Fitch Outlines Plans to Resolve Sept. 11-Related Insurer Rating Watches

October 19, 2001

On Oct. 16, Fitch outlined the timing, process and determining factors that will affect the resolution of those ratings that were placed on Rating Watch as a result of Fitch’s review of insurance and reinsurance companies exposed to losses from the Sept. 11 events.

Fitch placed 14 insurance and reinsurance organizations on Rating Watch Negative between Sept. 21 and Oct. 2, due to concerns that ultimate losses from the Sept. 11 events could impact their financial condition to a degree that is inconsistent with current rating assumptions. The following companies remain on Rating Watch Negative as of Oct. 15, 2001: ACE, American United Life, Atlantic Mutual, Kemper, Chubb, CNA, FM Global, Lloyd’s of London, Markel, Royal & SunAlliance (USA), SCOR, Swiss Re and XL.

Fitch intends to remove insurers from Rating Watch Negative in a timely manner, but only to the extent that information becomes available to determine that the insurers’ ratings should either be affirmed or downgraded. Fitch’s ability to affirm ratings will depend largely on whether material uncertainties remain outstanding with respect to the individual insurer’s loss estimates, and the ability of a company to replace lost capital if losses prove to be large. Removal of ratings from Rating Watch could also be impacted if Fitch found any problems in the companies’ investment portfolios resulting from economic weakness following the Sept. 11 events as well as if any companies’ business generation prospects were affected. Fitch’s analysis of insurers’ investment exposures is ongoing.

Towards this goal, Fitch has requested additional information from insurers placed on Rating Watch via a detailed survey and is analyzing each situation. Fitch is also inviting the management of each insurer to meet with Fitch to review, in detail, the steps and assumptions used in compiling their loss estimates, once they believe their estimates are firm.

The focus of the review is to judge the accuracy and conservatism of management’s loss estimate. Fitch believes it may be several months before some companies will be removed from Rating Watch. However, companies with particularly detailed, supportable and conservative loss estimates may be removed relatively soon. To date only Hartford Fire’s ratings have been affirmed and removed from Rating Watch, following the results of Fitch’s detailed review of Hartford’s loss estimates concluded on Oct. 15, 2001.

Fitch generally believes detailed ‘grounds up’ studies are likely to be more accurate than ‘top down’ studies, and will be better prepared to remove insurers from Rating Watch quickly if they have completed a ‘grounds up’ study. Companies adding significant conservatism to their loss estimates are also more likely to be quickly removed from Rating Watch.

Fitch will consider whether gross losses emanate from primary insurance or assumed reinsurance. The rating implication is that losses from an insurer’s primary lines, in general, can be estimated with greater certainty more quickly. Insurers with losses generated from large amounts of assumed reinsurance generally need to describe how they were able to estimate exposures so soon, given that reporting from ceding companies is probably still limited. Of course, this does not apply to those companies estimating losses from assumed reinsurance who conclude that covers are fully exhausted.

Fitch does not anticipate significant reinsurer insolvencies as a result of the Sept. 11 events. However, Fitch does believe there is potential for disputes that could lead to material bad debts. Generally, the lower the ratio of the insurer’s gross loss to its net loss, the quicker a Rating Watch can be resolved.

In order to determine the potential for increases in companies’ gross loss estimates, Fitch will consider whether losses under the affected policies were capped and, if so, whether the company recorded losses at policy limits. Fitch is also reviewing the capacity left in companies’ ceded reinsurance contracts to determine the amount of coverage still available to absorb adverse development of gross losses.

Fitch’s analysis differentiates ceded losses between finite and traditional reinsurance covers. A possible implication from the use of finite covers is the potential drag on future period earnings. Of particular concern would be the possible use of any ‘post event’ covers purchased for the purpose of moving the loss into future periods.

Fitch believes companies will be able to estimate and resolve property claims faster than liability claims. Thus, companies whose losses are primarily property-related will tend to be removed from Rating Watch faster than those with substantial liability exposures, all else equal. Additionally, companies with significant liability books may be disadvantaged versus property writers, even if they have not estimated significant liability losses, due to the concern that such claims may emerge over time.

Fitch believes that commercial insurance, reinsurance, and retrocession rates will all rise sharply as a result of the Sept. 11 events. However, not all companies will benefit equally from the price increases, especially considering that retrocession and reinsurance rates, which tend to not be subject to regulatory scrutiny, may rise more quickly and more sharply than rates on primary policies. Thus, primary insurers that face regulatory rate increase scrutiny and also rely heavy on reinsurance may find that increases in reinsurance costs can not be fully offset by increased rates on policies. Also, if adequate amounts of reinsurance prove unavailable, some primary insurers may need to cut back on or even exit certain lines of business as their own capitalization may not be sufficient to support the risk at current rating levels. The same capacity-related concerns hold true for reinsurers with heavy reliance on retrocession coverage.

Thus, the critical factors in assessing a company’s ability to recover capital through earnings, in addition to basic operating fundamentals, include an assessment of the balance between rising product pricing versus higher reinsurance or retrocession cost, and declining reinsurance capacity. Fitch will also consider the companies’ reputations and ratings, and how they will prove beneficial or harmful in a ‘flight to quality’ environment.

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