A.M. Best Explains Its Rating Fundamentals for Hedge Fund Reinsurers

September 22, 2015

Since the Aug. 11, 2015 withdrawal of PaCRe Ltd.’s financial strength rating and issuer credit rating at the company’s request, A.M. Best said there has been considerable speculation about A.M. Best’s view on these hedge fund-sponsored reinsurers.

A.M. Best said it remains committed to rating these types of structures, which differ from a traditional reinsurance company primarily as a result of the investment strategy pursued and how that is balanced with the risks associated with underwriting activities.

Currently, A.M. Best maintains interactive ratings with six hedge fund reinsurers (HFRs). The rating process for these structures remains in accordance with Best’s Credit Rating Methodology, which applies to all A.M. Best ratings and involves an in-depth analysis of a company’s balance sheet strength, business profile and (projected) operating performance.

A key part of the rating process includes a thorough due diligence on the process management follows to balance the asset management objectives against those of the underwriting considerations with respect to projected new business, the ratings agency continued.

Additionally, start-up HFRs are reviewed specifically against the “Rating New Company Formations” criteria, which, A.M. Best said, involves an analytical focus for companies that lack a demonstrated track record of operating performance. The rating agency also conducts “extensive due diligence on management’s expertise/track record, asset management capabilities, business plans, internal operational controls and overall enterprise risk management program.”

One of the key tools used is Best’s Capital Adequacy Ratio, which compares an insurer’s risk-adjusted capital against the required capital necessary to support its operating and investment risks. Finally, and equally important, A.M. Best said it maintains a structured monitoring program to track the company’s progress toward its stated objectives and strategy.

“It is important to understand that not every start-up business plan, hedge fund or other, presented to A.M. Best, achieves the coveted FSR of A- (Excellent) or an ICR of ‘a-‘ due to potential weaknesses in the overall strategy or concerns over the ability to execute,” the ratings agency said.

Additionally, once rated, shortfalls in the actual execution of the original business plan can also result in changes to the rating originally assigned, the company explained. “While these circumstances occur from time to time, they do not constitute a change in A.M. Best’s view of its own ability to rate a particular type of business strategy.”

Source: A.M. Best

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