Fitch completed the initial phase of its ratings review of insurance and reinsurance companies exposed to losses from the terrorist attacks of Sept. 11 in the United States.
Findings have been issued on 16 insurance organizations placing ratings on Rating Watch Negative, downgrading ratings, or both.
Fitch believes that insurers will be able to pay claim obligations arising from the attacks without a significant decline in the industry’s overall financial strength and creditworthiness. Fitch also believes that these events will give rise to a further “flight to quality” in the reinsurance and primary property/casualty industries, as awareness has been raised as to the importance of purchasing coverage from companies that are able to absorb losses of this nature.
Fitch’s ratings review will be ongoing, and moves to a second phase this week.
The initial phase focused mostly on the identification of companies with potentially large claim and policy benefit obligations resulting from the attacks. The second phase will focus on insurers’ investment exposures to both equity securities, and fixed income and other securities in industries adversely affected by the attacks, such as aviation and tourism. Fitch does not expect to take immediate broad-based actions tied to this second phase of analysis, since it is still too early to judge how investment valuations and default rates in these sectors will play out.
According to the report, it also remains premature to predict the ultimate level of claim-related losses tied to the attacks. Initial loss estimates for the property/casualty industry were in the $20-$30 billion range, but more recently some estimates have ranged closer to $70 billion. Should losses reach these higher levels, many insurers placed on Rating Watch Negative could be downgraded. In addition, some insurers not currently on Rating Watch would also face downward ratings pressures. However, if losses stay close to the lower end of the range of estimates, the ratings of many of the companies placed on Rating Watch will likely be affirmed.
Fitch believes that loss estimates in the $3-$5 billion range for the life/health sector continue to appear reasonable, and expects that there will be less volatility in life estimates than in the property/casualty sector. However, some upward movement cannot be ruled out. Losses in the life industry seem to be fairly well diversified across a variety of companies, with no single life insurer in Fitch’s ratings universe exposed to an estimated loss that is overly large as a percentage of capital. Health insurers, to date, have predicted minimal exposures since most medical costs will be borne by workers’ compensation policies.
Fitch will carefully monitor both aggregate and company-specific loss estimates, and take appropriate rating actions as information changes.
The most significant rating action announced by Fitch was the two-notch downgrade of the insurer financial strength rating of Lloyd’s of London, from “A+” to “A-,” and placement of the rating on Rating Watch Negative.
Lloyd’s has not yet publicly announced its own estimate of potential losses. However, based on Lloyd’s heavy participation in aviation-related risks and high-level catastrophic coverages, Fitch believes that of all the insurance entities within its ratings universe, it is likely that Lloyd’s will experience the greatest financial impact from the terrorist attacks.
Fitch also downgraded by one notch the ratings of four other property/casualty insurers – Atlantic Mutual, Kemper, Liberty Mutual, and Republic Western – though these downgrades were heavily influenced by reserving and operation issues, as opposed to strictly attack-related exposures. In fact, the downgrade of Republic Western was only due to operational and reserving issues. In addition to being downgraded, both Atlantic Mutual and Kemper were also placed on Rating Watch Negative due to the level of their exposures to the attacks.
Fitch placed a number of other property/casualty insurers and reinsurers on Rating Watch Negative since their current loss estimates related to the attacks reflect a material percentage of their capital. In several cases, the Rating Watch was also linked to operational and reserving issues. The list includes ACE, Chubb, CNA, FM Global, Hartford Fire, Markel, Royal & SunAlliance (USA), SCOR, Swiss Re and XL. Should losses for these companies increase to levels inconsistent with their present ratings, Fitch will discuss with management plans to replace lost capital. If these plans appeared viable, Fitch would permit management a reasonable time period to put into place its plans. If capital raising proved successful, the ratings would be affirmed and removed from Rating Watch; if unsuccessful, the ratings would be downgraded.
However, if losses increase to very high levels, Fitch would likely initiate a downgrade even if management planned a capital raising effort. Companies often face declines in financial flexibility and financing options in the face of very large estimated losses. If capital was ultimately raised, the ratings would then be upgraded.
The only rating action in the life sector related to the attacks was to place IDS Life on Negative Rating Outlook due to challenges Fitch believes parent American Express will face in its travel-related businesses. No life or health insurers were placed on Rating Watch or downgraded due to adverse claim exposures.
There are still tremendous uncertainties surrounding the ultimate resolution of the insurance industry’s exposures to the terrorist attacks. Some of these include: Fitch believes that as losses increase, there is a greater likelihood that disputes will develop between primary insurers and reinsurers, including the definition of the number of events that occurred. A higher level of losses would also lead to increased incidence of financial impairment among reinsurers, especially the more marginal mid and lower tier players. This could lead to delays in collections for primary companies, as well as uncollectable balances, which could strain liquidity and further negatively impact capital. There are still tremendous challenges faced by insurers in identifying the extent of their exposures, and developing loss estimates. For example, the extent of business interruption claims for property/casualty companies should prove especially difficult, since no catastrophic event in recent history has been as far reaching in slowing or stopping business activity. Typically, business interruption claims follow a natural disaster, such as a hurricane or earthquake, where the stoppage of business activities is fairly localized. In contrast, business interruption from the terrorist attacks was felt throughout the nation.
Though most insurers have indicated no plans to do so, there is still a chance some insurers, especially those facing financial difficulties, could attempt to invoke Acts of War exclusions to avoid claims payments. If successful, this could reduce losses borne by insurers. However, Fitch believes that insurers that invoked Acts of War exclusions would severely hurt their reputations and franchise values, as well as future competitive positioning. Thus, Fitch would very likely need to downgrade any insurer that invoked an Acts of War exclusion.
Many are projecting that the huge losses suffered in the property/casualty industry will lead to sharp rate increases at both the reinsurance and primary levels, and sharp declines in available capacity. As a result, many are also projecting that a vastly improved pricing environment will swiftly emerge and allow insurers and reinsurers with depleted capital to replenish their balance sheets through heightened earnings. Fitch believes this will likely occur in the near term.
However, Fitch also realizes that major disruptions in the insurance markets could lead to a more difficult long-term outlook for the industry. For example, after the ‘liability insurance crisis’ of the mid-1980s, when both pricing increased and capacity decreased sharply, adverse structural changes contracted the market available to commercial insurers. These structural changes included movements by corporate policyholders to self-insurance and other alternate insurance mechanisms. The drastic changes in pricing and capacity in the mid-1980s led to a short- lived but very strong hard market, followed the longest and most difficult soft market in history, extending from 1987/88 until 1999. It is still far too early to judge how the insurance markets will react in this current situation.
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