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Without fresh capital RSA’s S&P rating may be downgraded further to ‘A-‘

On Wednesday 13th November S&P downgraded RSA’s financial strength rating to ‘A’ from ‘A+’ and placed it on credit-watch negative.

Financial strength ratings (FSRs) are those related to policyholder credit risk.

These ratings, and particularly those from S&P and A.M. Best, remain critical carrier selection criteria for many insurance brokers in RSA’s core markets, and for larger and/or more sophisticated commercial lines insurance buyers.  While ‘A-‘ is seen as the benchmark by many brokers (below which they request explicit client approval for using the carrier), for larger commercial lines buyers an ‘A’ rating floor is not uncommon, especially for longer tail lines.

RSA dropped its A.M. Best rating last year , so it is particularly exposed to S&P’s views when it comes to its FSR (Moody’s and Fitch, while less closely followed by insurance market practitioners,  are both currently more sanguine; confirming ‘A’ FSRs with stable outlooks on those group core carriers that they rate).

So what is driving the S&P action specifically and what might the prognosis be?

In fact the downgrade to ‘A’ is not that much of a surprise.  S&P placed the rating on negative outlook back in July.  The primary driver of that was the outcome of S&P’s capital model analysis; RSA currently achieves a level consistent with only a ‘BBB’ FSR.

The ‘A+’ was therefore a long way north of the agency’s base case view of RSA’s capital adequacy. While that final rating level was achieved through both RSA’s ‘very strong’ “Business Risk Profile” and a recognition that the insurer’s own ‘economic capital model’ produces a stronger apparent capital position, the agency explicitly highlighted the need for retained earnings to materially improve the capital adequacy outcome in its analysis (which includes a view of current year and prospective earnings).

Clearly the combination of recent windstorm losses and the Irish motor book reserving problems (impacting both earnings and risk-adjusted capital) have removed that likelihood near term for S&P, hence the downgrade.

However these issues directly or indirectly lead to four further risks to the rating.

Currently the rating gains a one-notch uplift from S&P’s strongly positive view of RSA’s “Enterprise Risk Management (ERM)” process and of the group’s “Management & Governance” in general.

Key factors in the analysis of both of these areas in terms of risk controls, quality of reporting and operational oversight could well be viewed more negatively in the light of recent events leading to removal of the one-notch uplift currently reflected in the ‘A’ rating.

In addition the ‘very strong’ “Business Risk Profile” has been crucial to the rating level and this could be seen as having weakened (performance relative to peers plays a key role in this part of the analysis).

Finally, without retained earnings, improvements in capital adequacy require either injections of equity capital or some ‘de-risking’ of the business.  Current stock market sentiment towards the group seems to make the former unlikely (or at least contentious) and since the latter basically means reducing expected returns on capital employed going forward, shareholders might well not back that either.

From our perspective, without a material equity injection, the risk to the rating is significant. The agency caps the further downside rating risk as ‘one-notch’. That would mean an ‘A-‘ FSR rating for the group’s core carriers.

Of course, were the further downgrade to happen, it would still be a perfectly healthy rating level in theory, and one shared by hundreds of insurers globally.  Moreover RSA have been there before, carrying ‘A’- ratings for several years from both S&P and AM Best following the problems the group faced in the early part of the last decade. But it’s not the credit profile an insurer of RSA’s scale would be looking for or, we would imagine, comfortable with.

Stuart Shipperlee, Analytical MD, Litmus Analysis

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