In a single step we expect more than 10% of S&P’s insurance ratings to be placed “under criteria observation” (“UCO”)
Why? And what does it mean for rated carriers and rating users?
A Litmus Primer
- Summary of key takeaways
- Timings & numbers of ratings impacted.
- Why will this happen and how will the impacted ratings change?
- Communications by S&P to insurers and reinsurers with UCO-designated ratings
- What can (re)insurers with ratings that might be downgraded do?
- Ratings users: S&P communications and what could they do
See here for Litmus’ 30th August 2023 update to our 5-step guide to the capital model criteria change process.
Summary of key takeaways
On 14th July S&P’s Request for Comment (“RfC”) period for the proposed changes to its insurance capital model criteria ended. The agency is now reviewing those comments and deciding on the final execution of the new model criteria.
S&P estimates that 10% of its insurance ratings could change (be upgraded or downgraded) as a result of the adoption of its new criteria. We understand that the 10% estimate is not intended by S&P to represent the upper limit of possible rating changes.
Once it formally adopts any new criteria S&P’s policy is immediately to publicly disclose all ratings that could be changed. It does so by designating those ratings as “Under Criteria Observation” (“UCO”).
S&P will not publicly disclose the potential direction of a subsequent rating change resulting from the UCO designation. This will only be published by S&P via the release of whatever the rating decision of the UCO resolution rating committee is (which could take anything from a few weeks to a maximum of six months after the UCO designation is assigned). Despite a rating having the UCO designation, S&P’s rating opinion remains unchanged unless and until a rating committee subsequently decides to change the rating.
Litmus understands that rated (re)insurers will be told what UCO designations could imply for their ratings in advance of the rating committee. However, we also understand this will only happen once the agency’s analysts have gathered and reviewed information from the (re)insurer to populate the new model and have conducted their analysis sufficiently such that they can effectively inform the (re)insurer of the context and details the committee will be looking at.
Previously Litmus had understood this communication to (re)insurers on the potential direction of change for UCO designated ratings would take place at the point the designation is assigned. Further discussions with S&P have confirmed that, typically, the timing of the communication by S&P will be some time after the point of UCO designation. This is due to the time needed for the information gathering and analysis process noted above to be sufficiently completed.
S&P has nevertheless noted to Litmus on several occasions that it believes the details in its May 2023 Request for Comment (RfC) documents, and the issuance at that point of a prototype of its new capital model (though ahead of any final changes that derive from the RFC period that ended on 14th July), will have allowed (re)insurers to gauge the potential rating impact of UCO designations for themselves.
The exact timing of the new criteria adoption, and hence UCO list publication, is not knowable. However, late Summer or during the Autumn seems reasonably likely, absent any material source of delay.
Hence S&P may well have designated more than 10% of its (re)insurance ratings as being UCO by some point from shortly before the Monte Carlo Rendezvous to between that event and Baden-Baden.
We expect the number of UCO-designated ratings to be greater than the 10% S&P rating change estimate because we understand S&P’s policy to mean that it will seek to have all ratings that it can envisage might change designated as UCO.
S&P estimates that there will be more upgrades than downgrades, and that “the majority of” changes will be by no more than one notch.
Timings & numbers of ratings impacted.
The exact date of the issuance of the list of UCO-designated ratings will also be the date S&P formally adopts its new capital model criteria.
We understand that the 10% estimate of ratings that could change as a result of the new criteria adoption is intended to be as meaningful as possible. E.g., when the agency did the rating change percentage calculation, and where a group has two or more carriers that are rated at the group rating level derived from the group’s consolidated credit profile, they were treated by S&P in the calculation as one rating. We also understand that the “estimate” is exactly that, and it does not represent an upper limit of the number of likely changes.
We understand S&P’s goal, derived from its ratings surveillance policy wording, is that any rating subsequently changed by the application of the new criteria will have been on the UCO list; we therefore expect that the UCO list will be longer than what would be implied by S&P’s estimate that 10% of ratings could be changed.
A common misconception is that S&P has been anticipating the impact of its capital model change proposals in ratings up to this point. For reasons covered in our blog of 22nd February 2023 (here) that is not the case.
The agency has had considerable work to do since the July 14th RfC period closure before it can adopt the new model criteria and release the UCO list, including finalising the actual list of UCO-designated ratings to be published.
Resolution of a rating’s UCO status could take up to a maximum of six months, though we expect many to be resolved before that – in some cases, potentially, in a matter of only weeks.
Why will this happen and how will the impacted ratings change?
The assignment of the UCO designation will not reflect changes in the rated (re)insurer’s credit profiles, but rather S&P’s adoption of its new capital model criteria.
S&P’s policy is that it needs to inform rating users of the potential for any given rating to change driven by the new criteria’s adoption, hence the public release of a list of all those ratings the agency considers may change as a result of that new criteria.
