Brazil Economy Challenges Re/Insurers; No Rating Impact Expected: A.M. Best

July 21, 2015

As Brazil’s sovereign ratings hover just above non-investment grade status, A. M. Best said it is considering the effect a future sovereign downgrade would have on rated re/insurers’ balance sheets and risk-adjusted capitalization, according to a briefing published by the rating agency.

To date, re/insurers in Brazil rated by A. M. Best have not been materially adversely affected by the current economic environment.

Putting the complexities of the Brazilian economic situation into context, A.M. Best explained that the country’s economy has experienced strong growth over the past two decades, which was driven by an abundance of natural resources and strong agricultural and manufacturing production.

However, the world’s seventh largest economy now finds itself experiencing numerous economic challenges, including poor economic growth prospects, above target inflation, declining commodity prices and a reduction in investor confidence, said the A.M. Best report entitled “Economic Conditions in Brazil Present Challenges to Local Re/Insurers, But No Rating Impact Expected.”

The report went on to say that these issues are compounded by political turmoil and bureaucratic inefficiencies, as evidenced by the ongoing Petrobras scandal. [Brazilian authorities allege that officials from the state-run oil company operated a multibillion dollar kickback scheme on inflated contracts].

While the Brazilian government has taken steps to mitigate these challenges, the A.M. Best report said, the implementation of austerity policies and other initiatives have resulted in public rancor and have yet to take effect or have a meaningful impact on Brazil’s current economic condition.

As a result of these economic headwinds, the A. M. Best report examined the projected impact of a future sovereign downgrade on domestic re/insurers and which lines of business could be affected.

“For regulatory purposes, Brazilian domiciled re/insurers hold the vast majority of their invested assets in Brazilian securities with Brazilian sovereign debt being the most widely held,” the report said.

To test the resiliency of rated re/insurers’ balance sheet strength, A. M. Best applies various stress tests, including sovereign downgrades and even default scenarios, using its Best’s Capital Adequacy Ratio (BCAR), the ratings agency explained.

“The stress test methodology consists of haircuts to Brazilian sovereign securities, lowering the rating of Brazilian corporate bonds, as well as additional haircuts to equity and real estate holdings,” the report said, noting that the test mimics a potential sovereign downgrade and resulting market decline.

“While A. M. Best does not employ a sovereign ceiling on its financial strength ratings, it does assess how these external factors would affect a re/insurers’ future business prospects, operating performance and capitalization,” said the report. “A. M. Best also factors in an organization’s risk management capabilities to navigate through these scenarios.”

While the ratings agency has determined the domestic market has not been materially affected by the economic conditions in Brazil, it said it will continue to monitor the situation.

Source: A.M. Best

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