In a confidence-sensitive industry, many insurers have seen their financial strength acutely affected by market perception of their credit quality, according to “Evaluating Liquidity Triggers In Insurance Enterprises,” published by Standard & Poor’s Ratings Services.
“Ratings are based on fundamental analysis; however, when assessing creditworthiness, the speed with which confidence can be lost in an insurer is an important consideration for us,” said Standard & Poor’s Credit Analyst Mark Puccia.
When a crisis strikes, insurers that lack sufficient resources to cover all contingent calls on liquidity could quickly be insolvent, despite having otherwise healthy business operations and strong capital. American International Group (AIG) is an example where the combination of mark-to-market losses on securities backed by its credit default swaps and rating-related triggers required the company to post significant collateral.
S&P noted that the rating agency previously recognized AIG’s potential mortgage-related losses and collateral requirements, but the rapid decline in asset values and market confidence exceeded their expectations, causing the rating action. “This created a huge liquidity strain on what we had viewed as a healthy company: This limited its ability to access funding.”
According to Puccia, “We consistently have considered triggers, material adverse condition (MAC) clauses, and other covenants when assessing an insurer’s financial strength. Even in normal times, we evaluate how an insurer is positioned to handle stress scenarios, balancing sources of liquidity available in these scenarios against its liability structure and potential liquidity calls. We believe triggers elevate default risk, and therefore it is appropriate that ratings address this added risk. While two companies may be virtually identical in terms of operations and balance sheet, if one has material contingent liquidity calls and very tight triggers, we usually will consider it to have a higher credit risk.”
Source: Standard & Poor’s, www.ratingsdirect.com
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