The agency expects somewhat more upgrades than downgrades and that “the majority of” rating changes will be by one notch.
Communications by S&P to (re)insurers with UCO-designated ratings
The (re)insurers with ratings on the UCO list will have no advance notice of this from S&P prior to S&P’s public announcement when it formally adopts the new model criteria.
From the moment of its assignment of the UCO designation S&P will be actively engaging with the rated firms involved, not least to gather the full information needed to take the UCO designated ratings to rating committees.
While we understand S&P will inform (re)insurers of the potential direction of rating changes (upgrades or downgrades) that may come out of the UCO resolution rating committee, this will not happen until the S&P analysts have sufficient insight to sufficiently explain and clarify to the rated (re)insurer what the committee consideration would materially relate to.
The analysts will not typically be in that position until sometime after the UCO designations are released and, quite possibly, not that long before the UCO resolution rating committee is held.
The extensive details in S&P’s RfC on the model criteria change proposals, and the release of a prototype model in May 2023 (when the original December 2021 RfC was updated), suggests that at least some impacted (re)insurers will have been able to make an advanced “educated guess” as to whether they will have ratings designated as UCO (and, if so what the direction of that rating change could be); but Litmus considers it unlikely that all rated (re)insurers will have yet developed that degree of insight.
What can (re)insurers with ratings that might be downgraded do?
While S&P notes that upgrades are likely to be more common than downgrades it seems reasonable to assume that it is those (re)insurers who believe they may face a rating downgrade who will be most focussed on any UCO designation implication, although the degree of downgrade risk concern would also relate to where the current rating level is.
The UCO resolution period gives the (re)insurer the chance to discuss the model criteria change rating impact with S&P.
However, as noted above, S&P will not typically be in a position to indicate what potential rating change direction the UCO designation could represent until sometime after the UCO designation is assigned.
This forms the background to Litmus stressing the importance for any rated (re)insurer for whom a downgrade could be a material concern to have run the prototype S&P model (including for the “two years forward” forecast view that is S&P’s base-case perspective) and to have fully understood how that interacts with S&P’s wider rating criteria.
Armed with that insight, while the agency will be contacting the (re)insurers, the (re)insurers themselves should consider proactive communication with S&P.
An important question for a (re)insurer seeking to avoid a ratings downgrade will be whether there are capital management actions it can take to mitigate a negative capital model outcome change. For example, these options could include: raising fresh equity or qualifying hybrid equity capital, de-risking the investment portfolio, reducing reserve risk via ADC’s or LPT’s, or the purchase of more proportional and/or non-proportional reinsurance cover.
Any such actions would need to be seen by S&P as highly deliverable and sustainable.
The ability to deliver on timing of execution is also likely to be very important (e.g., for a capital raise).
The impact on all of the non-capital model elements of S&P’s insurance rating framework would also need to be considered. For example: the impact on debt coverage and/or leverage from hybrid issuance, the potential impact on prospective profitability from greater reinsurance purchasing and, fundamentally, how the mitigating action fits with the (re)insurer’s strategy, including its risk appetite.
Ratings users: S&P communications and what can they do?
While the public assignment of the UCO designation to any given rating is part of S&P’s disclosure to rating users, the UCO designation does not mean that S&P’s rating opinion has changed at that point. And no change to the rating may be the outcome of the UCO resolution process.
However, clearly the fact that the potential for a rating change due to the new criteria adoption has been identified by S&P can logically create some uncertainty in the minds of users of any UCO-designated rating.
Since the published UCO designation will not indicate whether any rating has the criteria change driven potential for either an upgrade or downgrade, some rating users may wish to try and judge that for themselves.
An assessment of this could partly be based on a rating user’s understanding of how the model criteria is changing and of how that relates to any given rated firm’s capital, risk profile, and key balance sheet items.
A review of S&P’s last full rating report, and any press releases or summarised reports, would help set the context, though a full understanding of these typically requires a robust understanding of S&P’s full insurance rating methodology.
However, the case-specific nature of the rating analysis of any (re)insurer will not make this a simple task.
It should also be kept in mind that S&P’s ratings reflect a great deal of non-public, forward-looking, and often market-sensitive, information to which a rating user will not typically have access.
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Litmus Analysis specialises in helping the re/insurance industry understand credit risk, the ratings agencies, and the financial analysis of (re)insurers. Its main areas of work are Ratings Advisory (helping companies manage their communications with the rating agencies), cedant analysis, (re)insurer selection and stress testing, market analysis, peer reviews & benchmarking and market security/counterparty credit risk management (including via the InsurTech application LitmusQ).
The Litmus team of consultant analysts all have a senior rating agency and/or broker market security background and includes the former heads of S&P Ratings Europe (insurance), A.M. Best EMEA and A.M. Best Asia Pacific.
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