November 1999 Special Comment Summary Contact New York Phone Robert Riegel 1.212.553.1653 Moody s Short-Term Insurance Financial Strength Ratings Moody s is introducing short-term insurance financial strength ratings to provide institutional investors and financial intermediaries with opinions about an insurance company s ability to meet its senior short-term policy claims. These ratings provide investors and contract holders with a simple system to measure an insurer s ability to repay punctually its senior short-term policy claims. The ratings apply to senior policyholder obligations that mature or are payable in one year or less. The tremendous growth of short-term funding agreements issued by life insurers and the recent liquidity problems at General American Life Insurance Company highlight the growing need for opinions on the short-term creditworthiness of insurers. These funding agreements are sold as an alternative to commercial paper to money market funds as well as to bank short-term investment funds and securities lending programs. SEC rule 2a-7 mandates that money market funds have their short-term investments rated, further driving demand for a way to gauge the relative risk of these investments. Moody s will use the same Prime ratings symbols for these ratings as it uses for other shortterm instruments and obligations. To date, Moody s has assigned short-term insurance financial strength ratings to 16 insurers, all of which are rated. Combined they have about $20 billion of putable funding agreements outstanding. Moody s Short-Term Insurance Financial Strength Ratings Special Comment continued on page 3
Moody's Insurance Research Internet Address: www.moodys.com/insurance Author Robert Riegel Sr. Production Associate Ruth Manso-Rivera Copyright 1999 by Moody s Investors Service, Inc., 99 Church Street, New York, New York 10007. All rights reserved. ALL INFORMATION CONTAINED HEREIN IS COPYRIGHTED IN THE NAME OF MOODY S INVESTORS SERVICE, INC. ( MOODY S ), AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, such information is provided as is without warranty of any kind and MOODY S, in particular, makes no representation or warranty, express or implied, as to the accuracy, timeliness, completeness, merchantability or fitness for any particular purpose of any such information. Under no circumstances shall MOODY S have any liability to any person or entity for (a) any loss or damage in whole or in part caused by, resulting from, or relating to, any error (negligent or otherwise) or other circumstance or contingency within or outside the control of MOODY S or any of its directors, officers, employees or agents in connection with the procurement, collection, compilation, analysis, interpretation, communication, publication or delivery of any such information, or (b) any direct, indirect, special, consequential, compensatory or incidental damages whatsoever (including without limitation, lost profits), even if MOODY S is advised in advance of the possibility of such damages, resulting from the use of or inability to use, any such information. The credit ratings, if any, constituting part of the information contained herein are, and must be construed solely as, statements of opinion and not statements of fact or recommendations to purchase, sell or hold any securities. NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY SUCH RATING OR OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY S IN ANY FORM OR MANNER WHATSOEVER. Each rating or other opinion must be weighed solely as one factor in any investment decision made by or on behalf of any user of the information contained herein, and each such user must accordingly make its own study and evaluation of each security and of each issuer and guarantor of, and each provider of credit support for, each security that it may consider purchasing, holding or selling. Pursuant to Section 17(b) of the Securities Act of 1933, MOODY S hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MOODY S have, prior to assignment of any rating, agreed to pay to MOODY S for appraisal and rating services rendered by it fees ranging from $1,000 to $1,500,000. PRINTED IN U.S.A. 2 Moody s Special Comment
SO FAR, 16 SHORT-TERM INSURANCE FINANCIAL STRENGTH RATINGS ASSIGNED To date, Moody s has assigned 16 shortterm insurance financial strength ratings. (See Table 1) Moody s uses the same symbols for short-term insurance financial strength ratings as for Moody s short-term debt ratings. Moody s employs three designations, all judged to be investmentgrade, to indicate the relative repayment ability of the rated companies. (See Table 2) INSURANCE FINANCIAL STRENGTH RATINGS VS. DEBT RATINGS PRIORITY OF CLAIMS IS CRITICAL Moody s insurance financial strength ratings apply to the insurer s senior policyholder claims and obligations, unlike debt ratings on securities issued by insurance companies or, more likely, their parent or affiliate. This is an important distinction for a U.S. insurance company Table 1 Assigned Short-Term Insurance Financial Strength Rating Insurance Company Allstate Life Insurance Company Anchor National Life Insurance Company AUSA Life Insurance Company Combined Insurance Company of America First Allmerica Financial Life Insurance Company First SunAmerica Life Insurance Company GE Life and Annuity Assurance Company Jackson National Life Insurance Company Mitsui Marine & Fire Insurance Company Monumental Life Insurance Company Peoples Benefit Life Insurance Company Safeco Life Insurance Company SunAmerica Life Insurance Company Transamerica Life Insurance & Annuity Company Transamerica Occidental Life Insurance Company Travelers Insurance Company Rating Table 2 Short-Term Insurance Financial Strength Ratings Rating Prime-2 Prime-3 Not-Prime Repayment Ability Superior Strong Acceptable Not-Prime because there is a clear priority of claims structure favoring policyholders over other senior unsecured creditors in the event of an insurer insolvency or regulatory action. Moody s research indicates that in an insolvency, policyholder obligations typically suffer a much lower level of loss than even the most senior debt obligation. 