Zurich Insurance Company’s ratings may come under threat from increased debt leverage if it relies on credit to help fund a potential acquisition of RSA Insurance Group, Fitch Ratings has warned.
Zurich Insurance currently enjoys an AA- insurer financial strength (IFS) rating from Fitch, which the rating agency says is stable at present.
The Swiss insurer is evaluating a potential offer for RSA and has until August 25, 2015, to decide whether to proceed.
Zurich previously said it has about $3bn available for mergers and acquisitions.
This compares with RSA’s market valuation of around $8bn, Fitch said.
“Zurich has also indicated that it has an appetite to issue more hybrid debt, so Fitch expects Zurich, if it proceeds, would fund the acquisition with a combination of existing resources and new debt,” said the rating agency.
An increase in Zurich's Fitch-calculated financial leverage (adjusted debt-to-total capital ratio) to above 30% would be the strongest trigger for a rating downgrade.
The insurer’s financial leverage was 23.2% at the end of 2014. It is likely that the 30% level would be breached if Zurich raises $5bn or more of extra debt to help finance the deal.
If Zurich’s capital strength dropped under Fitch's "Prism" factor-based capital model, which Fitch said is likely if the acquisition goes ahead, it could lead to a downgrade.
While Zurich's capital position might benefit from the added diversification of RSA's business, it could also be dramatically weakened by goodwill associated with the buy, Fitch has argued.
Finally, a corrosion of Zurich’s profitability because of an acquisition could also lead to a downgrade, the rater suggested, although Zurich has emphasised that any investment the insurer makes must yield at least a 10% return on equity.
RSA’s annual premium income of $11bn in 2014 is much smaller than Zurich’s 2014 revenue of $74bn.
However, RSA would give Zurich access to attractive markets where it does not yet have a presence, like Scandinavia, and strengthen its position in the UK and Latin America.
RSA has faced more than its fair share of trouble in recent years, most notably with the reserve strengthening that was required in its Irish business.
The group also had to restore its capitalisation through several actions including a rights issue in 2014 that raised £748m net of expenses.
RSA’s negative outlook on its ratings reflects risks around its strategic plan to cut costs and rebalance its underwriting portfolio.
“We believe that gaining a larger, more diversified and higher-rated parent would ultimately be positive for RSA's rating, as it could help it to address the outstanding issues weighing on its credit profile,” said RSA.