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S&P revises insurer capital adequacy model


NEW YORK—Standard & Poor's Corp.'s release this month of a revamped insurance capital model for global insurers and reinsurers could place added burdens on certain property/casualty insurers, while removing burdens from some life and health insurers.

New York-based S&P—which has periodically updated its insurance capital model since it was introduced in 1991—said that this is the first major overhaul of the model.

In a conference call with analysts, S&P Credit Analyst Grace Osborne said the changes to capital assessment stem from the increased complexity of insurance products and growing volatility in the insurance sector in recent years.

At S&P, capital adequacy has historically been one component in a nine-part framework used to determine insurance company ratings. The other parts include competitive position, enterprise risk management, financial flexibility, industry risk, investments, liquidity, management and strategy, and operating performance.

Under the proposed changes to S&P's capital model, a formula would be applied to all rated insurers and reinsurers to calculate a "target capital" figure. That figure would estimate the total amount of capital the company needs to cover all of its potential risks, including asset, credit and underwriting risks.

Although the impact of the new requirements will vary depending on individual companies' risk profiles and the way each insurer manages its risks relative to its capital base, insurers with long-tail liability reserves and providers of long-term care and annuity-like products can expect higher capital requirements, S&P said.

Meanwhile, companies with less volatile exposures, such as short-tail business and selected life and health reserves in certain markets can expect reduced capital requirements, according to S&P.

S&P also noted that capital requirements may be eased if companies diversify their exposures through alternatives to the traditional market, like sidecar structures and catastrophe bonds.

S&P expects to finalize the updated capital model in the first quarter of 2007, and is seeking feedback on the proposed revisions from insurance companies and other industry participants by Feb. 14, 2007.

"It does seem to be a more extensive overhaul of their model, which is why we sent it out to our members for their reaction," said Phillip L. Carson, assistant general counsel at the American Insurance Assn. in Washington.

"My guess is that individual companies will want to discuss their concerns with the rating agency because the impact is going to vary from company to company," Mr. Carson said. But, he noted, "as a general notion, they are always concerned if the capital adequacy requirements are increased."

"Strong capital bases are fundamental to meeting clients' financial security needs," Bradley L. Kading, president and executive director of the Hamilton, Bermuda-based Assn. of Bermuda Insurers & Reinsurers, said in an e-mail.

Robert P. Hartwig, senior vp, chief economist and incoming president of the Insurance Information Institute in New York said S&P's capital model "comes as no surprise. Ratings agencies have become more conservative."

Other rating agencies also have placed more attention on capital requirements over the past year. Chicago-based Fitch Ratings in June launched Prism, its new insurance capital model, and Oldwick, N.J.-based A.M. Best Co. Inc. in February emphasized in a special report that "the ability of a company to monitor and manage its capitalization is an important rating consideration."

"Insurers are going to, generally speaking, be required to carry more capital," Mr. Hartwig said, but at the same time, "insurers, generally speaking, have been more conservative."

There will be some added pressure on profitability, he noted, which "underscores the need for insurers to charge adequate rates" for property and reinsurance coverage in catastrophe-prone areas, Mr. Hartwig said.

"I think the extremely hard market we're seeing for property catastrophe coverage—both for insurance and reinsurance—has entirely been driven by the changes in the capital models and the changes in capital requirements by ratings agencies," said Gary Marchitello, property practice leader for Integro Ltd. in New York.

"Buyers of insurance are alert and interested in A ratings or better—that's been an increasing trend over time," Mr. Marchitello said. "On the other hand, when you get into a squeeze like we are in now for property catastrophe insurance, you have to make a decision: relax standards for ratings, or is no rating, or a poor rating, better than no insurance at all?"