Moody's: Stress Testing A Key Part Of Ratings Evaluation

When rating property and casualty insurance and reinsurance companies globally, stress-testing is applied to evaluate the resiliency of (re)insurers' credit profiles, Moody's Investors Service said in a report.

"Our objective is to present forward-looking ratings that incorporate the companies' risks and consider the impact of downside stress scenarios," said Sarah Hibler, Moody's senior vice president and co-author of the report titled "Stress Testing Property and Casualty (Re)insurance Companies."

She noted, "Consistent scenario testing is an important component of our analysis and helps facilitate global comparisons. It also provides a basis for more rigorous discussions in terms of companies' capital adequacy."

Moody's said its analysis of insurers' financial strength focuses on the most crucial, common risks:

o Reserve adequacy

o Natural and manmade catastrophes

o Investment performance

Because of differences among companies' business and financial profiles, p&c (re)insurers may vary considerably in their exposures to such risks, Moody's said.

For each of the three key risk areas, Moody's said it applies standardized approaches outlined in its insurance rating methodologies to determine an indicative rating under a base case scenario, which incorporates a moderate amount of investment losses, catastrophe losses and reserve development.

Moody's also projects an indicative rating under the stress case scenario, applying assumptions that reflect more stressful outcomes for the key uncertainties. Under the stress case, the underlying assumptions will cause many of the key rating factors in Moody's insurance methodology to deteriorate together, given that they are highly likely to do so under harsh conditions.

"Usually, the rating Moody's assigns to the company will be consistent with Moody's expectations under the base case, except where the stress case suggests a significantly lower overall rating (e.g., stress case more than three rating notches lower than base case)," said Jeff Berg, senior vice president and co-author of the report. "In such a situation, the assigned rating will incorporate the downside scenario and will be shaded down from the rating indicated by the base case assumptions."

He added, "Our objective is to position the current rating such that--if the stress case scenario were to happen--we would not lower the rating by more than a few notches. Of course, should the assumptions underlying the stress scenario begin to materialize, our ratings would continue to migrate downward--arriving closer to the rating levels indicated under the stress scenario."

"Stress Testing Property and Casualty (Re)Insurance Companies" is available at Moodys.com.