CRISIL Methodology for rating Life Insurance Companies. Tarun Bhatia Head Financial Sector Ratings

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1 CRISIL Methodology for rating Life Insurance Companies Tarun Bhatia Head Financial Sector Ratings August 3, 2007

2 2. CRISIL

3 Background First Rating Agency in India Largest Rating Agency outside of USA (fourth largest rating agency in the world) A subsidiary of Standard & Poor s (S&P), the world s largest rating agency Market leader in India with 60% market share Activities Include : Rating Services, Advisory Services, Information Research Services. The only full service rating agency with the most comprehensive range of ratings for Corporates Banks and financial institutions Insurance companies State governments Municipal and other urban local bodies Mutual funds 3.

4 Unique width: Data to Solutions Databases Fixed-income mutual funds financial analysis software Research and Insights Financial News Integrated Research Economy Industry Company Markets SME Customised Analytical Tools, Valuation Services. Benchmarks Investment mgt Tools Credit Risk Tools Market Risk Tools Bond/Gilt Valuation Mutual Fund Indices Ratings and Opinions Credit Rating Services Corporate, Banks, Govt. Structured Fin Microfinance Fin Strength of Insurance companies Governance & Value Creation Fund Ratings & Rankings Performance Ratings Advisory Solutions Economic LNG/Gas Advice, Training Info solutions Infrastructure Corporate Risk Consulting & Training for BFI 4.

5 Being first CRISIL has many firsts to its credit: First rating agency in India First rating agency in India to rate Insurance companies and mutual funds First rating agency in India to rate ABS/MBS deals First rating agency in Asia to rate a municipal bond First rating agency in world to rate partially guaranteed debt 5.

6 S&P affiliation CRISIL is an affiliate of S&P S&P holds about 10% of our equity CRISIL has full access to the analysts, criterion and methodologies of S&P CRISIL s senior management personnel have been trained with S&P and this is a continuous and ongoing process CRISIL employees have worked in various offices of S&P for periods ranging between six months to two years on S&P assignments CRISIL is actively involved in the credit rating of Indian corporates by S&P CRISIL is currently assisting S&P in various analytical projects across various regions in the world 6.

7 7. Rating Process

8 The Rating Process Request for rating Commence information review Top Management Meetings Evaluation Rating committee Assign rating (option for appeal) Publish rating Ongoing surveillance Total Duration = 3-4 weeks 8.

9 CRISIL s Financial Strength Rating Scale AAA Highest Safety AA High Safety A Adequate Safety BBB Moderate Safety Investment Grade cut off BB Inadequate Safety B High Risk C Substantial Risk D Default 9.

10 Key features of the process Confidentiality Transparency Interactivity of process Multilayer process to ensure integrity and objectivity 10.

11 CRISIL s Risk Assessment Framework for Insurance Companies 11.

12 CRISIL s Financial strength rating (FSR) What is an FSR Indicator of the insurance company s financial capacity to meet policyholders obligations Two broad categories- Secure from AAA to BBB, Vulnerable from BB to D FSR does not indicate Timeliness of payment or the likelihood of the use of a defense such as fraud to deny claims For global insurance companies, any foreign exchange restrictions to prevent policy obligations from being met FSR not a guarantee of financial strength nor a recommendation to purchase or discontinue a certain policy Does not refer to an insurance company's ability to meet nonpolicy obligations such as obligations on debt contracts 12.

13 How does CRISIL assess insurance companies? CRISIL has outstanding financial strength ratings on three public sector general insurance companies CRISIL has done private assessments of financial strength for many more general insurance companies CRISIL s methodology includes an assessment of the following aspects: Inherent industry risk relative to other industries Analysis of the business and financial performance Effect of parent/group support on the standalone ratings of the insurance company, if applicable Identification of Rating Sensitivity Factors (RSF) and crystallization of Outlook 13.

14 CRISIL s Rating Methodology Analysis of factors that influence claims paying ability. The key drivers are: Industry Risk: While arriving at a company s business risk rating, CRISIL factors in the risks associated with the external environment, that is the insurance industry in which the company operates. Business Risk: The company is assessed on parameters that drive its relative business position in the insurance industry. Financial Risk: The company is assessed on parameters like capitalization and profitability that determine its relative financial strength vis-à-vis other players in the industry. Parentage: This parameter evaluates the parental support that is available to an entity. 14.

15 Assessing Business risk profile Each segment benchmarked to other industries on inherent industry risk Factors that could determine the inherent industry risk are: Importance to economy Size of segment, growth potential and outlook Extent and direction of regulations Cyclicality Industry financials such stability and growth of underwriting profits, investment yields and earnings stability Competition intensity, entry barriers Bargaining power with customers Volatility of earnings vs. other industries Ease of liability prediction based on underlying historical mortalities (life), or occurrences of events 15.

