Earlier this year the New Zealand carrier CBL Insurance Ltd was placed in interim liquidation. The parent group’s Irish carrier (CBL Insurance Europe DAC) has also been put into administration (though the group’s Australian carrier, Assetinsure Pty Ltd, stresses that it continues to operate normally).

Whether the Irish and New Zealand firms are ultimately able to pay all claims in full must be open to some doubt.

For brokers the use of ratings and/or regulatory capital ratios are often central to how they manage selection of financially secure carriers for policyholders. The CBL case highlights three important lessons around that.

Lesson 1 – make sure the rating actually applies to the carrier you are using

Litmus understands the Irish carrier was never rated; the rating appears to have only been assigned to the New Zealand insurer.  In Litmus’ experience confusion as to which parts of a group carry a rating is not uncommon, despite ratings being specifically assigned to legal entities and published as such on “free access” rating agency websites.

This might seem moot given the current status of both carriers.  Nonetheless, we would suggest that for any organisation seeking to use rated paper as part of their compliance or governance processes, part of that process should be confirming that the insurer they are actually using is indeed covered by the rating.

Lesson 2 – be aware that reserve adequacy is always a source of uncertainty for rating agencies and regulators

Inadequate reserving on liability/casualty business is probably the most common cause of non-life re/insurer failure. It’s also among the hardest for auditors, regulators, rating agencies and others to identify. Indeed, reserving is a challenge for even a carrier’s management and their actuarial advisors. For example, A.M. Best’s last full rating report on CBL Insurance Ltd noted that CBL’s reserve valuations were carried out by a major actuarial consultancy.

This does not mean reserving risk is not taken into account in ratings and regulation. All of A.M. Best, Fitch and S&P’s capital models – and the Pillar 1 capital model under Solvency II –  require capital to be held for the risk of under-reserving. But, in the absence of overt evidence of under-reserving, these models basically just extrapolate a “buffer” from the reported position. Qualitative reviews of reserving practices and the wider Enterprise Risk Management of a rated insurer are also conducted but it can be very challenging to fully get into the detail of an insurer’s reserve adequacy.

Hence a radical reserving shock can transform even a healthy-looking rating opinion or regulatory solvency ratio that have both already taken reserving risk into account. CBL’s Irish carrier’s Solvency and Financial Condition Report for 2016 reported an SCR (Solvency Capital Requirement) ratio of 125%. It also forecast an expected 150% ratio by the end of 2017. Its 2016 MCR (Minimum Capital Requirement) ratio was 380%.

Lesson 3 – remember ratings are opinions not facts (and so, fundamentally, are regulatory capital ratios)

Ratings are forward looking opinions: in essence, forecasts. However expert a rating agency is, like any forecast, ratings will not always prove to be correct.  It is also a mistake to treat regulatory capital ratios as being facts. Even the “standardised” models used to calculate these are loaded with judgements made by regulators as to their calibration and content. And, for non-life insurers, the reality that loss reserve adequacy is itself an opinion means no metric reflecting that can be certain.

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