Connie Wong (Standard & Poor's) - Singapore College of Insurance

“The Role of Rating Agencies in
Reinsurance Security Assessment”
CONFIDENTIAL AND PROPRIETARY.
To Singapore College of Insurance
By Connie Wong,
Director and Team Leader,
Insurance Ratings, Asia
Permission to reprint or distribute any content from this presentation requires the written approval of Standard & Poor’s.
Copyright (c) 2006 Standard & Poor’s, a subsidiary of The McGraw-Hill Companies, Inc. All rights reserved.

Agenda
1). Introduction
2.) S&P Rating Methodology and Criteria Update
3.) Regional Outlook for Asian Insurance Market
4.) Case Study
4.) Q&A
2.
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Introduction
3.
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Standard & Poor’s Insurance Ratings
We Currently Rate Approximately 4,000
Insurance Companies In Over 70
Countries Across All Sectors Of The
Market
4.
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Standard & Poor’s Rating Scale
AAA ‘Exceptionally Strong’
AA ‘Very Strong’
A ‘Strong’
BBB ‘Good’
• ----------------------- Investment grade cut-off
between BBB-Minus and BB- Plus
BB ‘Marginal’
B ‘Weak’
CCC ‘Very Weak’
CC ‘Extremely Weak’
R formally ‘Under Regulatory Supervision’
D ‘In default’
NOTE: Interactive ratings can be further qualified through use of ‘+’ and ‘-’ suffixes
There is also a short-term scale: ‘A-1+; ‘A-1’; ‘’A-2’, ‘A-3’, etc.
5.
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Default Rates Over Time by Rating Category
15-yr Average Cumulative Default Rates (%) (1981-
2003)
70
60
50
Default rate
40
30
20
10
0
AAA AA A BBB BB B CCC
Standard & Poor's Ratings
6.
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Ratings
Insurer Financial Strength Rating (IFSR)
• An Insurer Financial Strength Rating is an current opinion of the
financial security characteristics of an insurance organization with
respect to its ability to pay under its insurance policies and contracts in
accordance with their terms.
Counterparty Credit Rating (CCR)
• A counterparty credit rating is a current opinion of an obligator’s
overall capacity and willingness to meet its financial commitments as
they come due.
7.
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Standard & Poor’s Rating Process
Rating request
Pre-meeting
information request
Management
meetings
Rating
committee
8.
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Insurance Ratings Methodology and Criteria
9.
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Interactive Insurance Ratings Methodology
Major Analytical Categories
• Industry Risks Analysis
• Management and Corporate Strategy
• Competitive Positions
• Operating Performance
• Investments, Asset-Liability Management and
Liquidity
• Capitalization, Reserving & Reinsurance
• Financial Flexibility
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Insurance/Reinsurance Industry
Retrocession Co.
Flow of risks
Reinsurance Co.
ABC Insurance Co.
Big Insurance Co.
Small Insurance Co.
Policyholders
Policyholders
Policyholders
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Industry Risks Analysis
Threat of New Entrants
Power of Suppliers
Competition
Power of Buyers
Threat of Substitute
Products
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Competitive Position
Identifies company’s fundamental characteristics and
source of competitive advantage or disadvantage
• Market position
• Product mix
• Distribution system
• Geographic dispersion
• Legal organization chart
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Competitive Position – Reinsurance Company
Some questions:
• Size
• National, regional and global players
• Distribution channel – brokers or direct
• Market know how.
• Follower or leader
• Technical expertise
• Risk tolerance, retrocession use
• Short tail or long tail underwriter
• Business portfolio mix
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Competitive Advantage
Competitive Advantage
Capital Adequacy
Earnings
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Management and Corporate Strategy
• Strategic goals
• Operational skills, planning, controls
• Financial controls, risk tolerance
• Background of senior officers
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Operational Performance
• Sources, stability and quality of earnings
• Both underwriting and investment
performance
• Measure of profitability
• Review other measures of profitability
• Review tax position
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Operational Analysis
Some key ratios:
‣In evaluating underwriting performance
• Premium growth rates
• Nonlife: - expense ratio, loss ratio and
combined ratio,
• Life: - payment ratios, surrender ratios
‣In evaluating investment performance
• Investment yields
‣In evaluating overall performance
• ROA, ROE, Return on revenue
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Operational Analysis – Nonlife
‣ Return on revenue (ROR)
Identifies the degree to which the company is able to convert
the insurance business into profits
‣ Return on equity (ROE)
Identifies the value relative to the invested capital represented
by a company’s profits – its profitability
‣ Return on assets (ROA)
Alternative measure of profitability, more useful in comparisons,
especially where A capital gains strategy is employed (use in life
insurance mainly)
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Insurance Company – Cash Flow
Policyholder
2. Claims
payments
4. Claims
recoveries
Reinsurance
company
1. Premium
income
Insurance
company
3. Reinsurance
premiums paid
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Investment
Factors we need to look at:
• Investment strategies
• Investment portfolio mix
• Liquidity
• Assets quality
• Interest rate risks
• Market risks
• Asset and liability management
• Investment performance
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Capitalization - Determinants
• Capital management and policy
• Capital quality
• Capital adequacy model – risk based
• Reserves
• Reinsurance credit risks
• Debts and hybrid used
• Financial leverage
• Contingent liability and guarantee
• Other threats to capital
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Capitalization –proxy ratio
Proxy ratio for P&C insurance company:
‣Nonlife:
Shareholders’ funds
Net Premium Income
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Risk Base Capital Assessment
For nonlife insurance company:
Total adjusted
capital TAC -
Asset related
risks (C1)
-
Pricing risks
risks (C2)
Premium risks
(C3)
Reserving risks
+ (C4)
+
Other
business risks
(C5)
TAC – total adjusted capital
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Assessment Of Capital Adequacy
Capital Adequacy Ratio
175% and above
150% - 174%
125% - 149%
100% - 124%
Below 100%
Assessment of Capital
Adequacy
Extremely Strong
Very Strong
Strong
Good
Marginal
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Reserving : Key Points
Analysis encompasses
• Company methodology
and assumptions
• Historic claims
development ratios
• Company systems and
processes
• Company reserve review
procedures
• Present and future
expected claims trends
CONFIDENTIAL AND PROPRIETARY.
