Standard & Poor's recently unveiled details of its new rating category for insurance companies, called a Financial Enhancement Rating. The agency has brought in its new rating in the wake of the increasing number of multiline insurers who have entered the asset-backed and corporate bond markets, and whose underwriting and payment standards may not be what investors are used to from traditional monolines.
S&P will unveil a list of the companies that have been granted an FER at the end of July. The agency said that around 40 insurers will make the list, with half coming from the multiline business and the other half being monolines.
According to the company's definition: "An S&P Insurer Financial Enhancement Rating is a current opinion of the creditworthiness of an obligor with respect to insurance policies or other financial obligations that are predominantly used as credit enhancement or financial guarantees."
In order to be eligible for an FER, insurers must demonstrate good company management, an understanding and commitment to the business they are insuring, as well as understanding timeliness demands. Each insurer's market position, historical record and prospects, underwriting expertise, liquidity, capitalization and financial flexibility will be taken into account to determine whether or not they get the rating.
For secured transactions, S&P expects that the rating will provide common payment expectations for investors and ensure that the analysis and risk exposure of insurers with regards to deals will be accurately reflected.
"The FER will identify which players are serious about the business," said Corrine Cunningham, a director of insurance ratings at S&P in London. "It's an independent assessment that you are a sound counterparty. Hopefully, this will squeeze out the opportunistic players and increase investors' faith that a deal won't break."
The principal purpose of the new rating surrounds the issue of timely pay by the insurers. S&P has raised concerns that unlike monoline insurance companies such as AMBAC Assurance, Financial Securitiy Assurance and MBIA, whose sole business is to act as guarantors or credit enhancement providers on bond issues, the multiline insurers come from an entirely different background.
Multilines, such as AIG, Reliance, AXA and Zurich Insurance, have been quick to join the capital markets, as the growth in deals in recent years has handed them an opportunity to significantly expand their businesses. However, multilines have been traditionally more careful in examining claims - in effect taking longer than is deemed acceptable by capital market standards.
"Insurance companies are increasingly adding guarantees, credit enhancement and wraps to asset-backed and other bonds," said Robert Mebus, managing director for insurance ratings at S&P in New York. "S&P's new ratings service will assist investors in evaluating the willingness as well as the capacity of insurers to make timely payments on insured investments."
The multilines' tradition of delaying payment, pending a resolution of disputes, could clearly lead to a culture clash that proves costly to investors. S&P believes that its latest measure will provide greater assurance to investors, who are sometimes unaware that without a rating or letter of credit, multilines may not be required to provide assurance that payment terms will be honored.
Not surprisingly, the monolines are happy that bond investors will now be able to gauge more accurately the quality of who is insuring the deal.
"My understanding is that the FER is really for the traditional multiline insurance companies, rather than monoline guarantors such as ourselves," said Phillipe Trompe, managing director at FSA. "We think it's really good news generally because it will highlight the difference between the financial strength of an organization versus its willingness to pay on a timely basis under the guarantee it has issued."
"For us, that's our sole business, so our rating is based on the fact that we are a triple-A entity as far as our willingness to pay goes," Trompe continued. "The big difference between our product and the traditional insurance product is that we wave all defenses on the guarantee we provide. That's why we pay such close attention to due diligence because we know that we have to pay even if there is fraud, misrepresentations or whatever.
"In the traditional insurance business, the insured has a burden of disclosure, so the day you want to claim, you may find it difficult to get paid under that insurance policy. That completely defeats the timeliness of pay aspect which is paramount to our product."
Although Trompe emphasized that the FER would be of most value to investors, he didn't deny that it would benefit the monolines by removing some competitors from the market. "Let's face it, from our point of view, anything that makes it difficult for the competition is a good thing," he said. "I suspect that some of the multiline companies might find it very hard to make sure that their willingness to pay rating is as high as their financial strength rating. For some of the smaller players, I think it is very possible that they will be forced out of the market."
On the investor side, Jrg Dresen, head of fixed income with AXA Colonia Asset Management, was unaware that S&P was employing such an initiative, but welcomed it nonetheless. "I think this idea sounds pretty good," he said. "We need the market to be open and want to know what's going on, so I think it's good news for investors in the future."
