S&P:EU Directive Prompts Senior Debt Criteria Changes.

Business Editors

LONDON--(BUSINESS WIRE)--Standard & Poor's

May 22, 2001--Standard & Poor's today announced a change in its rating criteria relating to the differential or `gapping' applied between primary insurance operating companies' senior debt and their insurer financial strength ratings.

The senior and explicitly subordinated debt obligations of European insurance companies will now be rated at least one notch lower than their counterparty credit and insurer financial strength ratings, reflecting the legal priority increasingly being accorded to primary insurance policyholders ahead of other creditors, including debtholders.

Standard & Poor's highlighted, however, that the rating changes resulting from the application of this new criteria should not be seen as constituting any intrinsic change in the credit strength of the respective issuers.

The change to Standard & Poor's rating criteria has been prompted by European Union (EU) Directive 2001/17/EC, which came into force on April 20, 2001.

"Under the directive, all EU countries are obliged to introduce local legislation by April 20, 2003 to protect primary policyholders in the event of an insurer's insolvency, although the criteria change for the countries affected will take effect immediately," said David Anthony, a director in Standard & Poor's Financial Services Group in London.

The impact of the new criteria on existing debt ratings, however, is expected to be limited.

"Local law in most EU countries already gives explicit priority to policyholders, and Standard & Poor's senior debt ratings in these countries are already gapped down by one notch from the insurer financial strength rating to reflect this," Mr. Anthony said.

He explained that the only EU-member countries where local law has previously enabled Standard & Poor's to assign equal ratings for insurer financial strength and senior debt--and which will therefore be affected by the current criteria change--are the U.K., Sweden, and Germany.

Nevertheless, Standard & Poor's has also elected to extend its amended gapping criteria to primary insurers in Switzerland, which is not a member of the EU.

"Although the directive does not formally affect Switzerland, as it is outside the EU, a review of local Swiss law suggests that policyholder claims are privileged ahead of the interests of debtholders and other creditors for the amount of assets corresponding to an insurer's technical reserves," Mr. Anthony added.

The low level of senior debt issuance by regulated insurance operating companies in Europe has also helped keep senior debt rating changes to a minimum.

"Debt issuance has traditionally been extremely low as regulatory factors have encouraged most insurance-related debt to be issued either outside the regulated entity--notably by a holding company--or in a subordinated form. In both these circumstances, Standard & Poor's ratings are already assigned at a lower level, reflecting either the explicit subordination of such debt or the perceived greater default risk of holding companies as issuers relative to their regulated operating subsidiaries," Mr. Anthony said.

He also noted that if a company's counterparty credit and insurer financial strength ratings drop to noninvestment grade, its senior debt ratings will normally be rated at least two notches lower, and its preferred and other hybrid debt three notches lower, than the higher ratings.

The directive requires formal protection for both retail and commercial nonreinsurance policyholders, either by legal priority in access to the insolvent insurer's assets or by means of a policyholder protection board.

"Even in those countries opting to use a policyholder protection board structure, debtholders and other financial creditors are expected to remain subordinate as protection boards usually gain a priority right to assets to reimburse themselves against payments made to policyholders of an insolvent insurer," commented Mr. Anthony.

Pure reinsurance companies, however, are not affected by the directive or the change in criteria, as local law across the EU and Switzerland will continue to treat their policyholders, debtholders, and other creditors equally in the event of insolvency.

Mr. Anthony also noted that it is unclear how broadly European regulators, insolvency administrators, and courts will interpret the priority accorded to primary policyholders or policyholder protection boards in the event of an insurer's insolvency.

"Some uncertainties remain in the life assurance sector, for example, where it is unclear whether policyholder-savers will receive full priority for the entirety of their accrued policy value or merely for that part that is guaranteed," he said.

For U.K. `with-profits' policyholders, the question remains whether policyholders will be protected in respect of their `reasonable expectations' (inclusive of a share of terminal bonus funds), or whether they will simply be refunded in settlement of the guaranteed sum assured and already declared annual reversionary bonuses.

"In these latter cases, priority settlement merely of the guaranteed amounts may still leave considerable sums available to settle debt and other obligations. Nevertheless, as there will almost certainly be a delay in debt servicing while policyholder claims are being assessed, the prudent approach is to apply gapping between a primary insurer's financial strength and other debt-related ratings," Mr. Anthony said.

The criteria change has resulted in certain rating adjustments based on the application of the new criteria. These adjustments are not downgrades resulting from any intrinsic change in the credit strength of the respective issuers. The rating changes are outlined below.

In the U.K., the rating on Royal & Sun Alliance Insurance PLC's commercial paper program (with an authorized amount of $1 billion) has been changed to `A-1' from `A-1'-plus.

In Switzerland, the senior unsecured ratings on Zurich Finance (USA), Inc. and Zurich Finance (Bermuda) Ltd., which are guaranteed by Zurich Insurance Co., have been changed to double-'A' from double-'A'-plus.

No ratings are affected in Sweden. Given their maturity in 2002, the $100 million 6.75% unsecured bonds issued by Skandia Capital AB and guaranteed by Skandia Insurance Co. Ltd. will have matured before local Swedish law is likely to be changed to accommodate the new directive. The current senior debt rating of triple-'B'-plus on these bonds therefore remains unchanged.

No ratings are affected in Germany. Reinsurers, rather than primary insurers, have issued the only operating company senior debt currently rated in Germany. All such debt is therefore outside the terms of the current directive and is not affected by this criteria change, Standard & Poor's said. -- CreditWire

Copyright 2001, Standard & Poor's Ratings Services