Rating the risk

Helping to reassure insureds, and even insurers, that the insurers and reinsurers respectively are safe to entrust funds with is a key role of credit rating agencies. Greg Carter, Managing Director of AM Best, told delegates at the African Insurance Organisation Reinsurance Forum in Tangier that often insureds and insurers are paying premiums years ahead of any potential payback and need confidence in that investment. Because gaining a rating is a voluntary exercise, take-up, even in mature markets, is not 100% but Mr Carter believes the value of such ratings is worth the investment. “Commercial clients pay significant premiums to insurers and they immediately have a significant credit risk. In the event of a claim they are looking for payment in full. They pay premiums to ensure the business will continue to run in adverse circumstances.”hideOne of the key assessment tools in rating a company is its level of impairments. Mr Carter explains that even the highest rated companies will have some kind of impairment within a 15-year period. For an A or A- rated company, the risk of impairment in a 10-year period rises to 5.5% but Mr Carter stresses this is an impairment and not necessarily a failure. He says it is quite straightforward in that a company can decide on its level of risk and then choose an appropriately rated insurer to do business with. “It is no surprise that the higher rated companies tend to be more stable with higher volatility among the B and C rated businesses,” he says “and that smaller companies are likely to suffer impairments. Smaller companies are likely to be less diverse, have limited reserves and have limited access to funding.” Looking specifically at emerging markets, Mr Carter says there are challenges, not least from a lack of information. “Without an accurate loss history, it is difficult to price risk in the first place,” he says. “It can be hard to value assets, particularly in many emerging markets where the quality of audits is still evolving.” However, despite the challenges, Mr Carter firmly believes credit ratings will help emerging markets by improving transparency and in helping these markets develop. Looking at the trends for the next year, Deniese Imoukhuede, Associate Director Analytics at AM Best, warns: “We are likely to see more negative than positive underwriting and, in terms of the global reinsurance market, AM Best continues to hold its negative outlook. “We believe the reinsurance market is well capitalised but it is suffering from overcapacity. At the same time some reinsurers are trying to maintain market share at the expense of profitability. She warns this is unsustainable going forward. On the positive side, for emerging markets and Africa in particular, she says: “ERM is at various stages of development but is something that should be factored in.” Ms Imoukhuede says there are various global developments which should be included in company thinking, however, overall she sees a relatively stable political environment and improvement in regulation across Africa. The rating agencies know they have to prove a point post the financial crisis of 2008. Mr Carter admits “rating agency reputations were damaged” but he adds: “I think it was a very important lesson for the rating agency sector.” He says some of the financial structures that helped create the housing bubble were immensely complex and had fooled everyone. He points out: “People could fool rating agencies because by that time, they had already fooled a lot of other people.” Mr Carter stresses that rating agencies interview management and analyse information presented but they do not carry out audits. “By interviewing many companies we do have a window on the industry,” he says, which is where they add value by uniquely comparing like with like. Ms Imoukhuede admits this comparison can negatively affect emerging market companies but says that is justified, simply because they have not been in business for so long and are not as mature. Asked if there should be separate ratings for selected areas of the world, such as Africa, Mr Carter says it can be done, but only in areas where there is sufficient data to ensure it is as accurate as possible and relevant. Delegates also wanted to know whether rating agencies could factor non-payment of claims into the process so that companies could easily identify where problems might come. Farouk Chedid, Chairman of the Chedidre Group, says they do look at late payers and also factor in how many times a firm will call in a lawyer “because we know that if lawyers get involved, there will be a problem with the claim even if there is no reason not to pay the claim.” And asked if insured’s opinions are factored in, Mr Chedid says they would certainly be aware of consumer opinion and it would raise questions. He says they are unable to monitor regulators’ opinions because these are rarely shared publicly but if that became public knowledge, then that would be factored in as well. Mr Carter adds: “Take payment protection insurance in the UK—it had a high margin but the regulator and consumers didn’t like it and now the industry is paying billions in remedy. It also focuses us on the management of the firm and the willingness to make money at the expense of the policyholder. But it is very subjective.”

Rating the risk

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