S&P Rates Arch Sidecar Triple-B-Minus

Standard & Poor's Ratings Services said yesterday that it assigned a "triple-B-minus" counterparty credit rating to Flatiron Re Ltd., marking the first time a sidecar was rated by the New York-based rating firm.

S&P also assigned a "double-B-plus" senior secured debt rating to Flatiron Re's $256 million term loan facility.

Flatiron Re is a limited-life, special-purpose Class 3 Bermuda reinsurer, which was set up specifically to offer reinsurance to Arch Reinsurance Ltd., S&P said.

S&P provided a general explanation of sidecars to National Underwriter, describing a sidecar as a limited purpose property catastrophe entity with senior debt and equity financing that sits alongside a high-quality reinsurer and takes on an agreed-upon percentage of business through a quota share agreement. Typically, according to S&P, the treaty period is one or two underwriting periods and the notes are at risk for only that period of time. The sidecars are highly capitalized relative to the risks assumed.

In a statement about yesterday's rating assignments, S&P Credit Analyst James Doona said, "The ratings on Flatiron Re are based on peril modeling supportive of investment-grade outcomes, Arch Re's brief but solid track record in managing property catastrophe risk and Flatiron Re's predetermined risk tolerances."

S&P added that these positive factors are offset, in part, by Flatiron Re's limited corporate powers, as the company can neither refuse business from Arch Re nor change the underwriting arrangement.

Other negative factors include high financial leverage and the structural subordination of the bank debt relative to policyholder claims.

S&P noted that Flatiron Re may borrow up to $520 million from a consortium of banks for a term of at most five years, receive equal amounts of equity from investors in its parent holding company, and--after setting aside a small portion to cover transaction costs--invest the proceeds in a portfolio of investment-grade securities within a collateral trust account. The assets in the collateral account provide Arch Re with a source of indemnity cover for losses relating to its property catastrophe lines of business and other related lines, S&P said.

Arch Re will make quarterly premium payments to Flatiron Re through a quota share reinsurance treaty under which Flatiron Re's liability will attach simultaneously with that of Arch Re and otherwise follow the fortunes with respect to the business retroceded to Flatiron Re.

The lending bankers and the holding company investors are subject to Arch Re's credit risk because Arch Re is the premium payer, S&P said. The bankers are also subject to market and currency risks related to the assets in the trust account, to leverage inherent in the capitalization of Flatiron Re and to the outcome of the peril modeling, S&P said.

S&P added that the outlook on Flatiron Re will likely parallel the outlook on Arch Re, which currently had an "A-minus" rating from S&P, with a stable outlook.