A.M. Best's Methodology: Securitization of Reinsurance Recoverables

Business Wire, August 20, 2007

OLDWICK, N.J. -- A.M. Best Co. has released its methodology, Securitization of Reinsurance Recoverables, which describes the criteria for rating securities collateralized by reinsurance recoverables.

Given the size of reinsurance recoverables relative to surplus, uncollectible reinsurance can adversely affect an insurance company's financial strength. For this reason, insurers and reinsurers have been looking for ways to reduce their exposure to uncollectible recoverables and concentration of exposure to specific reinsurers. One approach to achieving this goal is to securitize a portion of the reinsurance recoverable and pass the risk of uncollectible reinsurance to investors.

Securitization of Reinsurance Recoverables outlines A.M. Best's criteria in rating the securities that are backed by reinsurance recoverables. The main feature of the document is A.M. Best's determination of conditions under which insurers or reinsurers will be unable to fulfill their financial obligations. It specifically highlights the difference between the typical capital markets definition of default (which is missed interest and principal payments) and impairment, which A.M. Best considers the best way to measure the inability to pay on obligations in the insurance industry.

A.M. Best's definition of impairment of insurers and reinsurers includes defaults on financial obligations as generally recognized by the capital markets, as well as any type of publicly disclosed regulatory intervention in the operation of an insurance company. The unwillingness to pay on obligations, which can arise in reinsurance agreements, is explicitly excluded from the definition of impairment. Using the impairment definition as a benchmark, A.M. Best has published in this methodology two tables that it uses for assigning credit risk to insurance industry obligations in securitizations: Best's Idealized Default Rate of Insurers and Best's Idealized Default Rate of Reinsurers. This data is culled from the impairment studies conducted by A.M. Best, the latest of which is Best's Impairment Rate and Rating Transition Study - 1977 to 2006. The idealized default rate for reinsurers is higher for any given rating than the idealized default rate for insurers because of the propensity of reinsurers to go into distressed runoffs (after major downgrades) and enter into commutation agreements and schemes and arrangements with their cedants.

Securitization of Reinsurance Recoverables also discusses issues surrounding correlation of recoverables assets, recoveries on recoverables, the typical structure of the transaction (which may involve credit default swap and collateralized debt obligation technology) and the modeling methodology for the transaction.

Please visit www.ambest.com/ratings/methodology to download a PDF copy of this methodology.

Founded in 1899, A.M. Best Company is a full-service credit rating organization dedicated to serving the financial services industries, including the banking and insurance sectors. For more information, visit www.ambest.com.