March 1, 2006 by Canadian Underwriter
Fitch Ratings is implementing new ratings standards for the Global Reinsurance Sector that will add greater transparency to ratings. This new methodology released in the special report ‘Insurance Industry: Global Notching Methodology,’ is being implemented concurrently for the majority of international insurance sectors and follows the Dec. 14, 2005 publication of both an exposure draft of the methodology and a market feedback period.
Fitch adds that its new methodology delineates the impact of default risk, and recovery given default, on ratings and is furthermore designed to add greater transparency to Fitch’s insurance industry ratings by more clearly assessing the effect of default risk and recovery given default on ratings.
Specifically, the new ratings standards clearly distinguish how default and recovery risk are influenced by various insurance regulatory standards around the world, and varying treatments with respect to policyholder preference and payment restrictions between an operating company and holding company, according to Fitch.
As part of the new methodology Fitch is assigning a new Issuer Default Rating (IDR) to essentially all debt issuing entities rated by the ratings agency. The IDR is a pure measure of default risk at the entity level and Fitch says it believes that the distinction between the IDR and unsecured senior debt rating will make significant value added information available to investors. Fitch says the relationship between reinsurers’ IDRs and existing senior unsecured debt ratings is primarily dependent on characteristics of the regulatory jurisdictions and environments in which the debt issuing holding companies and subsidiary reinsurance companies operate.
In most jurisdictions in which the major reinsurers are domiciled, Fitch reports there is no priority afforded reinsurance obligations ahead of senior unsecured creditors and thus the ratings agency expects average recovery rates on reinsurance policyholder obligations.
In contrast, since primary policyholders typically have priority over senior unsecured creditors, Fitch expects above average recovery rates on primary policyholder obligations. In addition, many of the offshore domiciles in which reinsurers are located have less restrictive regulatory regimes, implying less differentiated default risk between an operating and holding company. As a result of these two features, Fitch says implementing the new methodology has led to a general tightening of the notching between Insurer Financial Strength (IFS) ratings and debt ratings.
Additionally, where an insurance group is made up of both primary and reinsurance companies, Fitch reports that the new methodology has in some cases resulted in a downward revision of IFS ratings for the reinsurance subsidiaries to a level below that of the related primary companies reflecting the lower recovery expectations in default for reinsurance policyholders relative to primary policyholders.
Fitch says that all rating changes being made in implementing the new ratings guidelines are being designated as “revisions,” as opposed to upgrades or downgrades in order to clarify that the rating change is driven by a methodology change, as opposed to a change in Fitch’s views on the fundamental credit profile of the entity or its rated issues.
All long-term issuer and short-term issuer ratings previously assigned in the Global Reinsurance Sector are withdrawn.