Fitch Ratings is seeking comment on a proposed method for developing its ratings of insurance-linked securities, but said the new approach won't change existing ratings.

In an eight-page report, "Exposure Draft: Insurance-Linked Securities: Ratings Criteria (Global)," the Chicago-based rating agency said there is a proliferation of new types of insurance-linked securities (ILS) in addition to current catastrophe bond structures. These new securities warrant the development and use of a broad rating approach that applies to this rapidly developing class of securities.

The report defines ILS broadly as securities whose principal and interest payments are conditional upon the occurrence or nonoccurrence of some insured event.

"Fitch believes this is a time of innovation and rapid change for ILS, with new hybrid structures and variations on traditional structures being introduced to the market almost monthly," the report said.

Beyond cat bonds, this class now includes reinsurance sidecars; catastrophe collateralized debt obligations; structures that transfer life insurance risks; reserve risks under certain life industry regulations; long-term disability reserve risks; automobile insurance risks; catastrophic mortality risk; and reinsurance recoverable risk to the capital markets.

To rate ILS, the report said the rating agency will take a three-step approach:

o Estimate the probability of loss using its own economic capital model (Prism) and other modelers to examine the probability that a special purpose vehicle set up as part of the ILS structure will fail.

o Finally, Fitch will analyze the risk of the ILS sponsor--the entity exposed to risk of loss, typically an insurer.

No rating changes are anticipated as a result of the new criteria, Fitch said. What it does plan to do is supplement a major report on all categories of ILS with a series of reports tailored to specific types of deals.

The rating agency highlighted two changes from prior methodology embedded in the new approach. One change is that the first step of the new methodology proposes rating all types of ILS structures using a probability-of-loss benchmark. By contrast, in the past some noninvestment-grade catastrophe bonds were rated based on an expected-loss method that also considered the level of expected recovery given default.

The second change is that the proposed new approach does not cap ILS ratings at the rating of the sponsor, making it possible for an ILS rating to exceed the sponsor rating.

Fitch said it is encouraging feedback on all aspects of this report, but the firm is particularly interested in opinions regarding these two changes.

Comments should be provided in writing to ils@fitchratings.com by Sept. 7.

Following this review period, Fitch expects to publish a final report incorporating the comments.

Special Reports /

New Cat-Bond Rate Method Won't Change Existing Ratings

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