This report does not constitute a rating action.

Reinsurers and insurers typically use risk transfer solutions to manage and protect their earnings and capital positions. Generally provided by reinsurers, these transactions can be supported by capital markets and come in the form of traditional reinsurance, structured solutions, and asset protection strategies.

Risk transfer solutions are an alternative capital source, beyond traditional equity or hybrid issuances. They can reduce an insurer's capital needs because asset or liability risk is transferred to a third party.

This credit FAQ discusses how S&P Global Ratings approaches risk transfers in insurance ratings.

Frequently Asked Questions

How relevant are risk transfers in your insurance rating analyses?

Our assessments of insurers' creditworthiness consider the benefits and risks of risk transfers.

An insurer's risk transfer strategy can influence its profitability, which is among the factors we consider in our assessment of an insurer's competitive position. For instance, reinsurance may improve earnings stability and provide additional capacity to access some markets or increase market share.

On the other hand, overreliance on reinsurance could imply that the insurer's ability to offer a product may depend on the availability of cost-effective reinsurance. It could also suggest a lack of internal capabilities or expertise in underwriting the risks, as well as insufficient risk return optimization.

On the financial side, we generally capture the effects of risk transfers by measuring exposures on a net basis in our capital model analysis, which is part of our capital and earnings assessment. We also consider the potential counterparty credit risk. In the case of reinsurance, for example, we factor in the reinsurer's credit quality and the amount and quality of collateral.

Furthermore, we consider the effectiveness of insurers' risk controls and their risk appetite. For example, do they ensure that exposure to a specific reinsurer remains within predetermined limits? Such controls are particularly relevant for managing concentration risk and credit quality exposure.

How do you recognize risk mitigants in the risk-based capital model?

Where an insurer has mitigated risk through reinsurance, we typically apply charges to the exposure net of reinsurance. If risk mitigants are not material to our capital adequacy assessment, or if they cannot be reliably quantified, we capture them in our qualitative considerations.

We may apply analytical adjustments to certain inputs to the capital model to ensure that we capture the effects of risk mitigants. For example, genuine risk transfers that can be reliably quantified in the context of our capital model and that we consider sustainable and material to our analysis are typically reflected quantitatively in the model. We define materiality and provide examples in our capital model criteria.

Where net exposure already reflects reinsurance arrangements, we typically do not make any adjustments to the capital model.

What are examples of risk transfers you have recognized in your capital model?

We have adjusted our risk-based capital requirements for different types of risk transfers across non-life, life, and market risks, including:

• Adverse development covers or loss portfolio transfers, which enable the transfer and reduction of non-life reserve risk;
• Aggregate stop loss, which refers to the excess of loss reinsurance transactions that can cover multiple risks or business lines, be it life, non-life, or both;
• Longevity swaps, which allow for the reduction of longevity risk in life contracts, such as annuities; and
• Equity hedging programs, which reduce the effects of equity risk downward shocks.

How do you recognize proportional reinsurance transactions?

We capture proportional reinsurance transactions--also called "quota share," where risk is shared proportionally with reinsurers--in the net exposure measure we use to assess the risk in our capital model. For instance, to assess mortality risk, we use the sum insured, net of reinsurance; to capture non-life premium risk, we use the net premium. In both cases, we only apply our risk charges to the share of exposure that remains with the insurer.

Do you consider only collateralized reinsurance transactions as genuine risk transfers when applying an analytical adjustment?

We consider an adjustment to exposures or capital requirements in our capital model, whether a risk transfer transaction is collateralized or not. In both cases, we reflect the counterparty credit risk when assessing the potential capital effect of the transaction.

We include credit for up to 100% of the collateral to offset the reinsurance counterparty credit risk charge. We may reduce the value of collateral to reflect the asset risk if it is material.

Do you give credit for catastrophe bonds (cat bonds) or other forms of third-party capital risk transfers?

For natural catastrophe risk, we expect the loss estimate provided by insurers is calculated net of reinsurance and other forms of risk mitigation, such as cat bonds. This means we are unlikely to need to make further model adjustments for cat bonds.

For other lines of business, we may consider insurance-linked securities as a form of risk transfer and apply company-specific adjustments to capital requirements or adjust exposures. To date, we have not made adjustments for pandemic cat bonds or cyber cat bonds. This is because none of them met our materiality threshold or we were unable to reliably quantify their effect in our capital model.

We typically capture sidecars, which are mostly used on a proportional basis, in a way that is similar to other traditional reinsurances. In our capital and earnings assessment, we would nonetheless consider the potential specific risks that these structures entail, including governance and counterparty risks, limits, collateralization levels, and the permanency of capital. Life and non-life insurers increasingly use sidecars to access third-party capital.

How may regulatory considerations affect the treatment of risk transfers under your capital model?

Receiving regulatory credit for a risk transfer transaction is not a pre-requisite for considering the transaction in our capital requirements, for example through a company-specific adjustment.

