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GCC: Tackling differences in rating scales for insurers

Source: Middle East Insurance Review | Jun 2018

The difference in rating scales and the underlying methodology of rating agencies often make insurance financial strength ratings across agencies incomparable at the ‘A-’ rating level, particularly for small-sized insurers with total capital below $250m, said a report by Insurance Monitor.
 
   About 40% (56 insurers) of the national insurance sector in the GCC carry financial strength ratings by leading rating agencies of which 20 insurers are UAE-based, the report noted. At least 10 GCC insurers, particularly those with total equity exceeding $250m, maintain multiple ratings.
 
   S&P and A.M. Best are dominant rating agencies across the GCC, followed by Moody’s with a notably higher rating activity in Kuwait, the report said.
 
   Generally, a minimum rating of ‘A-’ is the established rating standard by most rating users and represents the target rating for insurance companies.
 
   The report noted that rating symbols used by rating agencies are similar in the use of alphabet letters as grades. However there are important differences to note in the rating scale and methodology. The rating scale used by S&P, Moody’s and Fitch is a 19-21 category scale that is fairly similar with the main difference being the use of positive and negative signs at ‘CCC’. On the other hand, A.M. Best uses a 13 category scale.
 
   A.M. Best is seen to have a much higher tendency to assign a rating of ‘A-’ to smaller insurers and categorises insurers by financial size (total equity), while other rating agencies generally do not assign a rating higher than ‘BBB’ to insurers with total capital below $250m as such companies are considered small, the report said. The view is that smaller companies are more vulnerable to competition from larger companies with greater resources, have less diversification and lower levels of financial flexibility, among other limitations.
 
Addressing the differences
The difference in insurer financial strength ratings at the ‘A-’ rating grade between rating agencies has the potential to encourage ratings shopping by insurers to obtain the highest rating. Ratings shopping can put ratings users at significantly increased risks when making a purchase or security decision, particularly in the case of smaller-sized insurers, where ratings users may be exposed to a false sense of comfort.
 
   One of the most effective ways to manage ratings shopping is for ratings users such as reinsurers, brokers, bancassurance partners, government entities and large corporate customers to strongly suggest that insurers obtain more than one rating.
 
   The issue can also be addressed by insurance regulators in capital adequacy models which include credit risk-based capital charges for receivables on reinsurance ceded to non-affiliates based on the financial strength ratings of A.M. Best, Fitch, S&P and/or Moody’s, using an equivalency.
 
   The ratings of insurers are based on the review of several factors, including capital adequacy, leverage and liquidity; reserve strength supported by actuaries; reinsurance, profitability and earnings; market positioning and peer benchmarks; investment spread and security; governance and management quality; risk management; dividend policy; ownership – financial strength of the parent company; and credit rating of the country of domicile (sovereign rating). M 
 
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