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Credit FAQ: Understanding S&P Global Ratings' Revised Request For Comment On Proposed Changes To Its Insurer Risk-Based Capital Adequacy Methodology

On Dec. 6, 2021, S&P Global Ratings published a request for comment (RFC) on its proposed criteria for insurer risk-based capital adequacy. Following feedback from market participants, we published a revised RFC, "Request For Comment: Insurer Risk-Based Capital Adequacy--Methodology And Assumptions," on May 9, 2023.

You can find the RFC and all related materials and information on this webpage:

Frequently Asked Questions

What has changed in the new proposed criteria relative to the previous proposed criteria?

We considered the extensive feedback received and revised several aspects of our proposed criteria. We published an overview of the notable changes we made to the proposed criteria (see "Summary Of Feedback On Proposed Criteria For Insurer Risk-Based Capital Adequacy," May 9, 2023).

We also made available a capital model prototype to aid market participants in evaluating the proposed criteria.

How will the proposed criteria, if adopted, affect ratings?

We believe that, based on our testing and assuming entities in scope maintain their credit risk characteristics, the proposed criteria could lead to credit rating actions on about 10% of ratings in the insurance sector. The potential ratings impact is based on our testing assumptions. We estimate the majority of rating changes would be by one notch, with more upgrades than downgrades. We expect the proposals to have a more material impact on our capital and earnings assessment, with changes in this key rating factor for up to 30% of insurers. These score changes could affect up to 20% of stand-alone credit profiles. The lower potential impact on ratings compared with components of our ratings reflects the application of the insurance ratings framework, our group rating methodology, and sovereign rating constraints.

How do the proposed capital model criteria affect S&P Global Ratings' insurers rating methodology?

We are not proposing any changes to our insurers rating methodology (see "Insurers Rating Methodology," published July 1, 2019). However, if the proposed criteria are adopted, we will make changes to the previously published guidance for the insurers rating methodology. See Appendix III in the RFC for specific details of the proposed changes.

Our insurance capital criteria remain an integral part of our overall analysis of insurance ratings. See the chart below, which shows rating components that could be influenced by our assessment of capital adequacy under the proposed criteria.

Why are you proposing changes to the existing criteria?

In line with our original RFC, the main reasons for the proposed changes to our existing criteria include:

  • Incorporating recent data and experience since our last update of the insurance capital model criteria;
  • Enhancing global consistency in our risk-based capital analysis for insurance companies;
  • Increasing risk differentiation in capital requirements where relevant and material to our capital adequacy analysis, as well as reducing complexity where it does not add analytical value;
  • Improving the transparency and usability of our methodology, such as with our proposal to supersede 10 related criteria articles with the new single criteria article; and
  • Supporting our ability to respond to changes in macroeconomic and market conditions by introducing sector and industry variables.

The proposed changes to our existing criteria are included in the RFC.

When will the new capital model criteria be in place?

Following the comment period, we will consider the comments we receive before publishing our final criteria, consistent with our standard criteria development process. Any rating actions we may take will reflect the criteria in place at the time of the rating committee.

How are you changing the methodology for the calibration of insurer risks, and what is the rationale for the different confidence levels chosen?

In line with our original RFC, we are proposing to recalibrate the risk charges to higher confidence levels relative to our existing criteria. The new calibration uses a one-year basis for the confidence levels, in alignment with the one-year stress for measuring the potential volatility in risk drivers. We determined the confidence levels using analytical judgment--informed by the confidence levels we use in other sectors--and using modeled outcomes based on observed ratings performance.

The objective in selecting the confidence levels was to ensure outcomes that preserve rank ordering and risk differentiation and that are consistent with the calibration of our insurance ratings framework. We also believe calibrating the lowest confidence level at a one-year 99.5% value at risk (VaR), for example, will aid transparency and improve our dialogue with insurers, given the similarity with many regulatory regimes.

How do the proposed criteria incorporate diversification?

In line with our original RFC, in the revised proposed criteria we intend to make the diversification benefit more explicit by revising the selected confidence levels and adopting an explicit, multilayered diversification approach that assesses risk dependencies using correlation assumptions between various risks--allowing for diversification within lines of business, within risk categories, and between risk categories.

The proposed approach continues to implicitly assume some level of diversification by using index and industry-level data in our calibration of individual risk charges. Where we see these diversification assumptions not being met, potentially leading to a material understatement of capital requirements, we reflect these specificities through the application of our insurers rating methodology. We also continue to capture geographic diversification benefits in the competitive position assessment within our insurers rating methodology.

The proposed recalibration to higher confidence levels has generally led to an increase in the underlying pre-diversification risk charges. However, we believe that the proposed changes to correlation matrices and diversification benefits, along with other methodological changes, may in many cases offset those increases and in some cases more than offset them. We believe that less diversified companies may not benefit as much, and diversification benefits for these companies may not fully offset the proposed increase in capital requirements from the higher charges.

How does the proposal incorporate criteria that will be superseded?

One of the many objectives of the proposed criteria is enhancing the transparency and usability of our insurance capital adequacy criteria. We are consolidating several criteria articles into a single criteria article, thereby embedding in the new criteria key principles of the superseded criteria. For example, we are proposing to integrate and update our criteria for assessing property/casualty insurers' loss reserves in the new criteria. We are also proposing to supersede certain other criteria, such as that for assessing insurers' economic capital models.

In other cases, we are superseding country-, sector-, or asset-class-specific criteria--for example, our methodology for assessing capital charges for commercial mortgage loans held by U.S. insurance companies--to enhance global consistency.

