NU Online News Service, March 28, 1:51 p.m. EDT

Insurance companies that adopt enterprise risk management solutions for their economic capital modeling can see a payoff through reduced capital requirements after obtaining a favorable rating from Standard & Poor's, a report says.

In a report released by Willis Group Holdings' reinsurance broking arm Willis Re, titled "Standard & Poor's Economic Capital Model Review Promises Capital Rewards," the firm says S&P is offering a carrot-and-stick approach to insurers.

Those insurers that invest in economic capital modeling (ECM) can expect to reduce their capital requirements, but the process is not cheap, and it may be difficult for investors and outside analysts to understand, the report says.

Over the past two decades, large insurers have been developing ECMs, and the use of this practice will spread with adoption of the European Union's Solvency II financial regulations, says the report.

"The potential benefits—lower capital charges and full recognition of non-proportional reinsurance, for example—create obvious incentives for the adoption of ECMs by a wide range of companies," the report says.

ERM remains key to developing these models, the report observes, and "insurers must already have a score of 'Strong' or 'Excellent' from their ERM review before they are eligible for any consideration of their capital model," Willis notes.

Those insurers that have achieved such a score have already passed S&P's version of Solvency II, the report continues.

The new name for this process is Level III ERM review, the reports says, and those insurers that are judged "credible" can see a reduction in their capital requirements for each rating level as determined by S&P.

Other rating agencies are expected to follow suit, Willis says, observing that A.M. Best added an ECM to its rating questionnaire for insurers.

"It remains to be seen how this process will unfold and how much trust investors and markets will put into the different assessments," Willis suggests.

The 12-page report concludes that insurers see this as the final payoff for their investment in ERM and for the time they have spent with the rating agency explaining their program.

However, Willis notes that S&P expects "only minimal changes to current ratings" because of the gradual adoption of the new criteria over the 12 to 18 months and a conservative approach the rating agency is expected to take initially. It also expects that insurers will not see "material benefit" in applying for ECM review initially.

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