S&P’s revises notching criteria

Standard & Poor’s Ratings Services has revised its notching criteria for Canadian insurance operating companies to achieve greater global consistency of its ratings on subordinated debt, hybrids, and preferred share instruments.
“This change will apply only to Canadian operating insurance companies,” Standard & Poor’s credit analyst Mark Puccia says. “The ratings on Canadian insurance holding companies and the Canadian banks will not be affected by this change.”
S&P’s says this rating action will affect approximately C$7.6 billion in debt, hybrids, and preferred share instruments outstanding.
Generally, S&P’s says insurers’ policyholder obligations remain the most senior and most significant obligation on a company’s balance sheet. This means that the financial strength rating (FSR), which evaluates the capacity to pay on policy obligations, will continue to be rated the same as the corporate credit rating (CCR), given that policyholders rank as the senior most creditors, according to the ratings agency.
The very best-positioned unsecured creditors will generally receive the same rating as the CCR, when corporate entities are rated.
Policyholders represent a material class of senior creditors; therefore, S&P’s says other classes of creditors would be considered together as a subordinated class. “When a debt issue is judged to be junior to other obligations of the company, and therefore as having relatively worse recovery prospects, that issue is notched down from the CCR,” S&P’s says. “Therefore, both senior debt and subordinated debt will be rated one notch lower than the CCR, since Standard & Poor’s rating convention is to never rate the lowest ranking issues (other than those that have incremental payment risk) lower than one notch from the CCR for investment-grade issuers (these issues will be rated two notches lower than the CCR for noninvestment-grade issuers).”
In addition, S&P’s says that since hybrid instruments are both subordinate to senior creditors and have incremental risk of payment deferral, they will be rated no higher than two notches lower than the CCR for investment-grade issuers (these issuers will be rated a minimum of three notches lower than the CCR for noninvestment-grade issuers).
Currently, S&P’s methodology is to notch down ratings for preferred stock and equity hybrids from the CCR on the issuer, based on subordination, and interest or dividend deferral characteristics. Given that Canadian law explicitly subordinates debt obligations to the policy obligations of Canadian insurers, S&P’s says it has been its practice to rate senior debt obligations one notch lower than the CCR or FSR on the issuer. As investment-grade insurance issuers in the Canadian market issued subordinated debt obligations, these were then rated one notch below the senior debt rating and hybrid and preferred stock instruments were rated two notches below the senior debt rating.