S&P Global Ratings' "What May Cause Insurance Companies To Fail--And How This Influences Our Criteria," published in 2013, studied insurance company defaults and the key factors behind them from the 1980s through the early 2000s.

We've since updated our analysis to account for more recent failures. Over the past 10 years, very few insurers we rate have defaulted. Because of this, it may be tempting to think of any failures as largely idiosyncratic.

This perspective is understandable considering the significant improvements in the insurance sector, including in enterprise risk management and risk modeling, asset-liability management practices, and operational and regulatory issues. But behind the failures that have occurred recently, the same themes as in the past persist:

How We Develop Our Criteria To Capture Risks

Our insurance criteria are intended to best capture the risks and exposures that arise for insurers over time. We continually fine-tune these criteria and respond to industry changes as they arise.

"Insurers Rating Methodology" provides the overall framework for insurers' business and financial risks and the exposures they take on in the course of their business. We updated these criteria in 2019, as well as updated the hybrid capital, bond insurance capital adequacy, and group rating methodology criteria.

Most recently, in November 2023, we published our updated methodology and assumptions for analyzing the risk-based capital adequacy of insurers and reinsurers. The publication of these updated criteria was the final step in our market consultation process, resulting in improvements in our ability to differentiate risk, the global consistency of our methodology, and the transparency and usability of our capital model methodology.

We also seek to capture the impact of megatrends on insurance and other entities, as described in "Assessing How Megatrends May Influence Credit Ratings," published April 18, 2024.

Recent Insurer Failures

Recent failures show commonalities, particularly management- and governance-related issues regarding companies' strategic capabilities and capital needs. Other key factors have been failures to adequately manage risk concentrations and asset and liability exposures.

Management and governance

Management and governance issues remained an underlying cause of several of the recent defaults. Management missteps often lead to or contribute to other kinds of events--mispricing of products in an attempt to gain market share that leads to operational losses, untenable growth in asset or liability risk exposures, or even liquidity issues--that could ultimately result in a default.

Several defaults involved significant shifts in strategy wherein management pursued aggressive growth. In the case of Penn Treaty Network America Insurance Co., this growth strategy was an attempt to gain greater scale in the long-term care sector, noted for its mispriced policy benefits, reserve adjustments, and curtailment of policy benefits with more recent policy offerings. Penn also had geographic concentrations and relied on reinsurers for capital relief. Ultimately, these limitations and poor results led to the company's placement under regulatory supervision in early 2009.

Strategic shifts can lead to operational weaknesses and capital strain, as in the case of Scottish Annuity & Life Insurance Co. (Cayman) Ltd., which also pursued aggressive growth, to such an extent that at one point in the early 2000s, it became the third-largest U.S. life reinsurer. However, this extreme growth outpaced its ability to manage, leading to significant losses, reputational damage, and liquidity issues that resulted in Scottish's defaults on its obligations.

Similar circumstances surrounded the defaults of Affirmative Insurance Holdings as well as Istmo Compania de Reaseguros Inc. For Istmo, the strategic shift occurred after QBE Holdings sold its participation in 2013, at which time the company attempted to shift its focus to primary insurance from reinsurance while attempting to expand in Mexico, Panama, and Chile. This move, combined with mismanagement of its receivable balances, proved too great a strain on capital, resulting in Istmo's placement under regulatory supervision in late 2016.

In a more unusual case, Grain Insurance Co. JSC underwent a change in management due to a sale of 50% of the ownership of the company. Due to disputes associated with this transfer, the succeeding management was unable to access the company's bank accounts, leading to liquidity issues that caused defaults on the company's obligations in March 2020.

MMM Holdings LLC, currently the largest Medicare Advantage (MA) plan and the second-largest Medicaid plan in Puerto Rico, also provides a recent example. Back in 2013-2014, the company faced significant earnings pressure due to cumulative MA rate cuts, higher medical costs, and industry taxes. It also had an aggressive financial policy with high leverage that made it more vulnerable to business downturns. Hurricanes in Puerto Rico were the source of those business downturns, resulting in the earnings pressure that caused MMM to default on its obligations in 2015. The underlying business remained viable, however, and ultimately Anthem Group acquired MMM in 2021.

Risk concentrations

Risk concentrations can appear on the asset side, in investment portfolios, or on the liability side, via the risk exposures for which insurers provide coverage. A company with highly diverse risk exposures is likely to exhibit less volatility. Conversely, risk concentrations can lead to volatility in capital and earnings, and in poor economic conditions, they may significantly contribute to a company's distress and lead to default.

Yamato Life Insurance Co. was a medium-size Japanese life insurer that had been in business for over 86 years at the time of its bankruptcy. The bankruptcy stemmed from rapid asset deterioration resulting from speculative investments, which made up about 30% of its investment portfolio. Yamato, along with other life insurers, had sought to increase yields from the investment portfolio to address guarantees associated with its policy offerings. When asset values deteriorated, it suffered $2.7 billion in stock holding and investment losses (including on subprime-mortgage-backed bonds) during the 2009 global financial crisis. The company ultimately filed for bankruptcy and was acquired. It now operates as Prudential Gibraltar Financial Life Insurance.

