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Credit FAQ: How We Analyze Insurance-Linked Securities

We are receiving many questions from the market in relation to the methodology and assumptions we apply when rating an insurance-linked securities (ILS) transaction (see "Methodology And Assumptions For Insurance-Linked Securitizations," published Nov. 18, 2018). The responses to the questions below highlight some of the key rating considerations identified in our criteria.

Frequently Asked Questions

What are the general principles and assumptions applied by your ILS methodology in assigning ratings to ILS transactions?

The rating on an ILS transaction is based on the following general principles as well as the transaction's structure and specific features of the security, such as the transferred insurance risks, our view of the robustness of the modeling, the presence of risks that are not incorporated in the modeling, collateral risk, and counterparty risk. We evaluate an issuance's structure and its terms and conditions to derive the relative likelihood of the rated bonds not making required payments. We typically determine an ILS rating based on a weak-link (lowest) analysis of the following factors:

  • Our issuer credit rating, financial strength rating, or credit estimate, as applicable, on the entity ultimately transferring the insurance risks to the noteholders (the "cedant").
  • Our assessment (the insurance risk factor) of the likelihood of either a reduction in the bond's principal amount or a reduction in the bond's coupon due to the occurrence of a covered event or events (a "triggering event"). We refer to this as the probability of attachment.
  • The credit rating, as applicable, on the collateral held in the note payment account, the reinsurance trust and/or collateral accounts, swap counterparty, and repurchase counterparty.
What if a third party provides a guarantee?

We apply our guarantee criteria if a third party--that we rate--guarantees the payments due from a cedant (see "Guarantee Criteria," published Oct. 21, 2016). These criteria discuss the elements that S&P Global Ratings typically considers in assessing whether a guarantee (or equivalent) is a form of credit enhancement. Guarantees that are credit enhancements shift the evaluation of creditworthiness from the primary obligor (the guaranteed entity) to that of the guarantor.

How do you determine the insurance risk factor?

We typically derive the insurance risk factor based on the results of modeling performed by third-party modeling companies that we recognize as sufficiently credible. We may also assess the results of modeling that transaction sponsors (or their designates) perform, using the aforementioned third-party models, if we deem their risk modeling, risk management, and other enterprise risk management capabilities credible. We expect transaction sponsors to send us reports and information as requested. If we do not receive this, we may not rate the bonds or may withdraw the ratings. We are unlikely to rate bonds that use a proprietary model of a ceding company.

The results of the modeling typically represent the baseline attachment probability, to which we apply stresses (adjustments) that may result in an insurance risk factor that is stronger or weaker than that indicated by the baseline attachment probability.

The stresses are based on transaction-specific risk factors and are intended to incorporate the modeling uncertainty of the covered events. We assess the modeled results, including several stress scenarios, to determine the effect of each risk factor on the results, and we analyze the results of additional stress scenarios as needed.

Once we have derived the stressed probability of attachment, we assign an insurance risk factor to the transferred risk by comparing the stressed probability of attachment to the thresholds identified in table 2 of our ILS criteria (see "Methodology And Assumptions For Insurance-Linked Securitizations," published Nov. 18, 2018).

What impact do your stresses have on deriving the insurance risk factor?

We typically limit the magnitude of such adjustments based on the preponderance of available information and our view of the relevance of these factors to the overall assessment. Adjustments to the baseline attachment probability--to derive the stressed probability of attachment--generally can lead to an insurance risk factor that is up to two notches higher or lower than that indicated by the baseline attachment probability.

Where triggering events can occur at any moment with limited or no warning, resulting in a default or downgrade (such as with natural catastrophes), we typically cap the assessment of the insurance risk factor as follows:

  • The insurance risk factor for a single-event risk ILS bond is typically capped at 'bb+'.
  • However, we may exceed the 'bb+' cap and assess the insurance risk factor for a single-event ILS bond at 'bbb+', 'bbb', or 'bbb-' if the one-year stressed probability of attachment does not exceed 20 basis points (bps), 30 bps, or 40 bps, respectively.
  • The insurance risk factor is typically capped at 'bbb+' for second-event ILS bonds and 'a+' for third (or more)-event structures.
How do you determine the insurance risk factor for transactions which have a maturity longer than a year?

