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 Criteriapotential of group membership damaging or benefiting a subsidiary's creditworthiness. We also use it to evaluate therelative likelihood that certain types of subsidiaries will be supported in a time of stress.Table 5 shows companies that were all in the same situation as the companies in Table 4, the only difference beingthat they had parent companies in Europe that provided capital to U.S. subsidiaries. In the cases of the first three, theU.S. subsidiaries would have been severely impaired without their parents' contributions. SCOR Reinsurance Co. raisedover a billion euro to avoid damage to the entire group. Swiss-based Converium chose to place its U.S. subsidiary intorun-off, however, and ceased to add additional capital, leading to the subsidiary's eventual insolvency in 2004.Table 5Subsidiaries And The Impact Of Underpricing And Reserving: 2002-2005Munich AmericanReinsurance Co.Converium Re (NorthAmerica) Inc.SCOR ReinsuranceCo.Surplus, 1/1/2001 $2.2 bil. $1.5 bil. $1.2 bil. $2.6 bil.Contributions from theparent, 2002-2005$4.1 bil. $100 mil. $540 mil. $1.5 bil.Surplus, 12/31/2005 $3.0 bil. $395 mil. $462 mil. $2.75 bil.Swiss ReinsuranceAmerica Corp.Since 2000, we have also seen several European parents support their European subsidiaries. The support several U.K.banks provided to their life insurance subsidiaries boosted solvency levels in the wake of overexposure to equities andunderpricing of embedded guarantees. For example, Abbey National PLC pumped several capital injections into itssubsidiaries Scottish Mutual Assurance PLC and Scottish Provident Ltd. in 2002 and 2003.It is our opinion that a parent company will likely try to provide support to distressed subsidiaries operating in marketsthat are most important to the group's franchise. This may involve overlap in customers, product lines, or geographicmarkets. Furthermore, such support may be provided to avoid reputational damage to the parent due to commonbranding or the impact on the parent's strategy. For example, AXA Group injected Turkish lira (TRY) 770 million intoits Turkish subsidiary, AXA Sigorta A.S., in the first quarter of 2013 to compensate for the subsidiary having incurredmaterial losses accounting for 97% of total 2011 shareholders' equity. The much-needed boost restored capital for thefirst quarter of 2013 to marginal levels. In our view, this support was due to the importance of the Turkish market tothe group both in terms of strategy and reputation.It seems to us however, that parents are less likely to provide support when the subsidiary is more peripheral and lesscrucial to the group's strategy and reputation. Gerling's decision in 2003 to not pay under the terms of a guarantee thecoupon of the subordinated notes issued by Gerling Global Finance Alpha B.V. stands out as an obvious example. Inour view, refusing to pay under the guarantee amounted in effect to Gerling deciding that the cash that wouldordinarily have been used to service the interest payment on the notes that it guaranteed, could be put to better use bysupporting the orderly run-off of its obligations to policyholders. Parents are also understandably reluctant to supporttheir subsidiaries when the required capital injection would be too great for the group to bear.A parent company may also reassess its subsidiary as less strategically important when the parent's core marketbecomes trickier to navigate.In addition to the assessment of parent group support for subsidiaries, our Group Rating Methodology also considersWWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 141144346 | 300323561
What May Cause Insurance Companies To Fail--And How This Influences Our Criteriathe degree of insulation a subsidiary may have from potential distress elsewhere in the group, which may support ahigher rating than for other group companies. In the case of HIH Insurance Ltd., trustee-type protection mechanismsfor the New Zealand subsidiary supported a higher rating on it than was assigned to its parent, because the localprotections restricted dividend flows to the parent. This ratings differential prior to liquidation has proved appropriate,in our view, given that New Zealand policyholders subsequently received payment of claims in full, and the businesswas ultimately sold as a going concern to QBE Insurance Group Ltd.These experiences inform our criteria for assessing the group status of insurance subsidiaries of financial servicesgroups because we see them as affecting the likelihood of such subsidiaries failing.Why extraordinary government support doesn't typically prevent insurer failuresGovernment intervention to prevent an insurer failure is rare. Usually, a government will become involved only tofacilitate an orderly run-off or closure, which does not prevent a default. Even when governments do intercede, forexample, when the Irish government supported both Insurance Corporation of Ireland (ICI) and Private MotoristsProtection Association (PMPA) in the 1980s, there is no certainty that the insurer will receive full support in futuretimes of stress. The Irish authorities decided to place Quinn Insurance into administration in March 2010, which wasfollowed by a restructuring of the group's debt in 2011.In our opinion, generally governments have only intervened when an insurer's failure would have had systemicimplications for a country's banking system. For example, we view that the U.S. government supported AIG to avoidthe damage its failure would have caused to the banking system as a whole. Similarly, the local systemic importance ofING Groep's banking operations provided the impetus for the Dutch government to ensure that it did not come understress. The Irish Government decided in 1985 to buy the failing ICI, which had reserving shortfalls, to bail out thehighly systemically important bank owner, Allied Irish Banks. We recognize that some insurers are likely to beconsidered global systemically important financial institutions (G-SIFIs) under future regulatory initiatives, but wedon't believe that this classification would increase the likelihood of government support to bail out creditors.We rarely raise insurer ratings to reflect the potential for extraordinary government support. The exceptions aregovernment related entities (GREs) that have specific policy roles and government links that lead to such support.Classification as a GRE reflects our opinion of the importance of the entity's role to the government, due to the severityof the effects that a default would have on the government or the local economy. The classification also looks at thestrength and durability of the links between the government and the entity, including the government's track record ofproviding support. Examples include French Caisse Centrale de Réassurance (CCR) and Morocco-based reinsurerSociété Centrale de Réassurance (SCR), both of which are assessed as GREs with an "almost certain" likelihood ofextraordinary government support.Sovereign-related stressesIn our view, sovereign distress creates profound financial and operating problems for local insurers. They can swiftlytrigger failures, even when insurers have otherwise been managed wisely. The state of the economy influencesbusiness volumes and claims experience, while investment markets affect an insurer's balance sheet strength. Forexample, falling values of sovereign bond holdings can affect solvency, as seen in the recapitalization needs of someinsurers following the 2012 Greek sovereign debt restructuring and in the pressures some Russian insurers faced inWWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 151144346 | 300323561
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