Why some reinsurance carriers have weaker credit profiles than their rating suggests

A key context for using ratings and counterparty risk management 

Key takeaways:

Reinsurance carriers that are part of a group can often have different credit profiles than are implied by their credit ratings. We highlight this in our chart below of LITMUSQ financial scores¹ of individual reinsurers compared to the ratings of their parent groups. 

We work with major brokers and cedants who look at their counterparty reinsurer’s individual credit profiles, not just at the rating they are assigned (very important though the rating is). 

Many reinsurance carriers have a rating that is a direct function of the “group level”² rating held by their parent. Yet parental guarantees supporting individual carrier claims payments are not common. Instead, the rating agencies are usually deploying a highly qualitative judgment of the likelihood of future support. 

That makes perfect sense. It would be irrational not to factor in a view of such implied parental support.  

However, by definition, such support is not guaranteed. Moreover, reinsurer ownership can and does change. A reinsurance carrier’s new owner’s rating and/or the nature of its potential commitment may not be the same as the previous owners.  

Hence the prudent approach of also considering the stand-alone credit profile of the individual reinsurer, not as a substitute for the rating but as a contextual supplement to it (e.g., in the management of carrier exposure limits). 

While the group level² ratings across the S&P Top 40 reinsurers (see SOURCE) are all “A-” or higher (with a mean of “A+”) our standard mapping of individual carrier LITMUSQ financial scores¹ to the international rating scale has more than half the individual reinsurers mapping to below “a-”, with 46% mapping to the “bbb range” and 10% below “bbb-”.  

Commentary

Reinsurers offer financial strength in the same sense that airlines offer the ability of their pilots to fly the plane. Any meaningful doubt can make other positive attributes moot. 

To state the obvious, holding an acceptable rating from a high-profile rating agency³ is a business requirement for the great majority of the carriers that supply the world’s traditional⁴ reinsurance capacity. 

Yet at Litmus we are engaged by both major reinsurance brokers and buyers to support their evaluation of the “stand-alone” credit profile of individual reinsurance carrier counterparties, notwithstanding the healthy ratings they are usually assigned. 

Why is this?

The graph below illustrates part of the answer. Individual reinsurers can have a credit profile that appears to be very different from the rating they carry. Typically, that’s because the rating they are assigned reflects the consolidated profile of the parent group.  Yet the provision of claims payment guarantees by rated groups to their individual carriers is not common. 

Graph - Group ratings² vs LITMUSQ reinsurance carrier financial score rating scale mappings¹ 

The above graph shows the percentage distribution of the group level ratings² of the 40 largest reinsurance writing groups as ranked by S&P, 37 of whom are rated for their financial strength by the agency. It also shows the percentage distribution of the LITMUSQ score ratings scale mappings¹ of the 73 non-life reinsurance carriers owned by the 37 groups as identified by S&P in its listing of Top 40 Global Reinsurers and Reinsurers by Country (see SOURCE below).

In practice the rating agencies are usually relying on their analysis of “implied” support to determine whether the group rating level² can be assigned to any given group carrier. Simply put, the agencies are trying to gauge how much financial pain a group would incur in order to keep paying a subsidiary’s claims even if it doesn’t legally have to. And how well risk controlled any given subsidiary is. Hence the “E” in ERM. 

In our opinion there’s nothing inherently wrong with this approach by the agencies. Indeed, we would argue that not to think like this would make no analytical sense. Moreover, the agencies publish clear and detailed descriptions of how they go about the assessment of potential group support. 

However, such forward looking judgements are inherently forecasts, not certainties.  It seems axiomatic that buyers and brokers should use reinsurer carrier ratings in the full knowledge of the central role these highly qualitative analytical judgements are playing. 

Therefore, one approach is to also review a specific counterparty’s individual credit profile. The risk of relying on an implied promise to pay by a highly rated parent group may feel different depending on whether a subsidiary carrier itself looks financially strong in its own right. 

