S&P Warns Insurers on Disputing Financial Guarantees

May 15, 2002

Standard & Poor’s has issued a statement warning that insurers who dispute claims payments on financial guarantee contracts, even in fraudulent cases, could now have their counterparty credit, insurer financial strength, and debt ratings lowered as a result.

At a conference in London held to address the challenges faced by market participants, S&P explained that for the last two years,”investors and intermediaries involved in insurance-wrapped transactions have benefited by being able to look to the insurer financial enhancement rating (FER) on an insurer for an indication of its willingness to pay claims on a timely basis. Insurers that chose to default on a payment risked having their FER withdrawn.”

” Now, however,” S&P stated, “criteria changes to FERs, made to better reflect the impact of a selective default on an insurer’s business position, could adversely affect the full spectrum of ratings held by the insurer.”

S&P’s Bob Mebus, managing director at Standard & Poor’s Financial Services Ratings Group in New York, the keynote speaker, affirmed that, “As part of a series of revisions to our rating criteria for financial guarantee insurers, the selective default applied to the FERs of insurers that do not meet their commitments has been extended so that the insurer would also be reviewed for a likely lowering of its counterparty credit, insurer financial strength, and debt ratings.”

” The announcement went on to state that “Before being assigned an FER, an insurer must now indicate in writing that claims arising from an insurance policy used as credit substitution in a structured transaction rated by Standard & Poor’s will be paid immediately, regardless of any legal or commercial disputes.”

“Any insurer that breaks this agreement is likely to impair its credibility in the capital markets and, consequently, its market position, financial flexibility, and even its ability to raise debt. Therefore, an insurer’s default on a payment could significantly compromise the other ratings on that insurer,” Mebus added.

S&P stressed the necessity of making “a proper assessment of a deal” and its structure. It broadened its definition of financial guarantee to include an actual “intent on the part of an insurer to underwrite such business,” rather than purely on the type of contract used.

Mebus underscored the differing views on financial guarantees and stressed the need to clarify exactly what all parties to such a transactions understand and accept. “The clarification of Standard & Poor’s criteria aims to bring transparency to this complex and culturally polarized market.”

“To date, none of the 28 multiline insurance companies to which an FER has been assigned has defaulted,”Mebus continued; “nevertheless, there is clearly value in the revisions to Standard & Poor’s criteria, as they have strengthened the function and clarity of the rating, and should work to minimize insurer defaults on payments in the future.”

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