S&P Bulletin on P/C Holding Company Analysis Method

September 27, 2004

Standard & Poor’s Ratings Services has published an article on its Website (www.standardandpoors.com) presenting the rating agency’s approach as to how it evaluates P/C insurance holding companies.

Such evaluation “is directly related to the creditworthiness of the subsidiary,” said S&P. It explained that while a lot has been written about analyzing operating insurance companies, “this article presents a comprehensive discussion of insurance holding-company analysis. Much of the criteria used to evaluate insurance holding companies are similar to those used to evaluate other financial institutions and other corporate entities. However, given the unique regulatory and operating environment that insurers operate within, key differences are also identified.”

S&P said it uses this approach “if the holding company is a true holding company, i.e., if the holding company has no operating characteristics in its own right. It also is used if the structure is direct (no intermediate holding companies) and if there is essentially one subsidiary.”

S&P noted that “the standard gap for holding companies is one category (three notches) lower than the financial strength rating on the operating company. A gap of this size recognizes the dependence on a dividend stream from subsidiaries for debt, preferred-stock servicing, or both. It also recognizes that regulatory intervention can restrict the flow of funds. In all sectors, Standard & Poor’s evaluates the parent companies of insurance organizations relative to the operating insurance company subsidiaries that they own.”

The rating agency also stressed: “The rating on an insurance holding company is influenced not only by the financial security of its operating subsidiaries but also by the capital structure employed by the organization. The level of financial leverage and coverage of interest and preferred dividends at a holding company ultimately might not only affect the debt and preferred stock ratings on the holding company but also could affect the ratings on the operating companies’ financial security.

“In the case of a holding company with several subsidiaries in diverse sectors—such as a major life insurance subsidiary and a major property/casualty subsidiary—the senior debt rating on the parent could be based on the portfolio of business owned and the quality of those businesses. If the portfolio is well-balanced and complementary and the levels of financial leverage and interest coverage are strong, the senior debt rating is the same as the issuer credit rating (also called counterparty credit rating) on the parent. It also could be equal to the financial strength rating on the subsidiaries or could even be higher than that of one of the subsidiaries.

“Therefore, it is possible that the gap between the holding company and its wholly owned subsidiary or subsidiaries could be narrowed from the standard one category. This is likely to occur if any one of the three following circumstances is applicable:
— Earnings and assets are well diversified at the holding-company level.
— Significant nonregulated operating subsidiaries are deemed able to upstream dividends with limited restrictions.
— Measures of the holding company’s financial strength—such as financial leverage and fixed-charge ratios—are significantly stronger than the standard rating gap would indicate under a variety of scenarios.”

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