All analysis by class of
business
• Looking for historic and
potential future trends of
redundancy or deficiency
• Case estimates – reported
claims
• Incurred But Not Reported
(IBNR)
• Incurred But Not Enough
Reported (IBNER)
• Inflation/Discount Rates
used
• Basis for superimposed
inflation
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Financial Flexibility
• Available sources of new capital
• Anticipated cash requirements
• Shareholder dividend policy
• Accessibility to reinsurance markets
• Impact of non-insurance activities
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Our Recent Major Updated Criteria Initiatives
Initiatives
Changes/Update
Enterprise Risk Management
(ERM)
Updating Capital Model
To enhance processes by
increasing our analytical focus
on insurers’ risk management
practices
From existing risk base capital
model to “target capital” based
on insurers’ risk profile
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ERM Evaluation Components
Strategic Risk Management
Risk
Control
Processes
Emerging
Risks
Mgmt
Risk &
Economic
Capital
Models
Risk Management Culture
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ERM Evaluation on 241 Insurance Entities – 2006
Weak
5%
Excellent
3%
Strong
10%
Adequate
82%
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Regional Outlook for Asian Insurance Market
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Asia-Pacific Region Life Insurance Trends
Outlook: Stable
• Supported by more favorable operating environment
• Expect favorable operating performance
• Strengthened balance sheet
• Good mortality experience
• Main growth driver: wealth management type products
• Growing markets
Some Challenges:
• Top line growth volatility
• Negative spreads burden in some life insurance markets
• Enhancement of asset and liabilities management
• Limited capital sources for rapid growing markets
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Asia-Pacific Region NonLife Insurance Trends
Outlook: Stable
• Supportive operating performance although lowered underwriting profit
• Strengthened balance sheet
• Strong potential market growth
• Increased reinsurance support
Some Challenges
• Heightening competition
• Weak market discipline in some markets
• Need more advance technical know-how in some markets
• Less stringent reserving practices in some markets
• Changing claims pattern, especially in some developing markets
• Limited capital sources for rapid growing markets
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Other Issues
• Greater delineation between successful and
marginal players
• Heightening regulatory control
• Consolidation, mergers and acquisitions are traced
• Opening of markets - foreign participation
• Capital management
• Shallow investment markets
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Economic and Industry Risk
Asia Pacific Life Insurance Markets
Economic Risk
Very high
High
Moderately
Moderate
Moderately low
Low
high
Low
Moderately
Australia
Industry Risk
low
Moderate
Moderately
China
Thailand
Malaysia
Taiwan
Singapore
Hong Kong
Japan
New Zealand
high
High
India
Philippines
Very high
Indonesia
Vietnam
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Economic and Industry Risk in
Asia Pacific Nonlife Insurance Markets
Economic Risk
Very high
High
Moderatel
y high
Moderate
Moderately low
Low
Low
Industry Risk
Moderately
low
Moderate
Moderately
high
China
Thailand
Korea
Taiwan
Malaysia
Australia
Japan
New Zealand
Hong Kong
Singapore
High
India
Philippines
Very high
Indonesia
Vietnam
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Outlook in the Asia Pacific Region
Stable outlook:
• Life and nonlife insurance markets of Australia, Japan, Hong Kong,
Singapore, India, Malaysia, Thailand, Philippines and
• nonlife insurance market of New Zealand
Positive outlook:
• Life and nonlife insurance market of China
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Case Study
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Case Study – Central Reinsurance Corporation
Background
• As one of the major reinsurers operating in Taiwan,
Central Re has built up strong long-term relationships
with domestic insurers.
• The company's gross premiums amounted to about
NT$18.9 billion in 2005, with 79% from property and
casualty reinsurance and 21% from life reinsurance.
• Mirroring the growth of the domestic insurance market,
annualized growth of gross premiums was about 2% in
the first half of 2006 and 12% in 2005.
