Fitch Sets Out Ratings Evaluation Criteria Focused on Investment Crisis

Fitch Ratings announced that it is “continuing its evaluation of insurance ratings globally, focusing on the impact of declines in investment portfolio market values, and other market pressures, related to the current recessionary economic environment.”

Fitch had previously moved its Rating Outlook for most insurance regions and sectors globally to ‘Negative’, with Outlook changes made for specific sectors or regions at various dates during the second half of 2008.

The rating agency said it “expects downward rating activity to continue throughout 2009, with a heightened level of activity over the next several months. Ultimate ratings migration will be broad-based, potentially impacting over half of Fitch’s rated universe of insurance ratings, but will also likely be shallow. In the vast majority of cases, Fitch expects downgrades will be limited to one or two notches. Downgrades will impact insurer financial strength (IFS) ratings of insurance operating companies, and both long- and short-term debt and hybrids security ratings of holding companies.”

Fitch also indicated that it “believes that the insurance industry thus far has fared better throughout the current financial crisis than other financial institutions, including financial guarantors, mortgage insurers, broker/dealers and commercial banks. This primarily reflects much lower liquidity exposures, lower exposures to subprime assets (including lower exposure to structured finance CDOs and credit default swaps) and generally stronger balance sheets at the onset of the crisis.

“Nonetheless, many insurers are feeling significant pressures from the financial crisis, mainly via sharp declines in the market values of their investment holdings, and via diminished financial flexibility as capital markets remain closed to a number of companies and very expensive for those with access. In addition, certain products that are exposed to the capital markets — such as variable annuities within the U.S. life sector — are creating the potential for material increases in reserves.

“These pressures are manifesting themselves through heightened earnings volatility, reduced investment portfolio liquidity and quality, and material declines in book capital. Fitch expects fourth quarter 2008 results to be particularly acute with respect to increases in unrealized and realized losses on insurers’ fixed income and common stock portfolios, and book capital under IFRS and US-GAAP based accounting (in which investment holdings are generally marked-to-market).”

However, Fitch added that it “expects the extent of downgrades to be greater among life insurers than non-life companies. This reflects life companies’ higher investment leverage, exposures to products such as variable annuities, and higher yet generally manageable liquidity exposures. The ratings impact will also likely vary by region. For example, Japanese insurers tend to have larger direct common stock investment exposures compared to companies in other parts of the world.

“Fitch is using estimated loss factors to aid in the assessment of investment valuation issues in the current environment. These estimates are being used in conjunction with various forms of pro-forma risk-based capital modeling. Fitch is also focusing its reviews on liquidity, as well as various idiosyncratic risks that may exist in ancillary businesses or linked to risk concentrations.”

The role for government capital, which has so far been limited “to a select number of cases (including AEGON and ING in the Netherlands, and AIG in the U.S.),” will continue to play a role. Fitch said it “believes the potential for government provided capital is real for some other of the larger, stronger insurance companies. For example, a number of U.S. life insurers have made applications under TARP. If provided, government funded capital or other forms of financial support could potentially temper downward ratings actions.

“A final important aspect of Fitch’s ongoing analyses will be potential mitigants available to management to address current challenges. These include use of hedging strategies (considering both the extent of hedge benefit versus heightened counterparty exposure and any basis risk), policyholder dividend adjustments, crediting rate adjustment through experience accounts, use of reinsurance, and unlocking hidden asset valuations. For some companies strong operating earnings and rates of internal capital formation could act as an important risk mitigant.

A special report published today discussing how Fitch is applying its ratings criteria in the current recessionary climate titled ‘Insurance Ratings Criteria: Application in a Stressful Environment’ can be found on Fitch’s web site at

Source: Fitch Ratings