1 However, in assigning this insurance financial strength rating, Moody s does not imply that any specific insurance company obligation is either legally enforceable or a valid senior obligation of a rated insurer. Although insurance holding companies or financing conduits are typically the issuers of debt securities, some insurance companies issue debt directly (e.g., surplus notes issued by several mutual insurers). Therefore, an insurance company can have both an insurance financial strength rating and debt ratings on securities. An insurer can also have two short-term ratings a short-term insurance financial strength rating covering its senior short-term policyholder obligations and a short-term debt rating covering its commercial paper obligations or other senior short-term financial obligations. In contrast to long-term ratings, Moody s short-term ratings primarily address the likelihood of timely payment. Nevertheless, the issue of priority of claims is also important for short-term investors, as the expected loss for commercial paper of an insurer is greater than the expected loss on its senior short-term policy obligations. Priority of claims is especially important for those investing in funding agreements, as the rules governing these contracts are not uniform across the various states. Some states accord the same level of security for funding agreements as they do policyholder obligations, while others regard funding agreements as subordinate to policyholder liabilities. SHORT-TERM VS. LONG-TERM INSURANCE FINANCIAL STRENGTH RATINGS Whereas Moody s long-term insurance financial strength ratings are opinions of the insurance company s ability to repay punctually all senior policyholder claims and obligations, the short-term insurance financial strength rating specifically addresses the insurer s ability to pay short-term policy obligations those that mature or are payable within one year or less. In contrast to long-term ratings, Moody s shortterm ratings primarily address the likelihood of timely payment. 1 See Moody s Special Comment "Life after Death Moody s Examines Life Insurance Insolvency," May 1999. Moody s Special Comment 3
LIQUIDITY ANALYSIS IS CRITICAL FOR DETERMINING SHORT-TERM ABILITY TO PAY CLAIMS Liquidity analysis, important in the credit analysis of our long-term ratings, is even more important in assigning short-term ratings. For example, the case study of General American Life (on which Moody s never maintained a short-term rating) demonstrated that an insurer s liquidity must be analyzed separately from its solvency to determine its ability to fund short-term liabilities. Over the past decade, experience (e.g., General American Life Insurance Company, Mutual Benefit Life Insurance Company, Executive Life Insurance Company) has demonstrated that life insurance company failures are usually caused by liquidity problems. In such cases, state insurance regulators intervene with regulatory actions designed to benefit policyholders. In assigning short-term insurance financial strength ratings, our analysis focuses on liquidity and asset/liability management, in addition to the industry and company fundamental analysis that is incorporated into the evaluation of an insurer s long-term creditworthiness. The key analytic areas evaluated in determining the level of short-term risk are: Risk Analysis Concentration in short-dated liabilities Put option commitments Contractholder/distributor profile Low asset quality Less-liquid assets Highly interest rate sensitive assets Reinsurance % of liabilities due in a year or less % of liabilities containing put options granted to contractholders. Term of put option is important the shorter the put, the less time the issuer has to maneuver. Concentration of liabilities that have put options or near- term maturities with specific investors and /or distributors. Also assesses likely behavior of investor/distributor in a stress situation. % of low credit quality securities with greater potential for credit and market losses % of less-liquid assets with greater potential for market losses upon disposition % of assets that are sensitive to interest rate changes with greater potential for market losses and prepayment/extension % of liabilities reinsured to less-creditworthy insurers with higher potential for recoverability losses 4 Moody s Special Comment
Appendix: Definition of Short-Term Insurance Financial Strength Ratings Short-Term Insurance Financial Strength Ratings are Moody s opinion of the ability of the insurance company to repay punctually its short-term senior policyholder claims and obligations. These ratings apply to senior policyholder obligations that mature or are payable within one year or less. Specific obligations are considered unrated unless they are individually rated because a particular insurance obligation s standing would depend on its relative standing under the laws governing both the obligation and the insurance company. It is important to note that Moody s makes no representation that rated insurance company obligations are exempt from registration under the U.S. Securities Act of 1933 or are issued in conformity with any other applicable law or regulation. Nor does Moody s represent that any specific insurance company obligation is legally enforceable as a valid senior obligation of a rated insurer. Moody s rating symbols for Short-Term Insurance Financial Strength Ratings are identical to those used for Short-Term Debt Ratings. Moody s employs the following three designations, all judged to be investment grade, to indicate the relative repayment ability of rated insurers: Insurers rated (or supporting institutions) have a superior ability for repayment of senior short-term policyholder claims and obligations. repayment ability will often be evidenced by many of the following characteristics: Leading market positions with highly valuable and defensible business franchises, strong financial fundamentals, and a very stable operating environment Conservative capitalization structure with moderate reliance on debt and ample asset protection High internal cash generation and broad margins in earnings coverage of fixed financial charges Assured sources of alternate liquidity and well-established access to a range of financial markets Insurers rated Prime-2 (or supporting institutions) have a strong ability for repayment of senior shortterm policyholder claims and obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Market positions are somewhat weaker, and earnings trends and coverage ratios, while sound, may be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternate liquidity is maintained. Insurers rated Prime-3 (or supporting institutions) have an acceptable ability for repayment of senior short-term policyholder claims and obligations. The effect of industry characteristics and market compositions may be more pronounced. Variability in earnings and profitability and weaker capitalization with greater reliance on debt may provide less protection. Adequate alternate liquidity is maintained. Insurers rated Not Prime do not fall within any of the Prime rating categories. Moody s Special Comment 5
Special Comment Moody s Short-Term Insurance Financial Strength Ratings To order reprints of this report (100 copies minimum), please call 800.811.6980 toll free in the USA. Outside the US, please call 1.212.553.1658. Report Number: 50431