S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Bond Insurancenet losses will occur in a normal operating environment.This expectation is based on the credit qualityof the insured portfolios, which overwhelminglyconsist of issues that are investment grade or nearinvestment-grade quality on an uninsured basis. Inother words, it is presumed that insurers only takeon liabilities judged to have minimal loss potential,except under extreme economic conditions.To date, losses incurred by monoline financialguaranty businesses rated by Standard & Poor’shave, in fact, been minimal. Based on this experience,there is little basis for establishing largereserves that normally are found with more traditionalinsurance lines, except where individualtransactions have necessitated “case-basis” reserves.Since the typical reserve analysis is not applicable,Standard & Poor’s uses a different approach—thecapital adequacy model—to determine the adequacyof capital reserves. This model tests the ability of thebond insurer to handle claims that would be expectedto occur in a hypothetical worst-case scenario.This scenario is structured to incorporate a level ofeconomic stress far more severe than might beexpected to occur in the normal cyclical functioningof the world’s economy.Another difference is that the criteria havebeen established with rating durability in mind.Table 1 Reinsurance Credit For Business Ceded ToA Monoline Reinsurer—Monoline reinsurer rating—(%) AAA AA A BBBCeding Company RatingAAA 100 70 50 N/AAA 100 75 70 50A 100 80 75 70N/A—Not applicable.Table 2 Reinsurance Credit For Business Ceded ToA Multiline Reinsurer—Multiline reinsurer rating—(%) AAA AA A BBBCeding Company RatingAAA 95 65 45 N/AAA 95 70 65 45A 95 75 70 65N/A—Not applicable.Investors expect that bond insurers’ ratings will bestable and not subject to frequent adjustmentbased on the normal ebbs and flows of credit qualityover the traditional economic cycle. While thecriteria have been crafted to encourage sound businesspractices that should result in stable ratings, itis not so limiting that ratings would never change.Poor execution of the business plan, underwritingpractices, or risk management, or decidedlyadverse credit quality changes to the underlyinginsured bonds, could result in a change to theinsurer’s rating.The following sections highlight rating criteria forrated insurers operating in the monoline format.Criteria for lower rated insurers is the same as for‘AAA’ rated insurers in many respects, differing primarilywith regard to underwriting, where the insurercan insure a higher proportion of speculative-gradetransactions; capital adequacy, where the insurer isnot required to be as strongly capitalized relative torisk assumed as would be an ‘AAA’ rated insurer; andcredit for reinsurance, where the credit given for aparticular reinsurer is somewhat higher and the ratingeligibility requirement is less restrictive.Monoline InsurersIn assessing the financial strength of each monolinebond insurer, Standard & Poor’s focuses on the followingareas detailed below.OwnershipStandard & Poor’s is comfortable with mature insurershaving significant public ownership as long as theinsurers practice long-range capital planning, includinga proactive capital sourcing philosophy that proposesto access capital well before it might be needed.Debt owed to third parties can also be appropriatefor mature insurers, as long as it is limited to a modest15%-20% of the holding company’s capital structureand its maturity structure is consistent with thecapital-generating ability of the business.Standard & Poor’s believes that the ideal ownershipprofile of a newer, less-established insurershould consist of large institutional investors ofhigh credit quality with a firm commitment to theindustry. The ideal capital structure for a holdingcompany is 100% equity. How-ever, minimal holdingcompany leverage is not a concern as long aseach debtholder also holds equity and all debtholdershold the same mix of debt and equity, as ownershipcreates a commonality of interest amonginvestors. The presence of high net worth individualsor public ownership of stock would not beviewed negatively, provided that such ownership isvery limited. Until the insurer has reached a level ofmaturity characterized by several years of successfuloperations, Standard & Poor’s does not considerwww.standardandpoors.com295