Western Pacific Insurance Ltd. was a niche insurer providing property/casualty insurance primarily in Papua New Guinea. Its small capital base was vulnerable to event risk and volatile earnings, although the use of a significant amount of reinsurance, resulting in the retention of only 15% of the risk exposure, somewhat mitigated these risks. However, the reinsurance was insufficient in the face of the Christchurch and Canterbury earthquakes of September 2010 and February 2011, after which Western was placed into liquidation.

Among insurers we don't rate, Eurovita SpA experienced a notable default, in late 2022. The Italian life insurer had concentrated product offerings that were significantly exposed to interest rate risk. Once the company came under stress from rising interest rates and increased lapsation, its deferred tax assets (which were allowed as capital under the Italian regulatory regime) eroded to the extent that they were deemed largely unrealizable.

Its regulatory capital declined rapidly as future tax benefits were written off in 2021 as the company came under pressure, and deterioration continued as the stress increased in 2022. In fourth-quarter 2022, the insurer deferred coupons on hybrid securities, and in first-quarter 2023, administrators were appointed.

Sovereign risk

Sovereign risk remains a significant factor in the insurance sector globally. While sovereign risk influences economic conditions generally, geopolitical developments can raise questions about the availability of reinsurance coverage, as well as the potential for disputes about insurance policy exclusions. Sovereign risk can thus affect revenue, claims, and business risk for insurers.

For example, we withdrew the ratings on all Russian insurers (see Related Research) following the EU's decision in March 2022 to ban the provision of credit ratings to legal persons, entities, or bodies established in Russia.

Each of our long-term local currency ratings on Russia-based insurers at the time of the withdrawals was 'CCC+' (apart from one entity that we expected would benefit from an unlimited parental guarantee) and incorporated the impact of various government actions on the entity. For example, the Central Bank of Russia had issued a decree according to which Russian companies were prohibited from transferring risks to reinsurance companies from a list of "unfriendly" countries.

Our understanding was that Russia-based insurers would need the approval of the central bank to make offshore payments. This example illustrates how government actions can affect the operating conditions for insurers.

Bond And Mortgage Insurers

The global financial crisis hit the bond and mortgage insurance sectors particularly hard. However, the same key factors responsible for failures in the broader insurance industry were also largely responsible for these failures. In particular, management and governance of coverage exposures and resulting risk concentrations played significant roles.

Generally speaking, in the 2005-2007 vintages, which were among the worst performing, bond insurers had varying exposures to nonprime and subprime residential mortgage-backed securities, collateralized debt obligations of asset-backed securities, home equity lines of credit, and Alt-A. These exposures mirrored the broader securitization market, notwithstanding their deteriorating risk characteristics.

As such, these were failures of risk management, wherein the tolerance levels were too permissive; the monitoring of risk exposures was not adequate, given the risk characteristics; and the underlying loss assumptions allowing for the less restrictive underwriting standards were too lenient in the face of the potential losses that could occur if assumptions were exceeded. Ultimately, these failures allowed for greater risk concentrations with greater correlations across portfolios, resulting in losses that rapidly accelerated amid declining macroeconomic conditions.

Similarly, mortgage insurers had ramped up exposure to the housing market in the 2005-2007 vintages, despite the deterioration in underlying loan risk factors. Loans with higher loan-to-value ratios, lower credit scores, and little or no verified documentation of income, as well as interest-rate-only loans, became more significant exposures. While each mortgage insurer might have handled particular risk attributes differently, nevertheless the dramatic macroeconomic shift, including significant deterioration in employment and real estate values, caused dramatic increases in mortgage defaults and losses for mortgage insurers.

While these insurers also faced significant reserve development, the underlying failure to adequately manage the increasing exposure to lower-quality loans was the primary factor in the defaults. Mortgage insurers hadn't expected that macroeconomic variables, particularly property values, could decline so rapidly.

For the most part, neither the bond insurers nor mortgage insurers were exposed to liquidity risk, given the losses they had to pay out on either were payable over a number of years (bond insurers) or took several years to fully develop and be payable (mortgage insurers). Indeed, some mortgage insurers, such as Republic Mortgage Insurance Co., ended up running off profitably after initially being placed under regulatory supervision.

Related Criteria

• Insurer Risk-Based Capital Adequacy--Methodology And Assumptions, Nov. 15, 2023
• Insurers Rating Methodology, July 1, 2019
• Methodology And Assumptions For Analyzing Bond Insurance Capital Adequacy, July 1, 2019

Related Research

• Ratings On Russian Insurers Withdrawn, March 31, 2022
• S&P Global Ratings To Withdraw Ratings On Russian Entities, March 21, 2022
• Russian Insurers Downgraded On Severely Adverse Macroeconomic Climate, March 7, 2022
• What May Cause Insurance Companies To Fail--And How This Influences Our Criteria, June 13, 2013