S&P Report Explains ‘Core Subsidiary’ Term

April 1, 2005

The London office of Standard & Poor’s Ratings Services has published a report – “Insurance Criteria Update: What Makes An Insurance Or Reinsurance Subsidiary ‘Core’ Under Group Rating Methodology?” – updating its criteria for rating insurance groups and, in particular, clarifying how the group status of insurance and reinsurance subsidiaries is determined.

“Companies typically want to achieve the highest rating possible, and so may argue that an operation is core to their business, which means that it should be rated at the group level,” S&P said. “However, Standard & Poor’s rating committees use the terms ‘Core’, ‘Strategically Important’, and ‘Nonstrategic’ when considering subsidiaries. Company managements’ usage of the term ‘core’ may differ from Standard & Poor’s definition, and the report clarifies our criteria.”

S&P said its “definition of Core relies on a subsidiary meeting eight criteria, one of which stipulates that a company should constitute at least 5 to 10 percent of total group capitalization and be integral to the group in terms of line of business and geography.

“The analysis of a company’s status to a group needs to reach beyond what may be the sincere beliefs of management, to consider the possibility of events occurring that could force group management to withdraw the previous levels of support. Both Strategically Important and Nonstrategic subsidiaries are rated on the basis of a ‘bottom-up’ analysis, starting with an assessment of their intrinsic, stand-alone position, to which additional notches of credit are added to denote the degrees of group support.

“There remains some debate about whether a remote, relatively high-risk subsidiary can ever be genuinely Core (as defined by Standard & Poor’s). Experience shows that, in a buoyant business environment, it is relatively easy to insist that all main elements of the group are Core, but the rating process has to assess this commitment in times of trouble. When the going becomes so tough that the independence or future of the whole group is threatened, former commitments are seen to be set aside as management instead comes only to distinguish in very black and white terms between those subsidiaries that it can sell or walk away from, and those that it cannot.”

S&P cited some recent specific examples, noting that this “is especially true if the subsidiary lies at the heart of difficulties–as in the recent case of Converium and its underperforming U.S. reinsurance operations.” S&P credit analyst David Anthony noted: “Nuanced guidelines for the factors that may prove decisive in establishing the appropriate group status are necessary if they are to accurately reflect the true standing of subsidiaries. While it is often misleading to analyze and rate a group subsidiary solely on the basis of its intrinsic strengths and weaknesses, there are a wide range of analytical questions, including financial, cultural, and geographical issues, that must be considered before the degree of support can be accurately factored into the rating.”

The report is available to subscribers of RatingsDirect, Standard & Poor’s Web-based credit research and analysis system, at www.ratingsdirect.com. If you are not a RatingsDirect subscriber, you may purchase a copy of the report by calling (1) 212-438-9823 or sending an e-mail to: research_request@standardandpoors.com. Ratings information can also be found on Standard & Poor’s public Web site at: www.standardandpoors.com.

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