Willis Re Upbeat on S&P’s New Insurer Capital Model

After several years of uncertainty, coupled with no small amount of angst, Willis Re, the reinsurance broker for Willis Group Holdings, has published a reassuring report on Standard & Poor’s new criteria for assessing insurers’ economic capital models. Willis Re said the criteria “incentivizes insurers to adopt more sophisticated internal capital models by giving them the opportunity to use the modeling results to potentially reduce their capital requirements.

According to Willis Re, S&P does this by “replacing a proportion of S&P’s standard formula with their own internal capital calculation, that proportion depending upon the credibility that S&P places on the firm’s economic capital model. Willis Re’s report discusses the structure of the new criteria and their relevance for insurers worldwide, with a particular focus on EU companies that will soon be subject to a parallel set of requirements under Solvency II.”

S&P’s revised ratings criteria, released at the end of January, emphasizes risk management, and “identifies the main features of the “ideal” economic capital model according to S&P and provides insights into how the agency is likely to apply its new methodology in practice.,” Willis Re noted.

David Simmons, Managing Director, Analytics and Head of International & Specialty Enterprise Risk Management for Willis Re, commented: “By at last offering the carrot of lower capital requirements to add to the stick of their existing ERM review, Standard & Poor’s has further increased the incentive for insurers to adopt tailored and more sophisticated capital models. But the bar is set quite high. Strong risk management remains key and only models embedded in business decision-making of companies judged to have strong ERM processes will be eligible for review.”

“While S&P’s criteria resemble Solvency II conditions for supervisory approval of internal models, the report notes that there are differences,” he continued. S&P does not approve models but rather weights their credibility. Willis Re says that it now looks likely that Solvency II implementation will be phased, assuming that the transition allowances recently set out in the Omnibus II Directive are followed. “Many companies, particularly in the London market, have invested heavily in their internal economic capital modeling, partially in expectation of gaining regulatory capital relief. This proposal promises a means to release real value from that investment by influencing their rating agency capital.”

Key findings in the report include the following:
• S&P’s review will have a markedly qualitative character. S&P will assign scores of “basic”, “good”, or “superior” to each component of an insurer’s economic capital model. These scores will then be aggregated into a comprehensive assessment summarized by a single number, the “M-factor”, which measures the model’s credibility in S&P’s view. The M-factor will be used to blend S&P’s capital model requirements with those from the insurer’s model. This is materially different from Solvency II, where approved internal models will fully replace the standard formula for the solvency capital requirement.

• Stochastic modeling per se may not be enough to obtain S&P’s approval and should be augmented by stress tests including, but not limited to, worst historical experience.

• S&P believes that capital fungibility should be explicitly and carefully modeled before taking any diversification benefits into account in the determination of economic capital – a crucial requirement for multi-national insurance groups.

• The immediate impact of the new criteria is likely to be relatively small, says Willis Re, as S&P will probably adopt a conservative attitude in deciding its M-factors. This is likely to change in the future, however, as insurers’ models increase in sophistication and S&P’s comfort in them grows.

Source: Willis Re

Topics Carriers Willis Towers Watson