How strong are your reinsurers?

It is understandable that the default for many brokers and cedants assessing the reliability of their counterparties is simply to examine their insurance financial strength rating. That, after all, represents an independent view of their likelihood to pay claims offered by a very well qualified third party. 

But that logic can be flawed, or at least incomplete, especially when it comes to the concept of parental guarantees, Litmus Analysis has argued in a new report called “Why some reinsurance carriers have weaker credit profiles than their rating suggests” published on September 7.

The company, which specialises in helping the re/insurance industry understand credit risk, has proved that reinsurance carriers can often have different credit profiles from what seems to be implied by their credit ratings. It has proved this by mapping financial scores of individual reinsurers generated by LitmusQ (LQ), its proprietary re/insurer credit scoring model application, to the ratings of their parent groups (Figure 1).

Litmus notes that many reinsurance carriers have a rating that is a direct function of the “group level” rating held by their parent. Yet parental guarantees supporting individual carrier claims payments are not common—in a legal sense. Rather, rating agencies usually deploy a highly qualitative judgement of the likelihood of future support.

“The prudent approach is to consider the standalone credit profile of an individual reinsurer.” Stuart Shipperlee 

Figure 1: Distribution of reinsurer group ratings² vs individual reinsurance carrier LQ scores¹

A supplement to a rating

Litmus agrees that this approach makes perfect sense and it would be irrational not to factor in a view of such implied parental support, but it highlights several flaws in this approach. It notes that the most obvious example is that reinsurer ownership can and does change. A reinsurance carrier’s new owner’s rating and/or the nature of its potential commitment may not be the same as that of the previous owner. 

Instead, the prudent approach is to consider the standalone credit profile of an individual reinsurer, says Litmus—not as a substitute for the rating but as a contextual supplement to it. The analyst works with a number of brokers and cedants on this basis.

Stuart Shipperlee, managing director of Litmus, said: “Reinsurers offer financial strength in the same sense that airlines offer the ability of their pilots to fly the plane. Any meaningful doubt can make other positive attributes moot.

“To state the obvious: holding an acceptable rating from a high-profile rating agency is a business requirement for the great majority of the carriers that supply the world’s traditional reinsurance capacity, yet at Litmus we are engaged by both major reinsurance brokers and buyers to support their evaluation of the ‘standalone’ credit profile of individual reinsurance carrier counterparties notwithstanding the healthy ratings they are usually assigned.”

For more news from the Rendez-Vous de Septembre (RVS) click here.

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