International Rating Agency Advisory Newsletter November 2012 Update Welcome to Aon Benfield’s updated Rating Agency Advisory Newsletter. In this edition, matters of interest include rating agencies global reinsurance and country risk outlooks, as well as our regular features on : Selected regulatory activities or updates throughout APAC and EMEA. List of rating actions in APAC and EMEA during the 3rd quarter. Links to reports released by Aon Benfield Analytics. We will continuously scan for new content to provide greater value to our clients. We will be glad to hear your feedback so that we can continue to provide the most relevant ratings news and information in future editions. Rating Agency Activity (Data source: Standard & Poor’s, A.M.Best, Fitch, and Moody’s) Standard & Poor’s Numerous market participants provided feedback on S&P’s proposed criteria for rating insurers, “Request for Comment: Insurers Rating Methodology”, published 9 July 2012. S&P has stated in its recent report “S&P Summarizes Submissions On Request For Comments” on 18 October 2012 that it received formal feedback from about 100 market participants, varying from rated insurers, insurance brokers, rating advisors, and industry trade associations. S&P is not yet in a position to comment on the final criteria. However S&P expects to respond to the comments in one of three ways: by changing the proposed criteria, by explaining the original proposals more clearly to remove ambiguity, or by leaving the proposal unchanged. S&P states that it is in the process of analyzing the feedback and testing the impact of various alternatives. It expects to complete the development of the revised criteria and to publish it to the market in about six months. Further to this report, S&P published its criteria for evaluating enterprises’ management and governance credit factors in an article titled “Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers” on 13 November 2012. Through these criteria, S&P wants to bring enhanced transparency by discussing how it scores this category of analysis. S&P announced on 2 November 2012 that it expects Hurricane Sandy to have a limited impact on the ratings on U.S. property/casualty (P/C) insurers, global reinsurers, and certain catastrophe bonds. Although the losses from this event will affect (re)insurers’ fourth-quarter earnings in 2012, S&P views that for most (re)insurers the hit will be offset by strong capital bases and strong earnings through the first three quarters of 2012. The event is unlikely to materially affect premium rates in loss-affected lines. Proprietary & Confidential International Rating Agency Advisory Newsletter “Diverging Models Shape the Growth Prospects for Takaful” was released by S&P on 24 September 2012 to discuss its concerns on this growing industry. S&P is seeing a widespread use of high risk investment strategies by takaful providers, as well as lack of accounting standards and Sharia compliance. Consequently S&P is uncertain of long- term profitability, particularly in the Gulf Cooperation Council region. However, Malaysia, which is the largest takaful market in South East Asia, appears to be in a more healthy state with supportive, sophisticated regulatory oversight and a stronger investment profile in the industry . Another S&P report entitled “Breaking Out of the Holding Pattern: Which Way Now for Global Reinsurance?” was published on 4 September 2012. The report discusses the current state of the global reinsurance market, where excess capital, modest rate rises and macroeconomic uncertainty are its key features. It added that S&P expects reinsurers to seek new areas for generating profitability or risk being marginalized should there be changes in the market. S&P added that it could consider raising the ratings on some of the reinsurers if they are able to position themselves to exploit a widespread turn in the market. However it warned that following the herd mentality could put capital levels at risk if firms entered into lines of business when the prices do not adequately reflect the risks. On 4 September 2012, S&P published a report discussing its analysis on which factors it expects to drive reinsurers’ ratings. Based on its analysis of a peer group that writes about 75% of global net reinsurance premium, S&P commented that capitalization, liquidity, and enterprise risk management (ERM) continue to be strengths to the sector. Meanwhile, financial flexibility and operating performance are relative weaknesses, which supports its view that profitability will come under pressure in the next two to three years as underwriting and investment returns are likely to remain low and exposed to volatility. “How Regional Reinsurers are Evolving in Search of