What May Cause Insurance Companies To Fail ... - Standard & Poor's

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What May Cause Insurance Companies To Fail--And How This Influences Our CriteriaThe case of JapanThe collapse of Nissan Mutual Life, Japan's 16th-largest life insurer, in April 1997, showed that Japanese life insurancecompanies could fail. This bankruptcy, the first in the industry's history, triggered a loss of confidence, resulting in asharp increase in surrenders for most insurers in the subsequent 12 months. Because no regulatory or industry schemeexisted to protect policyholders, suspicions about the credibility of life insurers spread rapidly, particularly amongordinary individual policyholders. Subsequently, several then-rated insurers, including Chiyoda Mutual Life InsuranceCo., Kyoei Life Insurance Co., and Toho Mutual Life Insurance Co., voluntarily entered rehabilitation proceedings orclosed their insurance business under regulatory order. These failures were primarily the result of industry-wideafflictions. Japanese life business was being written at negative spreads, so insurers were taking on investment risk tocompensate, creating higher risk profiles. High payout rates (typically of greater than 95%) were common and wereused to support the mutual business models. However, they left insurers with thin balance sheets and inadequatecapital resources.Criteria ReponsesOur various criteria enhancements since these events aim to address the negative effects of market pricing andreserving dynamics in several ways. First is the IICRA, which takes account of industry underwriting standards andwhich could be adjusted to reflect poor market operating conditions. Our entity-specific assessments also addressnegative trends that affect only a segment of the market. As appropriate, our assessment of companies concentrated ina market sector that is experiencing tough competition or narrow-margin prices would likely include a negativebusiness risk profile (BRP) adjustment to reflect the risks associated with the competitive position, as well as a negativescore for additional sources of capital volatility. This would weigh on the BRP and the financial risk profile (FRP), andtherefore on the ratings.The IICRA can also capture contributors to insurer distress such as distortionary legal restrictions on investments,government-imposed controls, and problems with the regulatory framework.Catastrophe-Fueled FailuresAlthough certain insurance companies are exposed to specific catastrophes, such as floods and hurricanes, we haveseen few failures due to the occurrence of such events. That said, ultimate losses may have been greater than insurershad anticipated.One insurer that came near to failure following the terrorist attack on the World Trade Center (WTC) in 2001, wasJapanese Taisei Fire & Marine Insurance Co. Ltd. The losses incurred exceeded Taisei Fire's capital such that itmerged with Sompo Japan Insurance Inc. soon after, in December 2002. However, in our view, the distress at TaiseiFire cannot be solely attributed to the size of its exposure to a specific catastrophic event, but rather to the riskmanagement issues that allowed such an exposure to build.New Zealand's Christchurch and Canterbury region earthquakes in September 2010 and February 2011 were againunexpected, and therefore the effects on insurers would have been difficult to anticipate. The region is not consideredWWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 101144346 | 300323561
What May Cause Insurance Companies To Fail--And How This Influences Our Criteriaa traditional earthquake zone and, therefore, was not modeled by the industry to the sophistication of other identifiedcatastrophe zones in New Zealand. Some insurers were therefore hit heavily by the cost of the earthquakes, due totheir concentration in the region, the accumulation of multiple events in a short period, and inadequate reinsurancepurchase.Small entrepreneurial insurer Western Pacific Insurance Ltd. was placed into liquidation effective April 2011, becausethe cost of the multiple events exceeded its internal resources and reinsurance cover. Christchurch-based AMIInsurance Ltd. had its liabilities assumed by the New Zealand government under an ad-hoc government bailout, whilethe government-owned Earthquake Commission, which provides insurance against natural disasters in New Zealand,received government support (that had already been legislated for) because its liabilities exceeded its own substantialresources. Many insurers fortuitously benefited from group reinsurance covers purchased for larger exposures inAustralia, without which local cover would have been insufficient.Our criteria address exposure to catastrophe in the IICRA, as well as charges under our capital model methodology.Business and geographic concentrations, size constraints, and risk management and governance issues are assessedthrough the insurance criteria framework.Management And Governance IssuesOverexposure to liabilities that were difficult to measure in advance (such as medical liabilities regarding asbestos)have certainly played a part in the downfall of some entities. But in our view, distress due to concentrated exposure ismore often due to companies expanding into areas outside of their core competences. In these cases, liabilities weredifficult for the companies to predict due to their risk management deficiencies.Taisei Fire was a small Japanese fire and marine insurer that sought growth by expanding rapidly outside of its coredomestic markets. But we understand it did not keep effective track of growing risk concentrations and used thirdparties to broker business, subject to delegated authorities. Some of these brokers exceeded their authority in terms ofwritten cover, which is why such a large exposure to WTC risk was able to build up, unbeknownst to seniormanagement. The successor company subsequently sued to recoup money from some third parties, but in themeantime, Taisei Fire had lost its independence and had been forced to merge. Events such as this have led to thefocus of our criteria on ERM and on assessing insurers' ability to manage complex business growth.The importance of ERM, and management and governance, can be seen again in the case of Quinn Insurance Ltd., ageneral insurer, on which we did not have a rating. On March 30, 2010, following an application by the Central Bank ofIreland, the Irish High Court appointed joint provisional administrators to Quinn Insurance, due to what the regulatorstated were "significant breaches" of regulatory solvency requirements. The solvency problems arose following largeexposures to the collapsed Anglo Irish Bank, which were originally created through the use of financial transactions,known as contracts for difference, to build up a 28% equity stake in the bank. To us, this again highlights riskconcentrations as a main cause of distress. The regulator also had concerns over several guarantees provided by theinsurance operations to the benefit of other non-insurance parts of the Quinn Group that reduced insurance assets. Webelieve this may be an indication that the group as a whole suffered from an inadequate risk management governanceWWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 111144346 | 300323561
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