LONDON (S&P Global Ratings) Nov. 15, 2023--S&P Global Ratings today published "Insurer Risk-Based Capital Adequacy--Methodology And Assumptions," which provides criteria for analyzing the risk-based capital (RBC) adequacy of insurers and reinsurers. We apply the output from these criteria in our insurance framework to assess capital and earnings--a key rating factor for insurers.

In conjunction with these criteria, we also published "RFC Process Summary: Insurer Risk-Based Capital Adequacy--Methodology and Assumptions." A request for comment (RFC) process summary summarizes the comments received from market participants during the RFC review period, presents our responses to these comments, and summarizes how--if at all--the market feedback resulted in changes to the final criteria.

Key Changes

These criteria incorporate changes that improve our ability to differentiate risk, enhance the global consistency of our methodology, and improve the transparency and usability of our methodology. This article supersedes 10 criteria articles that we used to assess an insurer's capital adequacy. We maintain separate capital adequacy criteria only for assessing bond insurers. However, these changes affect the assessment of total adjusted capital (TAC) and asset-related risks for bond insurers.

More specifically, the changes to TAC relative to our previous criteria are:

• Revising our calculation of TAC to reduce complexity and align with changes to our measure of an insurer's RBC requirements, including i) removing various haircuts to liability adjustments (such as non-life reserve surpluses and allowing for up to 100% credit for life value-in-force), ii) not deducting non-life deferred acquisition costs, iii) updating our approach to non-life reserve discounting, and iv) updating, simplifying, and clarifying the approach to unconsolidated insurance subsidiaries, noninsurance subsidiaries, associates, and other affiliates;
• Revising our methodology for including hybrid capital and debt-funded capital in TAC--although there are no changes to our hybrid capital criteria--by i) updating the principles for determining the eligibility of debt-funded capital in TAC, ii) aligning globally the hybrid capital and debt-funded capital tolerance limits, and iii) introducing a new metric (adjusted common equity, or ACE) to be used in determining the amount of hybrid capital and debt-funded capital that is eligible for inclusion in TAC;
• Clarifying how we adjust equity for life insurers when there is a mismatch between the balance-sheet valuation of assets and liabilities;
• Updating our treatment of certain equity-like reserves to enhance global consistency;
• Using a narrower definition of policyholder capital that is eligible for inclusion in TAC, clarifying our treatment of unrealized investment gains on participating business, and making enhancements to our criteria for assessing risks relating to ring-fenced participating business;
• Consolidating the separate criteria articles, as well as updating the analytical principles, relating to property/casualty loss reserves and U.S. life insurance reserves; and
• Clarifying that adjustments to determine TAC are net of the related tax impact (unless otherwise stated), and all capital requirements are pretax.

The changes to RBC requirements relative to our previous criteria are:

