Best Offers Analysis on Securitization of Reinsurance Recoverables

August 21, 2007

A.M. Best Co. has released its methodology, “Securitization of Reinsurance Recoverables,” which describes the criteria it uses for rating securities collateralized by reinsurance recoverables.

Best noted that “given the size of reinsurance recoverables relative to surplus, uncollectible reinsurance can adversely affect an insurance company’s financial strength.” This explains why “insurers and reinsurers have been looking for ways to reduce their exposure to uncollectible recoverables and concentration of exposure to specific reinsurers.” The search has led to renewed interest in securitizing “a portion of the reinsurance recoverable and pass the risk of uncollectible reinsurance to investors.”

Best said the publication describes its “criteria in rating the securities that are backed by reinsurance recoverables.” One of the primary features is a list of Best’s determination of conditions under which insurers or reinsurers will be unable to fulfill their financial obligations. “It specifically highlights the difference between the typical capital markets definition of default (which is missed interest and principal payments) and impairment,” which Best said it “considers the best way to measure the inability to pay on obligations in the insurance industry.”

Best points out that its “definition of impairment of insurers and reinsurers includes defaults on financial obligations as generally recognized by the capital markets, as well as any type of publicly disclosed regulatory intervention in the operation of an insurance company.”

However, Best stressed that the “unwillingness to pay on obligations, which can arise in reinsurance agreements, is explicitly excluded from the definition of impairment.”

Using the impairment definition, Best has published two tables that it employs for assigning credit risk to insurance industry obligations in securitizatons: “Best’s Idealized Default Rate of Insurers” and “Best’s Idealized Default Rate of Reinsurers.” The data is culled from the impairment studies Best has conducted, the latest of which is “Best’s Impairment Rate and Rating Transition Study – 1977 to 2006.”

Best also noted that the “idealized default rate for reinsurers is higher for any given rating than the idealized default rate for insurers because of the propensity of reinsurers to go into distressed runoffs (after major downgrades) and enter into commutation agreements and schemes and arrangements with their cedants.”

Securitization of Reinsurance Recoverables also discusses issues surrounding correlation of recoverables assets, recoveries on recoverables, the typical structure of the transaction (which may involve credit default swap and collateralized debt obligation technology) and the modeling methodology for the transaction.

Go to: to download a PDF copy of
this methodology.

Source: A.M. Best

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