If you didn’t have your morning coffee the other day, the recent report from Moody’s Investors Service, New York, examining the sustainability of ‘Aaa’ sovereign ratings was enough to give you your morning jolt.
The report examines the challenges facing the four largest ‘Aaa’-rated governments - France, Germany, the United Kingdom and the United States - as well as those of Spain and of the much less fiscally-challenged Nordic European countries.
While not dire at the moment, it is cause for pause and concern over the long term. According to the March 2010 Sovereign Monitor Report, four largest Aaa-rated governments - France, Germany, the United Kingdom and the United States – are facing challenges. The report also mentions Spain and even the “much less fiscally challenged Nordic European countries.”
The main factor that can push a country from ‘Aaa’ to ‘Aa’ status in the current crisis is a deterioration of its balance sheet, according to Moody’s.
The outlook for the U.S. is sobering. According to the report, “The ten-year outlook included in the budget for the federal government shows a continuous rise in the ratios of debt to GDP and interest to revenue (despite some decline in the ratio of debt to revenue). By the end of the period, debt affordability would deteriorate to approximately the peak level seen during the 1980s, i.e., a ratio of interest to revenue of about 18%. The difference this time, however, is that the ratio would reach that level due to the size of the debt, whereas during the 1980s it was monetary policy that caused interest rates to be high. As monetary policy was eased, affordability improved.”
When asked if companies in the U.S. would have a ratings ceiling imposed if there was a sovereign downgrade, a Moody’s spokesperson responded that “Under certain circumstances, a company’s debt can “pierce the sovereign ceiling.” But, Moody’s did not explain how this could be done or how common the piercing is.
Although the rating threat is not imminent and if action is taken, may never occur, one can’t help but wonder what impact it would have on insurers, either in the U.S. or in the other countries cited.
The report follows another released by Moody’s last week. The report, titled “Moody’s Global Liquidity Stress Test for Life Insurance Operating Companies,” details a global stress test for operating companies and examines the results of that test’s application.
As detailed by Moody’s, “the global liquidity stress test model uses a simple classification scheme to rank and classify operating companies’ assets and liabilities into discrete “buckets”, comprised of assets (or liabilities) with similar liquidity characteristics. Stress liquidity haircuts are ascribed to market values for each asset type (for both market volatility and liquidity premia) and stress surrender rates are ascribed to book-value liabilities, over a one-year timeframe.“
The results indicate that there are significant variations by region, Moody’s says. For instance, “life insurance groups in the US exhibited the lowest Liquid Assets/Liquid Liabilities (LA/LL) median ratio at 208%, while Asia ex-Japan displayed the highest median ratio at 331%, with the UK a close second at 310%.”
The U.S. also was the biggest negative outlier when measured by realized gains (losses) and realized gains (losses) to equity by region. However, according to Moody’s the reason may be, at least in part, that the U.S. companies report different amounts for book and market values while other regions or the world report book value as market value.
But for the U.S. personal lines industry, the good news is that the outlook is stable despite a very competitive underwriting environment and a weak U.S. economy, Moody's notes in a recent credit outlook for the sector.