In an age where structured financial transactions and guarantees are becoming more complex, certain insurance companies now provide transparency and a willingness to pay claims as a value-added for their investors, said a new Standard & Poor’s report.
The transparency in question relates mostly to insurance companies that offer credit enhancement underwritten through an insurance policy where the insurer accepts specified transaction risks that affect the financial performance of a transaction. For example, a municipal authority may sell a bond for a bridge in Springfield, USA. The municipal bond on its own may be rated rather low, but the issuer may purchase financial guarantee insurance on the bond from a higher rated insurance company. This acts as a guaranty in that the insurance company then takes on some of the risk and in a sense, lends its rating to the municipal bond.
These types of transactions were the domain of mono-line bond insurers who paid claims immediately when called upon, but as the complexity of transactions increased, multi-line insurers entered the fray. These new entrants, however, may address claims on a “denied first” basis and may not always be prepared to pay claims as readily as the investor and bond issuer may believe.
“Often it is only those close to the insurance industry know that insurance companies’ approach claims with a ‘denied until proven otherwise’ manner, as opposed to a ‘pay first no matter what’ basis,” said Bob Mebus, Managing Director Standard & Poor’s Insurance Ratings Group. “So the actual enhancement of the bond’s rating may be misrepresented in borrowing the insurance company’s own financial strength rating, depending on the willingness of the insurer to pay claims on such transactions. Insurer’s financial strength ratings do not take willingness to pay into account.
“If the bridge has a problem, and the insurance company denies the claim, or takes a long time to pay out, then the bond really is not ‘enhanced’ at all. For credit support supplied by insurers, as with other types of guarantors, capital markets want a high degree of assurance that their claims will be paid if it comes to it.”
Several insurers participating in providing financial enhancement through insurance policies are now seeking “financial enhancement ratings (FER),” which Standard & Poor’s introduced in mid-2000 to show and clarify to the capital markets not only how able, but also how willing and likely they are to pay claims received; and thereby to show investors that a given bond or transaction is truly enhanced.
“The FER ratings give the capital markets an indication of an insurance company’s willingness to pay on structured transactions wrapped by the insurer,” said Mebus. “This is especially relevant now given the degree of uncertainty associated with insurance companies’ willingness to pay quickly and with the rise in the complexity of structured transactions.”
The reports, “Financial Enhancement Ratings Help Reconcile the Cultural Differences Between Multiline Insurers and Financial Guarantors” and “Revised Financial Enhancement Ratings Gauge Insurers’ Willingness To Provide Timely Payment,” can be found at http://www.ratingsdirect.com for subscribers, otherwise, please visit http://www.standardandpoors.com/ResourceCenter/RatingsCriteria/Insurance.
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