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Case Study – Central Reinsurance Corporation
Background
• Central Re mainly writes proportional reinsurance, and its
risk profile is relatively short tail in comparison with that of
international reinsurers. In 2005, about 90% of the
company's total business consisted of proportional
treaties, while about 96% of the total business was
sourced in Taiwan.
• Central Re has a diverse premium mix. Of total gross
premiums written in the first half of 2006, motor
accounted for 40%, followed by compulsory earthquake
(10%), life insurance (10%), fire (9%), marine (6%),
casualty insurance (6%), health insurance (6%),
engineering (1%), and others (12%).
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Case Study – Central Reinsurance Corporation
Selected Statistics
Total assets (Mil. US$)
Total assets (Mil. NT$)
Equity (Mil. NT$)
Net profit after tax (Mil. NT$)
--Year-ended Dec. 31--
2006* 2005 2004 2003 2002
713 690 610 565 490
23,538 22,782 20,137 18,655 16,157
6,381 6,568 5,288 4,493 3,744
281 647 399 359 309
Business Statistics
Gross premiums written (Mil. 9,648 18,936 16,861 17,191 15,877
NT$)
Gross premiums written
1.9 12.3 -1.92 8.3 10.2
growth per annum (%)
Business mix--gross premiums written:
Domestic (%) N.A. 96.5 98.2 N.A. N.A.
International
N.A. 3.5 1.8 N.A. N.A.
(%)
Total (%) N.A. 100 100 N.A. N.A.
Operating Statistics
Net premium income (Mil.
NT$)
Earned premium income (Mil.
NT$)
Underwriting profit (Mil. NT$)
Return on revenue (%)
Investment yield excluding
capital gains (%)
Investment return including
capital gains (%)
Loss ratio (%)
Expense ratio (%)
Combined ratio (%)
6,492 12,591 11,468 11,580 10,737
6,466 12,153 11,574 11,370 10,524
131 347 406 319 235
6.8 8.5 6.9 6.5 6
2.6 2.3 2.2 2.2 2.6
2.9 3.5 2.2 2.6 2.7
64.9 64.2 63.6 63.2 66.6
33 31.8 33.2 33.4 30.5
97.8 96 96.8 96.6 97.2
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Case Study – Central Reinsurance Corporation
Investment Statistics
Total investment assets (Mil.
NT$)
Investment composition:
21,008 20,501 18,547 16,758 14,165
Deposits (%) 27.9 31.5 30.5 23.1 46.5
Public
0.7 1.2 3.5 8.5 11.3
securities (%)
Debentures/n
31.9 50.7 51.9 52.2 31
otes (%)
Shares (%) 11.2 7.6 6.6 7.5 3.6
Loans (%) 0 0 0 0 0
Property (%) 2.2 2.3 2.5 2.8 2.6
Other (%) 26.1 6.7 5 6 5
Total (%) 100 100 100 100 100
Capitalization Statistics
Equity (Mil. NT$)
Special reserves (Mil. NT$)
Equity/net premium income
(%)
Equity/net outstanding claims
(%)
Equity/assets (%)
6,381 6,568 5,288 4,493 3,744
2,931 2,829 2,518 2,220 1,928
98.3 52.2 46.1 38.8 34.9
103.5 112.9 98.5 93.6 90.6
27.1 28.8 26.3 24.1 23.2
*Six months ended June 30. Note: Equity excludes special reserves. Pretax and aftertax income include
changes in special reserves.
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Case Study – Central Reinsurance Corporation
Rating committee:
1. Group into 5 teams
2. Study the information and fill in the rating analysis
score sheet (15 mins)
3. Please discuss with team members on their
business and financial profile and make the
recommendation on rating (15 mins)
4. Vote for the recommended rating
5. Rating outcome and rationales
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Contact for Insurance Ratings
Key Analytical Contact for Insurance Companies in Asia Pacific
Ms. Connie Wong, Director & Team Leader, Insurance Ratings, Asia excl JP/KR
Tel: 852-2533-3553; connie_wong@standardandpoors.com
Mr. Paul Clarkson, Associate Director, Insurance Ratings, Asia excl JP/KR
Tel: 852-2533-3594; paul_clarkson@standardandpoors.com
Ms. Eunice Tan, Ratings Specialist, Insurance Ratings, Asia excl JP/KR
Tel: 65-6239-6343; eunice_tan@standardandpoors.com
Mr. Tatsuo Kurogi, Director, Insurance Ratings, Japan
Tel: 81-3-4550-8329; tatsuo_kurogi@standardandpoors.com
Ms. YuMee Oh, Ratings Specialist, Korea (based in Tokyo)
Tel: 813-4550-8413; yumee_oh@standardandpoors.com
Mr. Michael Vine, Director & Team Leader, Insurance Ratings, AU/NZ
Tel: 61-3-9631-2102; michael_vine@standardandpoors.com
Customer Relationship Contact
Mr. Rocco Sta.Maria, Managing Director & Head of Client Services and Sales Asia
Tel: 65-6239-6338; Rocco_StaMaria@standardandpoors.com
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