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 Criteriapredominantly real estate developments, including several intercompany loans. Real-estate equity investments alsodamaged the value and liquidity of Monarch Life's assets, and, in 1992, the insurer had to stop writing new life andannuity business. Around the same time, Kentucky Central and Confederation bore the brunt of large exposures tomortgage loans on commercial real estate, including construction loans on new developments and high loan-to-valuemortgages, which performed poorly following the 1991-1992 U.S. recession.Our capital model, introduced in 1994, has been refined over time to reflect experience of default rates on certaintypes of bonds and portfolio losses. One change, for example, was the increased loss experience data for commercialmortgages. The model applies substantial risk charges for speculative-grade bonds and for nonperforming real estateloans. Following the market downturn in 2007-2008, we introduced refined security-specific recovery analytics forcertain parts of insurance investment portfolios, such as structured finance assets.In 2012, we updated our capital model charges for commercial loan holdings of life insurers, adding greaterdifferentiation by loan quality characteristics and applying a commensurate risk charge to construction loans. Thischange aims at identifying and taking into account risk in the loan portfolios before losses emerge.The risk position factor within our new criteria framework takes account of the following heightened investment risks:• Outsized asset concentrations by single obligor or asset class; and• Outsized exposure to high risk assets.In this way, we seek to reflect the potential for increased volatility beyond what is modeled for under our capitalcriteria.…And Reinforced By The Liability StructureThese liquidity-related failures also highlighted to us the different ways in which certain types of policyholders react intimes of stress. Withdrawal rates spike for certain types of products, and we reflected this in the adjustments that wemade to our liquidity criteria (see below). In the case of the U.S. failures, the primary liquidity strains came fromaccelerated institutional Guaranteed Investment Contract (GIC) surrenders, while surrenders of fixed annuities andinterest-sensitive life insurance provided secondary constraints.Surrender rates can work against insurer creditworthiness in other ways, too. In Japan, low interest rates led to lowerpolicy surrender rates, reinforcing the effect of negative product spreads that reduced life insurer profitability, and, insome cases, lowered solvency. While the problems encountered by Japanese life insurers were not due to liquidity perse, they do highlight how surrender rates can affect the viability of business models.We introduced liquidity criteria for North American life insurers in 1994 and we have updated it on several occasionsup to 2004, prior to the introduction of our new criteria in May 2013. Our criteria measures liquid assets against liquidliabilities, applies haircuts to reflect the risks associated with lower-rated bond holdings, and gives no credit forliquidity on commercial mortgages. The criteria also apply liquidity charges for institutional GICs that reflect the veryhigh surrender risk.WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 61144346 | 300323561
What May Cause Insurance Companies To Fail--And How This Influences Our CriteriaU.S. insurance companies faced another round of liquidity-driven problems in 1999. Again, this was due to acceleratingsurrender demands, particularly on short-term GICs that were mainly invested in by mutual funds (see table 2).Table 2Accelerating Surrender Demands: 1999GenAmerica Financial Corp.General American Life Insurance Co.ARM Financial Group Inc.Integrity Life Insurance Co.RGA Reinsurance Co.High Surrender Demands: Case HistoriesIn 1995, General American entered into an arrangement with Integrity Life Insurance Co., a unit of ARMFinancial, whereby General American would distribute funding agreements designed by ARM and reinsure 50%of the funding agreement business to Integrity. Reinsurance Group of America Inc. (RGA) agreed to reinsure 25%of General American's retained risk under the funding agreement program. By 1999, the funding agreementbusiness accounted for 95% of Integrity's insurance liabilities, demonstrating that risk concentration and theeffect of rapid growth also contributed to the company's distress.Due to a rise in interest rates, ARM's shareholders' equity decreased by about 50% between Dec. 31, 1998, andJune 30, 1999. On July 29, 1999, the company announced that it would restructure its funding agreementbusiness and seek a buyer. Surrenders on the funding agreements, which allowed investors (mainly sophisticatedmutual funds) to put the funding agreements to the company with seven days' notice, increased significantly dueto the announcement and subsequent lowering of the ratings on ARM. On Aug. 3, 1999, General Americanrecaptured the reinsurance from Integrity, which forwarded $3.4 billion of liabilities and related assets ontoGeneral American's balance sheet.On Aug. 10 the same year, General American was taken under administrative supervision by the MissouriDepartment of Insurance because of its inability to meet high surrender demands. On Aug. 20, a similar actionwas taken on Integrity by the Ohio Insurance Department at the company's request because of insufficientliquidity to meet its remaining obligations. RGA returned $1.4 billion of liabilities and $1.8 billion of assets toGeneral American related to the funding agreement retrocession agreement, and other agreements related to itslegacy as successor to the General American Reinsurance business. Metropolitan Life Insurance Co. (MetLife)stepped in to acquire both General American and RGA one week later.We revised our liquidity criteria for life insurers in North America in 2000 because of these case histories toincorporate an assumption that any GIC that can be put to an insurer in less than 60 days will, in effect, beimmediately due. Any insurer currently issuing contracts with such features would, therefore, need to hold substantialliquid assets to be assigned an investment-grade rating by Standard & Poor's. In our new criteria framework, we haveimplemented a simplified version of the North American liquidity ratio for insurers other than North American lifeoperating companies.WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 13, 2013 71144346 | 300323561
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