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Throughout this report Fitch provides anecdotal evidence that demonstrates this lack of ratings comparability. It is most apparent with newly formed companies, insurers located in countries with high country risks, captives and smaller insurers.
In addition, Fitch examined historical statistical ratings performance by comparing default and impairment rates by rating category (over a 25- to 37-year period), using data reported to regulators by the various CRAs. This analysis indicates that the historical impairment rate for A.M. Best’s ‘A–’ IFS rating is approximately 7% (estimated by Fitch). This is significantly higher than the estimated 2% historic default rate for Fitch’s ‘A–’ ratings, and falls between Fitch’s 6.3% default rate at ‘BBB’ and 9.7% at ‘BBB–’. Fitch recognizes impairments are expected to occur at a higher frequency than defaults. However, Fitch also believes the noted difference at ‘A–’ falls outside normal impairment versus default expectations.
Fitch believes the lack of ratings comparability reflects a combination of differences with respect to how certain risks are weighed in the respective CRAs’ ratings criteria, and the fact that the IFS ratings scale used by A.M. Best does not directly map to the rating scales used by the other noted CRAs.
Based on their findings, IFS ratings users that treat the ‘A–’ IFS ratings of all four CRAs as directly equivalent are misestimating credit risk and, therefore, should consider adjusting their ratings standards accordingly. Specifically, Fitch believes the equivalency should be changed to ‘BBB’ for Fitch, as well as Moody’s and S&P, and retained at ‘A–’ for only A.M. Best. This also coincides with how capital markets view debt ratings, where debt ratings in the ‘BBB’ category (and above) are considered investment grade.
Inaction by ratings users will potentially perpetuate the unintended consequences of:
Furthermore, Fitch believes that misaligned ratings standards used by many ratings users also encouraged so-called “ratings shopping” by (re)insurance company management. Specifically, many (re)insurers are incentivized to only seek A.M. Best IFS ratings, since an ‘A–’ IFS rating is often more readily achieved than from the other CRAs.
Note, this analysis does not suggest that A.M. Best’s approach is wrong. Rather, it suggests that A.M. Best’s approach is different, and that this difference, in turn, makes A.M. Best’s ratings less comparable with those provided by Fitch and the other CRAs.
Further, Fitch believes most IFS ratings users are either simply not aware that such differences exist, or if they are aware, they are not appreciative of the magnitude of the differences. This white paper is intended to provide additional transparency around this important issue.