a Winning Formula” was published on 4 September 2012 discussing the strategies regional reinsurers could take to counter challenges posed by primary markets and global reinsurance peers. S&P believes that companies with well-thought-out strategies for future development are better placed than those relying on their existing position. It added that successful regional reinsurers think through a range of options available to them and determine a clear strategy for future development. Inactivity by others could be detrimental to their business position and ultimately could lead to lower ratings. On 4 September 2012, S&P published a report “A Cluster of Catastrophes: What Lessons Can Reinsurers Draw from the Natural Catastrophes Events of 2011” discussing the impact of the natural catastrophe on reinsurers. S&P expects reinsurers to adapt to new information by increasing the sophistication of current models used to assess risk exposures. It added that the extent to which companies are prepared for and learn from such events can affect their ratings. The report also pointed out that reinsurers in a globalized world must keep up with changes in natural catastrophe risk modeling. Embedding those tools in ERM and understanding the models’ limitations will be ever more critical for reinsurers. From a rating perspective, S&P comments that its assessment of risk culture and ERM will be even more necessary when risks and businesses are global. In September, S&P published a few other reports relating to Catastrophe Risk, which highlights the importance it places on this issue: Catastrophe Risk Insurance : Just How Much Capital is at Risk? Asia-Pacific Reinsurers Are Still Coming to Terms with Last Year’s Calamities Natural and Financial Catastrophes Fail to Rock Global Reinsurers and Their ERM Scores 2 International Rating Agency Advisory Newsletter A.M. Best Several special reports were released by AM Best during the quarter: “New Zealand Navigates Regulatory Reform Amid Recovery from Epic Disaster” was released on 12 November 2012 where A.M. Best discussed the state of New Zealand’s insurance industry following regulatory reforms and the two earthquakes in the Canterbury region that occurred less than six months apart. On 8 November 2012, due to the evolving Eurozone financial crisis, A.M. Best released a report clarifying the risk weighting given to sovereign creditworthiness in assigning Insurer FSRs. On 16 October 2012, “European Non-Life Sector Faces Further Economic Uncertainty” was released, discussing the impact of the Eurozone financial crisis on insurers. On 15 October 2012, “Rates Rise, but Economic Conditions Place Pressure on Performance” was released discussing the challenging market conditions for UK non life insurers due to the difficult economic environment. On 11 October 2012, “Germany Non-Life Insurers’ Focus on Rates Improve Profitability” was released. A.M. Best commented that the German non-life insurance market has continued to prove to be resilient with robust growth. On 10 October 2012, “France’s Non-Life Sector Resilient Despite Economic Difficulties” was released where A.M. Best discussed the market situation in France. “Italy’s Non-Life Insurance Sector Faces Shifting Landscape” was released on 9 October 2012 and discussed the changes facing the Italian non-life insurance market. “Spanish Non-Life Insurance Sector Profitable, But Challenges Lie Ahead” was released on 8 October 2012 discussing how the Spanish non-life insurance sector is facing challenging growth due to one of the bleakest economic environments since the 1930s. On 8 October 2012, “The China Market in Transition: Sharpening for Sustainability” was released. In the report, A.M. best discussed how the Chinese regulator is rolling out plans for sustainable and healthy growth in coming years. “Regional Cat Losses Drive Asian Reinsurers to Focus on Profitability, Capital Strength” was released on 24 September 2012. In the report, A.M. Best discussed how Asia-Pacific reinsurers were adversely affected by the large scale catastrophes in 2011 and how they have restored their capital position in 2012. “Reinsurers Show Resilience Under Weight of Catastrophes, Economic Woes” was released on 3 September 2012. In the report, A.M. Best discussed the financial position of the top 50 global reinsurers as they emerged from 2011, which was one of the costliest catastrophe years in history. Fitch On 5 November 2012, Fitch commented that it believes the global reinsurance industry’s strong capitalization can absorb material expected losses from Hurricane Sandy. It added that it does not anticipate substantive negative rating actions on a broad cross section of global reinsurers as a result of this event. However, due to