Insurers and reinsurers require a nuanced country risk approach, more in line with AM Best’s new proposed ratings methodology, than the sovereign-heavy approach of other rating agencies, which treat them more like banks.
That was the message from Carlos Wong-Fupuy, senior director of AM Best Europe Ratings Services, in an event presentation delivered today at the Guernsey Insurance Forum 2016.
“We’re not in favour of knee-jerk rating reactions or blanket rating actions,” said Wong-Fupuy.
He said capping insurers’ ratings to sovereign ratings was “more appropriate to banking than insurance”, speaking at the event held in London.
The sovereign debt crisis in Europe, particularly between 2009 and 2012, resulted in multiple sovereign downgrades for eurozone countries, triggering downgrades for many insurers domiciled within affected countries, he noted.
“It effectively acts as a cap for those ratings domiciled in that particular country,” said Wong-Fupuy.
“It’s clear the credit rating agencies have different approaches to how we view country risk,” he added.
AM Best’s own “country risk” approach for rated firms draws elements from a company’s balance sheet strength, operating performance and business profile, he noted, putting greater onus to rated firms’ risk mitigation efforts.
He said a relative lack of consideration for such factors was a “one of the main criticisms of a sovereign risk approach” as pursued by other ratings agencies.
“It should be evident that there’s no direct link between sovereigns and the ratings we assign insurers within a particular peer group,” said Wong-Fupuy, who described sovereign ratings’ impact as “limited” among 139 inputs used towards an insurers’ financial strength rating.
In 2009 Spanish insurer Mapfre and Italian insurer Generali were among those firms downgraded by Fitch Ratings and other rating agencies in response to the eurozone’s sovereign credit risk crisis.
Fitch has been active in recent weeks in suggesting AM Best’s “A-” ratings for start-up reinsurers or those within countries with high sovereign risks might be nearer to a “BBB” insurer financial strength score issued by itself.
Moody’s Investor Service added to Fitch’s comments by also noting the sovereign risk difference between the raters’ respective approaches.
AM Best hit back at the remarks by Fitch with a defence of its ratings approach, in an exclusive to Reactions.
In February last year Generali asked Standard & Poor’s (S&P) to withdraw its ratings for the Italian insurer, citing “inflexibility of S&P's criteria to take into account the significant improvement of Generali's credit strength achieved over the past two years”.
In 2012, Antonio Huertas, chairman of Spanish insurer Mapfre, told Reactions: "The reality is very different from the Standard & Poor’s methodology…We don’t agree with them about why we can’t have a higher rating than the Spanish economy.”
S&P went on to award Mapfre a higher credit rating than Spain's sovereign rating in February 2014.
The renewed spotlight on country risk is justified, Wong-Fupuy suggested, because counterparty risk was becoming a bigger factor.
He said some small- and medium-sized continental insurers – in particularly in France, Italy and Spain – were looking to internationalise their businesses, he suggested, particularly towards opportunities in emerging markets in Latin America and Asia Pacific.
Citing the Latin American example of Argentina’s 2014 default, he said ratings were however closely correlated when country risk became significantly elevated.
In the Argentinian case, Wong-Fupuy said AM Best’s move to raise its country risk to its highest tier was closely tied to Argentina’s regulatory demand, including mandatory cedance requirements to local reinsurers, and rules about investing in local assets such as infrastructure.
Wong-Fupuy noted AM Best had responded to more gradual sovereign ratings trends in the case of Japan, which faced stagnation rather than shocks to its economy.
This was relevant, he suggested, in relation to the present Brexit situation for UK-based insurers.
Wong-Fupuy suggested the initial “doom and gloom” economic forecasts for the UK’s Brexit economic outlook had been revised to reflect “initial market volatility”, citing an improved outlook on the UK from the Organisation for Economic Cooperation and Development.
Nevertheless, London market firms still had reason to consider their contingency plans, dependent on the outcome of UK-Brussels diplomatic negotiations, with potential for a “hard” or “soft” Brexit settlement when the UK exits the EU, particularly regarding continuing passporting access to the EU's single market for UK-based firms.
“We will have to conduct singular stress tests