We compare the stressed one-year and cumulative probabilities of attachment for each year up to and including the maturity of the bond with the thresholds in table 2 of the ILS criteria. (For example, in the case of a bond with a three-year maturity, this includes the one-year and cumulative two- and three-year stressed probabilities of attachment with the one-, two-, and three-year thresholds in the table.) For each relevant row, an indicative insurance risk factor is determined as the first column (reading left to right) for which the threshold value in the table exceeds the stressed probability of attachment. The lowest indicative insurance risk factor from all the relevant rows is the insurance risk factor assigned to an ILS. For example, if the one-year stressed probability of attachment equals 1.7% and the two-year stressed probability of attachment equals 3.0%, the assigned insurance risk factor will be 'bb'.

How do you incorporate model changes?

Models can change over time, and if the industry's view of the risk changes or we consider the current modeling or escrowed model doesn't adequately capture the risks, we will apply adjustments to align with our view of the risks, which may differ from the results of the modeling a third party performs.

What types of collateral do the ILS criteria permit?

Debt obligations:   If proceeds from the issuance are invested in debt obligations, we apply our temporary investments criteria (see "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, 2012). The cash flows from the debt obligations must be sufficient at all times to meet the issuer's portion of the scheduled payments due on the ILS on each payment and any redemption date. Absent this, we would either not rate the ILS or lower the rating by applying our criteria for assigning 'CCC+', 'CCC', 'CCC-', and 'CC' ratings (see "Criteria For Assigning 'CCC+', 'CCC', 'CCC-', And 'CC' Ratings," published Oct. 1, 2012).

Money market funds:   If the proceeds from the issuance are invested in a money market fund, the fund must be rated 'AAAm' for us to assign and maintain a rating on the ILS bond. If the rating on the money market fund is lowered below 'AAAm', the proceeds would have to be reinvested within five business days in another money market fund rated 'AAAm', otherwise we may withdraw our rating on the notes.

If the proceeds from an ILS issuance are invested in a money market fund, and 1) the proceeds account for 20% or more of the amount invested in the fund and 2) the money market fund has a provision that mandates a redemption if the net asset value goes below $1.00, the following conditions need to be met to rate the transaction:

  • The proceeds are invested in stable net asset value funds rated 'AAAm', and
  • 50 bps of overcollateralization in the form of cash or cash-like instruments is added to the segregated account holding the money market funds to cover any asset losses up to the amount due on the rated instrument.

Cash:   If the proceeds are invested or reinvested in cash, we apply our global investment and counterparty criteria (see "Global Investment Criteria For Temporary Investments In Transaction Accounts," published May 31, 2012 and "Counterparty Risk Framework: Methodology And Assumptions," published March 8, 2019). Our analysis focuses on third-party obligations to either hold assets (including cash) or make financial payments that may affect the creditworthiness of the rated instruments. If the account provider is investing the issuer's cash in securities, the issuer is exposed to credit risk and market-value risk on those securities. In instances when the issuer's cash is placed in a deposit account that would not benefit from legal protection, we would analyze the resulting counterparty risk according to our legal criteria (see "Structured Finance: Asset Isolation And Special-Purpose Entity Methodology," published March 29, 2017).

Total return swaps/tri-party repos:   If collateral arrangements are subject to total return swaps and tri-party repurchase agreements, we will incorporate the rating on the counterparty to the total return swap or the repurchase counterparty agreement for purposes of the weak-link analysis.

What happens if upon reinvestment there is a loss of principal and the loss is not de minimis?

If, upon a reinvestment, a loss of principal is realized and such loss is not de minimis, we would likely lower the rating to 'CC', and then to 'D' at maturity. If the collateral investments were expected to earn a net negative yield and we do not expect the ILS issuer to redeem the bonds in full at maturity, we would likely lower the rating to 'CC', and then to 'D' at maturity if the principal loss is not de minimis.

What structural considerations do you take into account?

We generally consider whether a transaction structure meets our structured finance criteria relating to asset isolation and special purpose entities, including with respect to the bankruptcy remoteness of the issuer. In addition, we generally consider whether legal comfort is provided such that the rated obligations are not subject to regulation as contracts of insurance or reinsurance under applicable law and that the holders of such bonds should not be subject to regulation as providers of insurance or reinsurance.

If you have further analytical questions on the criteria mentioned in this FAQ and its application, please contact the analysts listed in this article.

Related Criteria

This report does not constitute a rating action.

Primary Credit Analysts:Maren Josefs, London + 44 20 7176 7050;
Steven Ader, New York + 1 (212) 438 1447;
Abhijit A Pawar, London + 44 20 7176 3774;
Andrew Paranthoiene, London + 44 20 7176 8416;
Secondary Contacts:Simon Ashworth, London + 44 20 7176 7243;
Emanuele Tamburrano, London + 44 20 7176 3825;

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