Of course, a parental group may well have a very real commitment to support all of its carriers whatever it takes. And the drivers of that can be entirely aligned with commercial logic (which is exactly what the rating agencies are seeking to assess). But having a perspective on how likely the need for that commitment might be in practice seems only prudent. 

Another key factor is “change of ownership” risk. This was demonstrated by UK composite AVIVA. In 2020 a new CEO launched a strategic review (as would be expected). One outcome was to exit the French market by selling those operations. 

Prior to this strategic shift the French operations were deemed “core” by S&P and were rated “AA-” (the group rating level) with a stable outlook. Today, under new ownership and returned to their pre-Aviva branding of ‘Abeille Assurances’, they are rated A2⁵ (Moody’s), the equivalent of an “A” from S&P. 

The risk of a carrier rating change due to a change in group strategy is inherent. And it is not something a rating agency can necessarily anticipate. A “stand-alone” perspective of any carrier assigned the group level rating can be an important context for considering this risk. 

The individual carrier financial scores (“scores”) used in the graph below were generated using Litmus’ (re)insurer credit scoring application LITMUSQ¹. The score distribution may seem surprising. But it shouldn’t be. Parent groups are usually running the overall business with a “consolidated” mindset. I.e., As a portfolio of operations and with capital considered first and foremost at the group level. 

Of course, a group will want and need to keep the local regulators of each subsidiary’s domicile happy, but regulatory capital requirements, for example, may not be as high as might be assumed. For Solvency II, even the more onerous of the two capital ratio requirements⁶ is calibrated at the 1 in 200 1-year confidence level⁷. A 100% outcome is a “pass”.  But the 1 in 200 1-year probability of failure a 100% result indicates is essentially the same expected failure rate⁸ as that observed for S&P “BBB-” rated entities. And some reinsurer domiciles don’t have material risk-based capital requirements at all. 

In this context rated insurance groups do not necessarily have a reason to capitalise all carrier subsidiaries to the same degree of risk adjusted strength as that seen at the consolidated group level. 

¹ Litmus’ proprietary (re)insurer credit scoring model application, LITMUSQ, produces a numerical result that is then benchmarked to the international rating scale to aid LITMUSQ user interpretation of the outcome. Those rating scale benchmarks are expressed in lower case to highlight that they are not ratings which are expressed in upper case. LITMUSQ financial scores (“scores”) are not ratings. Rather they are purely the result of the running of a scoring model on publicly available financial statement data and do not reflect any specific judgment, or opinion held, by Litmus Analysis Ltd as to the scored (re)insurer’s financial strength. 

² The main rating agencies each have their own approach but, in essence, they all reach a conclusion about how strong a group is on a consolidated basis and then which carriers merit getting that “group level” rating directly assigned to them, which group carriers should be rated purely on their own “stand-alone” credit profile, and which group carriers should have their stand-alone rating level enhanced (or constrained) by the group level rating.  

³ Typically, at least one of A.M. Best, Fitch, Moody’s or S&P (although other agencies such as KBRA also rate some reinsurers). 

⁴ Reinsurers providing non-collateralised cover. 

⁵ Under MACIF group rating from Moody’s Ratings, affirmed 11th July, 2024 

⁶ The Solvency Capital Requirement (SCR) coverage ratio, defined as eligible own funds divided by SCR. 

⁷ The same premise as the likelihood of a 1 in 200 Cat. event over a one-year period.  

⁸ Fitch, Moody’s, and S&P monitor how frequently entities they rate default (or something they deem analogous to default) on relevant obligations. The results are published across multiple time periods at each rating level. A.M. Best, being solely insurance focussed, publishes data that reflects a somewhat wider, insurance industry specific, definition (“impairment”). 

SOURCE: Top 40 Global Reinsurers and Reinsurers By Country: 2023 (S&P Global, [republished] 8th September 2023) originally issued to accompany its report “Global Reinsurance Stabilizes as Green Shoots Emerge in Underwriting” (S&P Global, 5th September, 2023).