviews Magnitude of losses reported, both gross and net, relative
to capitalization, fixed charges, cash flows, and core earnings.
Uncertainty surrounding current estimates of loss, including the prospect for disputes about the extent to which reinsurance will respond.
The extent to which, following the recent attacks, the profile of risk within the insurance industry has changed, at least for some period of time.
Update on Legislative/Legal Update on Legislative/Legal InitiativesInitiatives Three primary areas of activity
Insurance/reinsurance dynamics
Initiatives addressing legal liability
Host of other matters impacting losses
Update on Legislative/Legal Update on Legislative/Legal InitiativesInitiatives
Insurance/reinsurance dynamics
Widely anticipated reinsurers to carve out terrorism on January 1 renewals
Primary companies substantially less flexibility - change in risk profile?
Coverage crisis, no coverage, will lenders lend?
Govt: Competing Bills in the House and Senate
Update on Legislative/Legal Update on Legislative/Legal InitiativesInitiatives
Initiatives addressing legal liability
Air Transportation Safety and System Stabilization Act
Limits liability to limits of insurance coverage
Cap on liability and exemption from punitive liability for 6 mos
Centralizes all claims in the So. District Court of NY
Host of additional matters, legislative and legal
One Vs. Two Events
TopicsTopics
Introduction
Moody’s P&C Insurance Ratings
Credit Risk in P&C Insurance
Update on Impact of Terrorist Attacks
Outlook for Ratings of P&C Insurers
Ratings Outlook for P&C Insurers Ratings Outlook for P&C Insurers
and Reinsurers and Reinsurers Pre Sept 11: Moving from Negative to Stable
Key issues: earnings quality, reserve adequacy, fallacy of excess capital (at existing rating levels)
Terrorist attacks could signal shift in stance over near term
Over medium term, cyclical upturn vs. possible change in nature of risk