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

Other CriteriaCommitted capital facilities will receive 100%credit, provided that asset credit quality and marketvalue risks have been eliminated to an ‘AAA’certainty. Credit will be reduced to reflect the existenceof asset credit quality risk, market value risk,or counterparty risk. Committed capital will becounted against an insurer’s overall soft capitallimits and will be limited as a percent of an insurer’scapital structure.Acknowledging the risk of a failed or dysfunctionalauction, Standard & Poor’s believes issuingauction-rate securities to fund a committed capitalfacility is most appropriate for those bond insurersthat are not part of a larger group, where there area greater number of potential sources of adversenews that could cause an auction to fail to properlyfunction. Specifically, bond insurers owned by alarge, diversified group or by a small pool ofinvestors are limited to auction-rate funded facilitiesequal to 10% of adjusted statutory capital (statutorycapital plus committed capital facilities). All publiclyheld monolines can have auction-rate fundedfacilities equal to 20% of adjusted statutory capital.Although these facilities offer many advantagesover other forms of soft capital, particularly withregard to the durability of the access to funds andthe absence of reliance on a third party to performunder a contract, they are not necessarily as permanent,nor do they provide as much flexibility, aspaid-in capital. Therefore, these facilities will beincluded in overall soft capital limits, and fees paidby the insurer are treated as interest expense whenanalyzing the consolidated enterprise. Once drawn,these facilities are viewed as debt at the consolidatedholding company level.Amounts issued in excess of the allowable limitswill not be treated as either debt or equity at theholding company level and will not be included ascapital in the capital adequacy model. Over time,the insurer will get more credit for the facility asallowable amounts expand, reflecting the growth inthe capital base and soft capital usage limits.Committed capital facilities are also constrainedby a test that limits total hybrid equity plus committedcapital facilities to no more than 20% of theinsurance holding company capitalization plus committedcapital facilities.Collateralized trust funds as a meansof enhancing credit given for reinsurance.Standard & Poor’s will give 100% credit againstceded capital charges for reinsurance backed by collateralas long as the following structure is in placeand under the following constraints:■ The structure is available only to reinsurers rated inthe ‘BBB’ category or higher.■ The collateral must be posted in a third-partytrust account for the benefit of the ceding company.Legal opinions must support the fact that thetrust is completely independent of the reinsurerand cannot be changed, impaired, or recapturedin the event of financial stress at the reinsurer.Legal opinions must also support a ceding companyto at all times have unimpeded access to thefunds in the event of nonpayment by the reinsurerfor any reason.■ Acceptable collateral is limited to cash, U.S. governmentsecurities, and ‘AAAm’ rated moneymarket funds. Other collateral will be consideredon a case-by-case basis.■ Collateral should be marked to market daily,and at all times should be valued (adjustedvalue) using Standard & Poor’s structuredfinance market value criteria. If the adjustedvalue falls below the amount required to achieve100% credit, the reinsurer must post additionalcollateral no later than three days from the datethe collateral fell below required levels.Shortfalls must be reported to Standard & Poor’sand the ceding company immediately, along withremedial steps to be taken.■ Standard & Poor’s should receive a quarterlyreport listing all securities held in the trustaccount. The report should include the type ofsecurity, maturity, Standard & Poor’s collateralfactor, and net adjusted value. The independentthird-party trustee for the trust should preparethis report.To compensate for the fact that the book of businessceded to the reinsurer is not identical to the cedingcompany’s book of business, raising the possibilitythat the ceded book of business might performless favorably than the ceding company’s book, theamount of collateral posted, after market valueadjustments, must be at least 125% of the totalceded capital charges. Where the reinsurer’s book ofbusiness does not exhibit satisfactory sector and geographicdiversity and single-risk management, thisadjustment can be increased. This adjustment is notapplied when collateral is being posted to increasethe credit given for facilities where a specified dollaramount of losses is being covered in excess of anattachment point.Reliance on soft capital providers. Standard &Poor’s monitors the reliance that a bond insurerplaces on reinsurance and other capital substitutes,such as owners’, third-party, or prefunded capitalcommitments to provide additional capital.Reliance on soft capital is thought to be excessivewhen these alternate forms of capital provide morethan 33% of an insurer’s total depression-periodclaims-paying resources. For this test, collateralized298 Standard & Poor’s Public Finance Criteria 2007