In the U.S., we are proposing to remove explicit capital charges for convexity risk and regulatory closed blocks, which are currently addressed by separate criteria articles.

How do the proposed criteria address different accounting standards and potential accounting changes?

Under the proposed criteria, we will continue to make adjustments to reported equity for differences in the valuation of assets and liabilities under different accounting standards. These adjustments also enable us to address recent and ongoing financial reporting changes.

The proposed criteria also indicate we may use regulatory-basis financial statements if they provide information that we believe is more relevant to our capital analysis.

More generally, our expectation is that insurance entities, including those reporting under IFRS 17, will be able to provide us with sufficient information to support our analysis even where they do not provide it as part of financial disclosures.

Will you use statutory or generally accepted accounting principles (GAAP) financial statements for U.S.-based companies under the proposed criteria? And when both are available, how will you calculate debt-funded capital and hybrid tolerances when you use statutory financials for the capital analysis?

We expect to factor in the same considerations we currently do to determine the appropriate set of financial reports to use. In practice, this means that if we use GAAP financials for a company under the existing methodology, we will likely use GAAP under the proposed criteria; if we use statutory financials, we will most likely use statutory financials under the proposed criteria.

For some U.S.-based insurers (typically life insurers) that produce both GAAP and statutory financial statements, we may determine that the statutory financials are better suited to our capital analysis. Given the statutory reports do not typically include the holding companies that issued the debt and hybrid securities, we may calculate adjusted common equity (ACE) using the GAAP financials solely for the purpose of determining the debt-funded capital and hybrid tolerances and incorporate these tolerances into the statutory-based capital analysis.

How will you treat certain IFRS 17 elements under the proposed criteria?

CSM and RA:  We propose recognizing the contractual service margin (CSM) and risk adjustment (RA) as equity-like reserves and not applying risk charges to these reserves. In our view, both the CSM and RA are explicitly reported reserves above the best estimate life and non-life reserves. We intend to include in ACE and total adjusted capital (TAC) other equity-like reserves, such as CSM and RA, on a posttax basis, where we determine they are available to absorb future unexpected losses.

While we expect the majority of future profits from in-force books to be captured in the CSM and RA, some elements may still not be recognized on insurers' balance sheets. An example would be short-term life products that are accounted for using the premium allocation approach. Under the proposed criteria, we will not include off-balance-sheet life value in force where we determine the reported financial statements are on an economic value basis, such as IFRS 17.

As described in Appendix III to the RFC, we also propose updating the guidance to our insurers rating methodology to include nonfungible equity-like reserves as a weaker form of capital, which may include CSM and RA. If the composition of capital relies primarily on weaker forms of capital, we may adjust the capital and earnings assessment if we determine it is overstated.

Our financial leverage calculation is based on reported shareholders' equity and is unaffected by this proposal.

Non-life reserve surpluses and deficits:  Although the liability for incurred claims (LIC) under IFRS 17 is based on best-estimate reserving, we recognize that there may still be some material non-life reserve surplus, or deficit, present in LIC. Where we determine that loss reserves are either deficient or in surplus compared with our view of the best estimate (for example, by our own reserve analysis, external actuarial review, or explicit margins required by regulation), we propose including an adjustment for the surplus or deficit in ACE (and TAC).

Unrealized gains on insurers' life bonds:  The proposed criteria aim to capture the full market or fair value of investments in ACE. We do not expect to adjust for unrealized gains on insurers' life bonds when they are included in reported equity, which is generally the case under IFRS 17.

Use of IFRS 17 accounts:  The IFRS 17 standard does not require the closing 2022 and opening 2023 balance sheets to be fully audited. While auditors might have reviewed a given IFRS 17 opening balance sheet, such a review might have a different level of quality compared with a full audit. However, we may use the IFRS 9 and IFRS 17 balance sheets in our forward-looking risk-based capital adequacy analysis--both under our current and proposed methodology--subject to our view on reliability and data quality. In cases where IFRS 9 and IFRS 17 summary financials have been published but with insufficient details for our purposes--or where we have other concerns about data quality--we will base our analysis on the latest available audited and published accounts.

Will you give capital credit for senior notes?

We are proposing to include in TAC debt-funded capital, which is debt raised by a nonoperating holding company (NOHC) where the proceeds are available to regulated operating entities, subject to certain conditions. We will include senior notes issued by an NOHC of an insurance group as eligible debt-funded capital in any country if we conclude that there is high structural subordination of creditors of the NOHC relative to those of the insurance operating entity, subject to the other conditions laid out in our proposed criteria. This is typically the case when the NOHC is outside the regulatory perimeter, such as in the U.S.

We define structural subordination as high or low based on the potential regulatory restrictions to payment between regulated operating entities and the NOHC. The additional risk for NOHC creditors is generally reflected with wider notching in our ratings on NOHCs relative to the group credit profile.

In addition, we are proposing to include NOHC debt instruments with loss-absorbing features as eligible debt-funded capital, subject to certain conditions. This could apply in any jurisdiction globally, including those where we determine structural subordination is low.

Related Research

This report does not constitute a rating action.

Analytical Contacts:Simon Ashworth, London + 44 20 7176 7243;
Ali Karakuyu, London + 44 20 7176 7301;
Carmi Margalit, CFA, New York + 1 (212) 438 2281;
Eunice Tan, Singapore + 852 2533 3553;
Charles-Marie Delpuech, London + 44 20 7176 7967;
Methodology Contacts:Ron A Joas, CPA, New York + 1 (212) 438 3131;
Mark Button, London + 44 20 7176 7045;

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