S&P says insurer ratings resilient for now but potential pressure coming from erosion of capital buffers
S&P’s latest commentary on global insurance ratings continues the focus on COVID-19 as the current primary driver of ratings. The headline message remains that most insurer ratings are still ‘resilient’ given the extent of capital buffers. However, erosion of these is expected during the second half of 2020, as financial markets remain volatile and claims pile up. A second wave or a disrupted recovery, though not currently part of S&P’s base case (which assumes an economic recovery by the end of 2021), would eat further into capital.
According to S&P, most rated companies have capital buffers that are ‘healthy enough’ to support ratings, with stronger buffers generally in EMEA and North America. Under S&P’s base case “the bulk of claims” will be reported in Q2 and Q3 of 2020. This forecast will have been informed by the agency’s discussion with rated firms, although S&P did not comment on the extent to which these will generally include reserving for areas of contention such as Business Interruption.
Across the industry asset risk continues to outweigh insurance risk as the greatest threat to ratings, but the latter is deemed to be rising both as far as top-line (restricted premium growth) and claims (from pandemic and economic disruption) risks are concerned. S&P has produced a table of six key risks and trends across Asia-Pacific, EMEA, North America and Latin America: asset risk, insurance claims, insurance top line, financial conditions, hybrid ratings and sovereign risk. Against these, risk levels are divided into ‘Elevated’, ‘Moderate’ and ‘Low’ and show, for instance, that S&P views asset risk as ‘Elevated’ in all regions, whereas insurance claims risk is defined as ‘Moderate’. Sovereign risk is also seen as increasing and is ‘Elevated’ in Latin America. These assessments, however, reflect the aggregate risk across ratings of all (re)insurer types in a region.
Elsewhere in its report, S&P specifically notes pressure on capital buffers from insurance claims for industrial lines (re)insurers, and from asset risk for life insurers (and for (re)insurers in general that have thin capital buffers versus their current capital adequacy assessment). While most (re)insurers tend to have limited exposure to non-investment grade debt, S&P notes that it estimates $640bn worth of “fallen angel” (investment grade moving to non-investment grade) downgrades by the end of 2020.
For casualty/liability books, Litmus would also note that the negative reserving trends that were increasingly being noted before COVID-19 are likely to also remain a concern.
Thus far, the only ‘Sector Outlook’ (which S&P defines as an “indication of credit trends over the next 12 months which may be informed by existing outlook distributions, existing sector wide risks or emerging risks that may dominate rating actions”) to have been changed is that for ‘Global Reinsurance’ (from ‘Stable’ to ‘Negative’). This is notwithstanding the improved pricing conditions and reflects the assumption that earnings will not cover reinsurers’ cost of capital in 2020 largely on the back of the pandemic-related issues.
Overall, S&P notes that only 9% of its insurance ratings have suffered negative rating actions (meaning either a downgrade or negative outlook change), compared with 40% across all sectors. 38% of negative rating actions on (re)insurers were linked to sovereign rating downgrades (principally South Africa and Mexico), and a further 38% by weakened capital and/or operating performance concerns. Fully 83% of insurance downgrades to date were sovereign-related, meaning that only a very few downgrades thus far were derived purely from insurance risks, which are a developing story.
Hybrid debt ratings are a possible area for future negative rating actions driven by perceived heightened deferral risk, where regulatory solvency ratios are exhibiting unusual volatility. S&P may decide to widen notching for some Bermudian and European issuers with mandatory coupon deferrals triggered by breaches of going-concern capital levels. In Litmus’s view, it would be unlikely that S&P would raise this subject without it already being conscious of some cases for which it would consider that.
Looking ahead, the most potentially severe emerging risk to insurer ratings that S&P flags is the consequence of a second wave and/or a disrupted recovery. Each of these could have a material rating impact via the agency assessments of Capital & Earnings and Competitive Position (and would include the impact of lower demand, particularly in discretionary lines). S&P believes the second largest emerging threat comes from reputational damage to the industry due to the perceived non-payment of business interruption claims – even if the industry can legally demonstrate that the pandemic scenario was excluded from the cover. This could negatively impact insurer Competitive Position assessments.
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For further information please contact:
Stuart Shipperlee, Managing Director +44 (0) 7917 067048
Rowena Potter, Senior Consultant +44 (0) 7771 885882
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