16 Business mix largely determines business risk General Insurance Life Insurance Business mix Fire, marine, aviation, motor, health, miscellaneous Diversification- across industries and geographies Projected business plan Business mix Life policies vs. annuities Risk perspective- good mix essential to hedge both risk of early death and annuity Projected business plan 16.

17 Underwriting policy and Business Risk Pivotal to solvency of life insurer, important for general insurer Ability to manage risks associated with underwriting are critical General Insurance Life Insurance Underwriting policy Profitable underwriting Vs. volumes Superior service and value added risk management services Vs. uneconomic rates to grow volumes Underwriting Policy Mortality table used Vs. actual claims experience Systems to mitigate adverse selection Key characteristics of company s existing insured portfolio 17.

18 Pricing capabilities and business risk General Insurance Life Insurance Pricing Regulatory tariffs Claims experience in various products, geographies, industries Pricing For annuities-longevity or survival rates Mortality rates Interest rate view and risk taking capacity Age at entry Product features Occupational risk Family and health history Personal habits 18.

19 Distribution/ reach and business risk General Insurance Life Insurance Distribution/reach Corporate relationships Group/ parent synergies Agents Vs. alternate channels Distribution/ reach Agents, alternative distribution channels Own retail branch network Profile of agents Effectiveness of distribution channel 19.

20 Asset management and impact on business risk General Insurance Life Insurance Prudent investment policies liquidity emphasis Credit quality, capital appreciation, long term safety and easy liquidity Prudent investment policies liquidity emphasis Credit quality, capital appreciation, long term safety and easy liquidity Quality of loan book - rating distribution of top 100 exposures Credit appraisal procedures and processes for loan book Investment policy and quality of investment exposures Performance of investment portfolio and stability of returns Weak assets approach used to analyze the inherent credit quality of the investment portfolio Weak assets approach is based on rating distribution and industry concentration 20.

21 Reinsurance policy- impact on business risk Performs function of diversifying the underwriting risk amongst a pool of re-insurers Increases the underwriting capacity of the insurance company For assessing business risk and re-insurance policies the factors taken into account are Credit quality of re-insurers Extent of re-insurance Estimation of probable maximum loss - correct estimation of the probable maximum loss 21.

22 CRISIL s framework of assessing financial risk Financial risk profile of an insurance company is assessed on the following parameters : Financial performance of both underwriting and investment operations Capitalization levels Capital adequacy and solvency margins Loss provisioning policies Accounting and valuation policies Earnings and profitability Liquidity and financial flexibility 22.

23 Management Assessment The quality of management can be a primary differentiating factor in the performance of an entity CRISIL s analysis is based on the following factors Integrity Goals and Strategies and capability to implement the same Success of past strategies Processes and systems for managing credit risk / market risk / operational risk Appetite for risks Stability of top management and the capability of the second layer of the management Management pro-activeness 23.

24 Parent support assessment -Notching up credit ratings Over 70% of all financial sector entities have been notched up for parent support or government support or group support Parent support Multinational banks / NBFCs Government support Public sector banks / financial institutions Group support from a strong group Parent support criteria Economic rationale Moral obligation Extent of consolidation Government support criteria Policy role Implications of default Moral obligations 24.

25 How are ratings notched up by CRISIL? Evaluation of the standalone credit profile of the entity to arrive at a standalone credit rating Evaluation covers industry, business, financial and management profile Rating of parent assessed on the CRISIL rating scale Established benchmarks for mapping of international ratings (S&P) on domestic scale based on past correlation data of default and transition Evaluation of the level of notch up required for the standalone rating based on Economic rationale for the parent to support the subsidiary Moral obligations for the parent to support the subsidiary Notch up applied to the standalone credit rating of the company to arrive at an overall credit rating 25.

26 How does notching up of ratings work? Standalone rating Rating of parent on CRISIL Scale Notch up for parent support Standalone rating Overall credit rating Effect of parent notch up Cap for subsidiary rating is its parent rating and the floor is its standalone rating CRISIL explicitly highlights the benefits that the assigned ratings derive from the parents support in its rating communications. 26.

27 27. S&P s Rating Framework

28 Standard & Poor s The International perspective S&P adopts the traditional corporate ratings approach to insurance ratings also, though ratings are again an assessment of ability to pay policyholders claims S&P has two broad categories of ratings on insurance companies Interactive ratings With formal mandate and active co-operation of client Pi ratings- Public Information S&P s key areas of analysis include Industry Risk Assessment Business review Management and corporate strategy Operational analysis, investments, capitalization, earnings, liquidity & financial flexibility Overall the approach of all rating agencies to rating insurance companies is more quantitative than the approach towards normal corporate ratings 28.

29 Thank you! Contact Details: Mr Tarun Bhatia Phone: +91 (22) Fax: +91 (22)

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