CRISIL Methodology for rating Life Insurance Companies

Tarun Bhatia Head Financial Sector Ratings

August 3, 2007

CRISIL

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Background First Rating Agency in India Largest Rating Agency outside of USA (fourth largest rating agency in the world) A subsidiary of Standard & Poors (S&P), the worlds 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 State governments
Corporates Banks and financial institutions Insurance companies Municipal and other urban local bodies Mutual funds

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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

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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 CRISILs 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

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Rating Process

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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

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CRISILs 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

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Key features of the process

Confidentiality Transparency Interactivity of process Multilayer process to ensure integrity and objectivity

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CRISILs Risk Assessment Framework for Insurance Companies

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CRISILs Financial strength rating (FSR) What is an FSR

Indicator of the insurance companys 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

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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 CRISILs 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

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CRISILs Rating Methodology Analysis of factors that influence claims paying ability. The key drivers are:
Industry Risk: While arriving at a companys 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--vis other players in the industry. Parentage: This parameter evaluates the parental support that is available to an entity.

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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

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Business mix largely determines business risk

General Insurance Life Insurance

Business mix
Fire, marine, aviation, motor, health, miscellaneous

Business mix
Life policies vs. annuities Risk perspective- good mix essential to hedge both risk of early death and annuity

Diversification- across industries and geographies Projected business plan

Projected business plan

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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 companys existing insured portfolio

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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

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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

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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

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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

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

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CRISILs 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

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Management Assessment The quality of management can be a primary differentiating factor in the performance of an entity CRISILs 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

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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

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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

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How does notching up of ratings work?

Notch up for parent support Rating of parent on CRISIL Scale Standalone rating 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.
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S&Ps Rating Framework

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Standard & Poors 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&Ps 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

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Thank you!
Contact Details: Mr Tarun Bhatia Phone: +91 (22) 6691 3226 Fax: +91 (22) 6691 3050 www.crisil.com