S&P Rating Revision Hits Insurers

Posted on Aug 09, 2011 by Sergio Ulloa (G+)

Standard & Poor's decision to lower the long-term sovereign credit rating on the United States of America from 'AAA' to 'AA+' with a negative outlook has now had implications on the worldwide insurance industry, with subsequent action taken against several US-based insurance groups by the credit rating agency this week. On August 5^th 2011, Standard & Poor's (S&P) stripped the United States government of its AAA credit rating for the first time in history. The contentious move came in the aftermath of the last-minute deal brokered by Congress and the White House to finally raise the federal debt ceiling and guarantee that the federal government would continue to honor all of its escalating financial obligations. The outcome of the budget agreement has however been subject to criticism as the threat of a similar government standoff over spending remains a distinct possibility in the near-future. The inability of political leaders from the most powerful nation on earth to enact meaningful policy to address the country's fiscal issues pushed S&P into action. John Chambers, head of S&P's sovereign ratings committee, explained to reporters that "the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges." The two other major international rating agencies, Moody's and Fitch, have not made similar moves to downgrade the US sovereign debt. On Monday, S&P identified 10 American insurance companies whose financial strength was now at risk due to their creditworthiness being tied to the US Treasury and the ability of the national government to continue to pay off its debts. The ratings agency quickly stripped the coveted 'AAA' status from the following 5 firms' long-term counterparty credit and financial strength ratings: Knights of Columbus, New York Life Insurance Co., Northwestern Mutual, Teachers Insurance & Annuity Association of America (TIAA) and United Services Automobile Association (USAA). S&P noted that the ratings on all these companies and their affiliates moved down a notch to 'AA+' with a negative outlook, in line with its action on the US sovereign rating. At the same time on Monday, S&P affirmed the 'AA+' ratings status for Warren Buffett's Berkshire Hathaway, Assured Guaranty, Guardian Life Insurance Co, Massachusetts Mutual and Western & Southern Financial Group Inc. and had all their outlooks cut to negative from stable. The move has also come in conjunction with the additional downgrades of other government-sponsored enterprises, Fannie Mae and Freddie Mac. S&P explained that their decision to downgrade these insurers did not reflect upon the fundamental credit characteristics of these companies, which remain unchanged and sound. "These companies maintain very strong capital and liquidity." S&P noted. Rather, the credit ratings agency justified their actions on the grounds that all 10 of the affected insurance firms are significant holders of US Treasury bonds and agency securities, and are thus overtly exposed to any potential sovereign downgrade that further increases the cost of borrowing. The financial strength and mobility of these insurers is also impacted by the fact that their business and asset portfolios remain largely concentrated in the United States. According to S&P, the firms with the greatest exposure had sovereign US Treasury investments that comprised as much as 200 percent of their total adjusted capital in 2010. "Our view of these companies' fundamental credit characteristics has not changed. We factor direct and indirect sovereign risks ½ such as the impacts of macroeconomic volatility, currency devaluation, asset impairments, and investment portfolio deterioration ½ into our financial strength ratings," S&P said in a statement, adding that "Per our criteria, the sovereign local-currency credit rating constrains our financial strength ratings on insurers." Going by S&P's criteria, the US sovereign credit rating will continue to restrict the ratings outlook for domestic insurance companies as well. If S&P decides to lower the US debt rating again, the same rating action would likely be taken on the affected insurers and their related obligations. "Alternatively, if we were to revise the rating outlook on the U.S. to stable, we would likely revise the outlook on the affected insurers to stable, assuming there is no deterioration in a particular insurer's business and financial profiles," S&P added. The impact of S&P ratings actions may be difficult to determine for the international insurance industry. A downgrade could lower the price of US government debt and, thus, book values of the insurers who own a significant amount of it. However, these same insurance companies generally have positive cash flows with a shrewd investment strategy and could maintain their government-bond investments despite any adverse short term price fluctuations. While a downgrade surely stings the pride of these American insurance companies, their credit ratings all remain very high and it is unlikely that a AA+ rating will affect consumers in the long term. According to statements released from many of these affected insurers in the past week, the problems being addressed by S&P now are entirely political and have no bearing on the operational capacity or solvency of any company. Outside of the United States, the potential to close the trillion dollar gap in coverage between the West and the emerging Eastern economies could present sufficient business opportunity for multinational insurers to re-capitalize and offset any calamitous developments in their mature home markets. Ratings Companies Mentioned Standard & Poor's Standard & Poor's (commonly referred to as S&P) is a business branch of publishing house McGraw-Hill. Operating out of 20 countries, S&P provides the investment community with independent credit ratings on important financial vehicles such as stocks, municipal bonds, corporate bonds and mutual funds. In addition to its risk management, investment research and credit rating services, Standard & Poor's is known for its indexes, in particular the S&P 500 index.