Standard & Poor’s Ratings Services has lowered its counterparty credit and financial strength ratings on nonlife reinsurers IPCRe Ltd. and IPCRe Europe Ltd. (collectively referred to as IPCRe) to “A-‘ from “A.” S&P also lowered its “BBB+” counterparty credit rating on Bermudan holding company IPC Holdings Ltd. (IPCR) and its “BBB-” rating on IPCR’s $236.3 million Series A mandatory convertible preferred shares to “BBB” and “BB+,” respectively.
In addition, S&P lowered its preliminary “BBB+” senior debt, “BBB” subordinated debt, and “BBB-” preferred stock ratings on IPCR’s universal shelf to “BBB”, “BBB-“, and “BB+,” respectively. The outlook on all these companies is stable.
S&P said the downgrade reflects the following factors:
— Constraints placed on IPCRe’s strategic flexibility caused by its chosen narrow business focus, making it more vulnerable to external factors that are beyond its control than are its diversified peers.
— The belief that the significant concentration of catastrophe risk in IPCRe’s book of business exposes the company to high levels of earnings and capital volatility and is more in line with an ‘A-‘ business profile. This belief is reinforced by the possibility that the recent uplift in the frequency and severity of weather-related events might persist.
— Although IPCRe’s operating performance improved significantly in 2006, the company’s overall operating returns over the past six years were lower than what Standard & Poor’s had expected for its risk profile.
S&P nonetheless indicated that its ratings on IPCRe “reflect its established competitive position, seasoned management team, very strong capitalization, track record of resilience to major loss events, and historically strong operating performance in absolute terms.”
However, S&P said these “strengths are partially offset by IPCRe’s limited strategic flexibility because of a relatively narrow business focus, exposure to balance-sheet and earnings volatility given the significant proportion of property catastrophe writings, and lower-than-expected risk-adjusted returns given its inherently volatile profile.
“IPCRe’s strong overall competitive position stems from its underwriting expertise, particularly within the property catastrophe arena, and the relative longevity of the relationships it enjoys both with its clients and intermediaries. However, Standard & Poor’s appraisal of IPCRe’s competitive position is constrained by the concentration of its risk profile and the particularly low barriers to entry that characterize the property catastrophe segment.
“The company has enjoyed a stable senior management team since inception.” S&P said it “believes the broad experience of the company’s management and underwriting staff are a positive ratings factor.
“IPCRe’s capital adequacy ratio, based on Standard & Poor’s risk-adjusted model, was extremely strong for the financial year ended Dec. 31, 2006. Capital was bolstered by the very strong earnings reported by the group during the year. Quality of capital is high, with minimal reliance placed on the so-called soft components of capital. The overall assessment of capitalization also benefits from the minimal tail risk attributable to the group’s loss reserves as a result of IPCRe’s focus on short-tail business lines.
“IPCRe has proven resilient to the major loss events witnessed in recent years, including Hurricanes Katrina, Rita, and Wilma in 2005 and the World Trade Center disaster in 2001. However, in 2005, IPCRe was forced to tap the capital markets to replenish its balance sheet to a level necessary to protect its competitive position.
“IPCRe’s inception-to-date combined ratio is a good 92.6 percent. This compares favorably, in absolute terms, with those of some of the group’s larger and more diversified peers. However, the variability in IPC’s earnings, which is inherent in its business model, translates into lower overall earnings quality and weaker earnings on a risk-adjusted basis. This is demonstrated by IPCRe’s combined ratio having ranged from 33 percent to 252 percent over the past five years.”
S&P also indicated that in its opinion “the magnitude of IPCRe’s risk appetite is, at least in part, a function of its narrow business profile. This, in turn, makes it more vulnerable than its more diversified peers to factors that are beyond its control, including a potential uplift in severe weather-related events, softening market conditions, and regulatory changes such as those recently seen in Florida.
“IPCRe aims to cap its total aggregate exposure per zone to 70 percent of its shareholders’ equity. The group’s risk appetite has been reduced from its historical level, with total aggregate exposure per zone to shareholders’ equity of 80 percent, in recognition of the enhanced level of risk posed by the frequency of large weather-related events in recent years.”
S&P warned, however, that it “considers IPCRe’s risk appetite to be very high, both in absolute terms and particularly when measured relative to its more diversified peers.”
Commenting on the stable outlook, S&P said it reflects the rating agency’s “expectation that IPCRe will continue to prove resilient to major loss events. IPCRe is likely to remain a focused property catastrophe reinsurer. Consequently, we expect that the volatility that has characterized its historical earnings will persist. IPCRe will materially outperform other, more diversified reinsurers in benign loss years but will underperform in heavily catastrophe-affected years.”
In conclusion S&P expressed the opinion that “IPCRe will likely carry its recent earnings momentum into 2007, reflecting the continued strength in premium rates, terms, and conditions seen for catastrophe exposed business (particularly in the U.S.) at the key Jan. 1, 2007, renewal. The group is expected to be prudent in its management of future pricing cycles, likely spurred by proactive capital management. We expect that capitalization will remain a strength for the rating, with the capital adequacy ratio likely remaining at more than 150 percent.”
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