Insurers seek financial enhancement ratings

Venkatachari Jagannathan
30 April 2002

FER ratings give capital markets an indication of an insurance companys willingness to pay on structured transactions wrapped by the insurer, says S&P Insurance Rating Group managing director Bob Mebus. This is especially relevant now given the degree of uncertainty associated with insurance companies willingness to pay quickly and with the rise in the complexity of structured transactions.

Today, when structured financial transactions and guarantees are becoming more and more complex, some insurance companies are now providing transparency and a willingness to pay claims as a value-added benefit for their investors. This is the trend now among insurance companies that offer credit enhancement underwritten through an insurance policy where the insurer accepts specified transaction risks, which affect the financial performance of a transaction.

What is credit enhancement? Consider this. A municipal authority is selling a bond for a bridge somewhere in the US. The municipal bond, on its own, may be rated rather low, but the issuer may purchase financial guarantee insurance on the bond from a higher rated insurance company. This acts as a guaranty in that the insurance company then takes on some of the risk and in a sense, lends its rating to the municipal bond.

These types of transactions were the domains of mono-line bond insurers, who paid claims immediately when called upon. But as the complexity of transactions increased, multi-line insurers entered the fray. These new entrants looks at claims on a denied-first basis and may not always be prepared to settle claims as readily as the investor and bond issuer may believe.

Often it is only those close to the insurance industry are in the know that insurance companies approach claims with a denied-until-proven-otherwise manner, as opposed to a pay-first-no-matter-what basis, says Mebus. So the actual enhancement of the bonds rating may be misrepresented in borrowing the insurance companys own financial strength rating, depending on the willingness of the insurer to pay claims on such transactions. Insurers financial strength ratings do not take willingness to pay into account.

If the bridge has a problem, and the insurance company denies the claim, or takes a long time to pay out, then the bond really is not enhanced at all. For the credit support supplied by insurers, as with other types of guarantors, capital markets want a high degree of assurance, that their claims will be paid if it comes to it, sums up Mebus.