For instance, a non-proportional transaction that covers extreme tail risk may be relevant at the confidence levels as per our capital model but not as per the regulatory framework. In this example, the regulatory treatment may not be as relevant for our analysis. Where available, we would nonetheless review the regulator's views of the transaction and its findings when performing our assessment.

Even though the reinsurer's domicile and the regulations it must comply with are relevant for our analysis, they are not material in our capital model treatment.

What could limit your ability to apply a quantitative adjustment in the case of a material risk transfer transaction?

In addition to being material, the transaction would have to be sustainable and quantifiable.

For instance, we may question the sustainability of equity hedging programs if they are opportunistic, rather than strategic. This is particularly important considering that our capital and earnings assessment is a three-year forward-looking analysis. For new structures without any track record, we consider the management's rationale for deploying these structures and their intent in maintaining these over time. While we also consider the terms of the structure, we, for instance, do not necessarily view multi-year transactions as more sustainable than short ones.

Quantification issues have constrained our ability to apply company-specific adjustments to various types of transactions. While the effect on an insurer is quantified in the context of its own view of risk and reporting, this may not be the case within the context of our capital model criteria.

For instance, risk transfers with parametric triggers respond based on parameters that are not aligned with the calibration of our risk charges. The disconnect between how we expect risks to materialize and how the risk transfer would respond could limit our ability to capture the transaction quantitatively.

Other examples include risk transfers that use a reporting basis that differs from the basis we use in our analysis. For instance, an insurer may seek to primarily protect its regulatory balance sheet such that the reinsurance structure may not protect its reported balance sheet (for example under international financial reporting standards or generally accepted accounting principles) in a similar way.

What do you understand by "qualitative considerations"?

If we do not capture a transaction quantitatively, we may reflect the potential materiality of the transaction for an insurer's risk profile by considering the qualitative effects.

Qualitative considerations can be reflected in multiple parts of our analysis. For instance, as part of our capital and earnings assessment, we could consider the possibility that risk may be overstated in our capital model after the transaction; or, when assessing risk exposure, we consider the ability to control risks through effective risk mitigation. Other examples include our choice of anchor or the comparable rating analysis adjustment where effects of risk transfers that are not captured quantitatively could weigh in our assessment.

Does every large risk transfer transaction lead to a bespoke capital model analysis?

Large reinsurance transactions, where a material part of the business is ceded to a reinsurer, will likely prompt a review of the different components of the credit ratings to assess the effects. In these cases, the review goes beyond assessing the potential effect on our capital model.

Nonetheless, the fact that the transaction is very large does not necessarily mean that a company-specific adjustment is required. For example, for large quota share transactions on in-force life blocks or non-life legacy loss portfolio transfers, the balance sheet after the transaction typically already reflects that the risks have been transferred.

How do you reflect the cost of a transaction in your capital and earnings assessment?

When making an adjustment to the capital model, we aim to factor in all current and future material costs incurred that are related to the reinsurance transaction--unless they are already reflected in an insurer's balance sheet. We consider these costs in our capital model or through our projected earnings.

Do you consider any analytical adjustments for the risk transfer provider?

Similar to our approach for beneficiaries of risk transfers, we may consider an analytical adjustment for the provider of the risk transfer if the risk transfer is material and the risk is not adequately reflected in the insurer's exposure. For instance, for providers of longevity swaps, reported reserves may not adequately capture the risk. We typically use the floating leg benefit payments as our measure of exposure.

How do you incorporate a deterioration in reinsurance companies' creditworthiness?

If an insurer's reinsurance counterparty risk materially changes due to a negative credit event at the counterparty, we assess the materiality and the implications, such as potential actions the insurer may take to manage its exposure. For instance, a rating trigger may exist in the terms of the transaction that enables the cedent to exit the arrangement in the case of a credit deterioration.

In our credit rating analysis, we consider the effectiveness of the reinsurance strategy and the risk controls, as well as potential material deficiencies in reinsurance protection, relative to the insurer's risk profile. If it is material, the deterioration of a reinsurance counterparty's creditworthiness could impair our assessments of the insurer's risk exposure or competitive position, among others.

In our capital model analysis, this could raise risk-based capital requirements, as a result of an increase in the reinsurance counterparty's default risk or higher retained exposure if the business is recaptured.

In our liquidity analysis, if we expect significant delays in reinsurance claim recoveries, we typically determine stressed insurance liability outflows using values, gross of reinsurance values.

Related Research

• Credit FAQ: Funded Reinsurance Deserves The Heightened Regulatory Scrutiny, June 4, 2024
• Criteria | Insurance |Insurer Risk-Based Capital Adequacy – Methodology--And Assumptions, Nov. 15, 2023
• The Growing Side: The Rise Of Offshore Reinsurance Vehicles In U.S. Life Insurance, Sept. 6, 2023
• Re/Insurers Seek Structured Solutions For Their Legacy Business, Aug. 27, 2019