• More explicitly capturing the benefits of risk diversification in RBC requirements by revising the confidence levels that we use to calibrate risk charges to 99.5%, 99.8%, 99.95%, and 99.99% from 97.2%, 99.4%, 99.7%, and 99.9%, respectively, and updating correlation assumptions and adding risk pairings;
• Updating capital charges for almost all risks based on the revised confidence levels and incorporating recent data and experience;
• Using a single set of charges for each risk with country- or region-specific charges as warranted to reduce complexity and enhance global consistency in the treatment of similar risks;
• Removing the potential adjustment to the capital model output resulting from our review of insurers' economic capital models (the "M factor") because of changes to these criteria, such as the update to our approach to assessing interest rate risk to better capture an insurer's risk exposures;
• Changing our methodology for determining credit risk charges on bonds (and certain other credit assets) to capture only unexpected losses, rather than total losses;
• Increasing risk differentiation in our credit risk capital requirements for bonds and loans to capture i) variations in loss given default based on sector, creditor ranking, and collateral features and ii) differences in potential losses for structured finance assets, compared with assets in other sectors based on our correlation and recovery assumptions;
• Introducing globally consistent assumptions for determining the rating input for bonds and loans to better differentiate risk;
• Enhancing global consistency in assessing capital requirements for residential and commercial mortgage-backed securities and mortgage loans;
• Updating our methodology for assessing interest rate risk to enhance global consistency, better capture an insurer's risk exposures, and increase risk differentiation in our interest rate stress assumptions by country, as well as i) use liabilities as the exposure measure for life and non-life liabilities in all countries, ii) enable use of company-specific inputs under certain conditions, iii) apply an assumption based on the mean term of non-life liabilities to measure the duration mismatch for non-life business, and iv) reduce the risk of understating capital requirements by introducing floors in our mismatch assumptions and limiting the ability to offset losses in one business segment with gains in another segment;
• Increasing risk differentiation in our equity risk capital requirements by introducing explicit risk charges for exposures to eligible infrastructure equities;
• Aligning our methodology for life technical risks (in particular, longevity, lapse, expense, and operational risks) across all countries, along with introducing additional risk differentiation for assessing the extent of longevity risk embedded in certain products;
• Introducing explicit capital requirements to capture morbidity risks on disability and long-term care products outside the U.S.;
• Revising the conditional tail expectation levels we use to determine capital requirements for variable annuities (VAs), consistent with the updates to our confidence levels, and increasing the amount of credit we include for VA hedging to up to 80% from 50%;
• Introducing capital charges to capture pandemic risk and contingent counterparty credit risk relating to reinsured catastrophe exposures;
• Replacing the flat one-in-250-year posttax property catastrophe capital charge with a pretax natural catastrophe (i.e., across all non-life business lines) capital requirement that varies from one-in-200 to one-in-500 years at different stress scenarios;
• Enhancing consistency in assessing liability-related risks by aligning the treatment of mortgage insurance, trade credit insurance, and title insurance with other non-life business lines;
• Introducing a scaled risk charge on life value-in-force (VIF) to capture the potential change in VIF in stress scenarios (this change is related to including up to 100% of life VIF in TAC);
• Removing explicit capital charges for convexity risk and regulatory closed blocks in the U.S.;
• Removing capital charges for assets under management and deducting the investment in asset management businesses to determine TAC to increase the consistency of our approach to noninsurance businesses; and
• Clarifying that we make company-specific adjustments only where they are material to our analysis.

Impact On Outstanding Ratings

We believe that, based on our testing and assuming entities in scope of these criteria maintain their credit risk characteristics, the criteria could lead to credit rating actions on about 10% of ratings in the insurance sector. The potential ratings impact is based on our testing assumptions. We estimate the majority of rating changes would be by one notch, with more upgrades than downgrades.

We expect these criteria to have a more material impact on our capital and earnings assessment, with changes in this key rating factor for up to 30% of insurers. These score changes could affect up to 20% of stand-alone credit profiles. The lower potential impact on ratings compared with components of our ratings reflects the application of the insurance ratings framework, our group rating methodology, and sovereign rating constraints.

We anticipate potential improvements in capital adequacy for some insurers, primarily due to capturing diversification benefits more explicitly and due to increases in TAC, owing to the removal of various haircuts to liability adjustments and not deducting non-life deferred acquisition costs.

On the other hand, some insurers could face declines in capital adequacy because of factors including changes to our methodology for including hybrid capital and debt-funded capital in TAC, as well as the recalibration of our capital charges to higher confidence levels.

We expect the criteria to have limited, if any, impact on issuer credit ratings or issue credit ratings on banks that own insurance companies. The criteria will likely lead to changes in the risk-adjusted capital ratios for some of these banks, due to expected changes in the capital adequacy of their insurance subsidiaries.

Fully Superseded Criteria

• Methodology: Treatment Of U.S. Life Insurance Reserves And Reserve Financing Transactions, March 12, 2015
• Methodology: Mortgage Insurer Capital Adequacy, March 2, 2015
• Methodology For Assessing Capital Charges For U.S. RMBS And CMBS Securities Held By Insurance Companies, Aug. 29, 2014
• Trade Credit Insurance Capital Requirements Under S&P Global Ratings' Capital Adequacy Model, Dec. 6, 2013
• Assessing Property/Casualty Insurers' Loss Reserves, Nov. 26, 2013
• Methodology: Capital Charges For Regulatory Closed Blocks Under S&P Global Ratings' Capital Model Framework, Oct. 31, 2013
• Methodology For Assessing Capital Charges For Commercial Mortgage Loans Held By U.S. Insurance Companies, May 31, 2012
• Methodology For Calculating The Convexity Risk In U.S. Insurance Risk-Based Capital Model, April 27, 2011
• A New Level Of Enterprise Risk Management Analysis: Methodology For Assessing Insurers' Economic Capital Models, Jan. 24, 2011
• Refined Methodology And Assumptions For Analyzing Insurer Capital Adequacy Using The Risk-Based Insurance Capital Model, June 7, 2010

Retired Guidance

• Guidance: Methodology For Calculating The Convexity Risk In U.S. Insurance Risk-Based Capital Model, March 2, 2018