Insurers that invest heavily in common equities and write long-tailed lines of insurance may see their capital charges increase in an updated capital model that Standard & Poor's announced today.

But the capital model is only one element of the rating, S&P analysts stressed during a conference call intended to fill in details behind a report released to insurers this morning.

"The capital model itself does not define a rating," said Grace Osborne, managing director of North American insurance ratings for S&P, detailing changes to the structure of the S&P's methodology and to the capital factors--or charges that are applied to various balance sheet and income statement items--proposed under the new capital component of S&P's rating analysis.

She noted that in addition to the capital component, S&P also examines eight other ratings components, including competitive position, enterprise risk management, operating performance, and financial flexibility, among others.

Focusing on the capital model revision, however, she said that for life and non-life insurers, the capital model will come up with "significantly increased" capital needed to cover investments in common equities.

For non-life insurers, specifically, she said, "both on the pricing risk and the reserving side, there is definitely going to be more capital required." A slide presented along with her remarks indicated that the higher requirements would apply mainly to long-tailed lines.

"I really do think we need to look at [this] away from just models and factors," she said, presenting a justification for the hikes. "From 1990-2005, the U.S. non-life insurance industry has posted underwriting losses for each year with the exception of 2004. The underwriting losses have been significant for several years, with a cumulative loss of $276 billion dollars."

"So without the benefit of investment returns [or] the financial flexibility to raise more capital..., the non-life insurance sector would have been in severe financial stress," she said.

"The volatility...is what's driving the sharp increase[s] in many of the non-life factors," she said, adding that while "this is the first time S&P will be directly incorporating the volatility in a quantitative fashion in its capital model," analysts have "acknowledged and worked through the pressures on earnings and capital" qualitatively throughout the last 15 years, she said.

Still, S&P, in its report "Request For Comment: Revisions In The Risk-Based Capital Model," said that "given the substantial breadth and scope of the risk factors that were under review for this capital model update, we see that markedly different views of an insurer's total risk-adjusted capital could emerge."

With respect to catastrophe risk factors included in the model, Ms. Osborne seemed to suggest that, if anything, some companies might get a small break with the latest update. While the cat factors will still be based on 1-in-250 year aggregate probable maximum loss figures (put in place for reinsurers in 2005 and for insurers in 2006), with the update, the charges will now be calculated on an after-tax basis.

"So reinsurers that are in a tax jurisdiction will be able to have that benefit incorporated into the capital model prospectively," she said.

Ms. Osborne said that starting today and up until Feb. 14, 2007, S&P will be soliciting feedback about the updated model, and that this year the rating agency will hold a Dec. 12 follow-up workshop to further describe the changes.

The plan is to have the factors finalized during the first quarter of 2007, she said, adding that both models will be run simultaneously during S&P's 2007 rating reviews.

The "Request For Comment" report is available to Ratings Director subscribers at www.ratingsdirect.com, and is available for purchase to others by calling 212-438-9823 or sending an e-mail to research_request@standardandpoors.com.

Comments about the model should be submitted to criteriacomments@standardandpoors.com.

Special Reports /

S&P Ups Capital Charges For Long-Tail Writers

Related Stories

Recommended For You