With uncertainty being the economic buzzword of 2016, the economic outlook can be challenging for the insurance sector. So how do you accurately assess your exposure to the risk factors currently inherent in the markets and ensure your business is protected?
Lower commodity prices, geopolitical tensions, European economic and political turbulence and the step change in the Chinese economy are creating a complex and potentially problematic scenario.
Underwriting performance is expected to suffer a marginal decline over the next three years, while on the investment-side ultra-low interest rates continue to drive the chase for higher yield. The inevitable consequence is increased credit, liquidity and market risk which need to be carefully assessed.
All of this highlights the need for strong risk management processes which use reliable data and effective models to inform intelligent business decisions.
Credit ratings and credit scores are a useful tool for assessing probability of default (PD). However, equally important, but often ignored, is loss given default (LGD). This is the ratio of credit losses to exposure at default (EAD) and is essential both for investing on the asset side and for pricing of risk on the underwriting side, as well as being required in risk-adjusted metrics and for regulatory purposes such as the Solvency II EU Directive.
While PD is essentially binary (default will either happen or it won’t), LGD is more complex to estimate because losses could range from 0% to up to 100% of the exposure. However, ignoring LGD or using a fixed average can severely affect the quality of your analysis, particularly when individual exposures are of a significant size.
This becomes more obvious when you consider that once default occurs in a particular scenario, recovery tends to lean towards being bi-modal, so whereas an average figure is likely to tend be around 45%, individual corporate insolvency is more likely to involve a loss given default in either the 0-10% or 90-100% range.
In assessing your exposure to LGD, country/region and industry-specific factors should be taken into account. For example, averages for Latin America are currently particularly high, while intra-regional variations are clear in the disparity between Ireland and Germany, and oil and gas is pushing estimates for the energy sector towards 70%.
In terms of sovereign risk, regions highly dependent on commodities such as the Middle East, the Commonwealth of Independent States (CIS) and Africa are increasingly dominating ratings actions, while political uncertainty and stalling reforms are creating a negative outlook for the UK, Poland and Croatia, for example. Countries beginning to bounce back from periods of austerity such as Iceland and Greece, dominate the upgrades.
S&P Global Market Intelligence provides a range of tools for assessing your overall risk exposure to supplement credit ratings provided by S&P Global Ratings. S&P Global Market Intelligence Credit Assessment Scorecards incorporate both qualitative and quantitative factors to assess PD in the non-rated universe, while CreditModel™ uses purely quantitative data.
Our LGD scorecards are particularly geared towards the low-default space where fewer defaults mean a lack of recovery data. These reflect qualitative factors such as country risk as well as financial detail such as leveraging and volatility of collateral values.
In terms of raw data, the S&P Capital IQ platform gives access to financials for 99% of the world’s market capitalisation, while our recently acquired SNL Platform combines data, news and analytics for all the major corporate sectors.
Incorporating the three fundamental factors of PD, EAD and LGD into your risk analysis will provide you with actionable data to maximise the robustness of your business in the face of uncertainty.
 5th Annual Insurance Underwriters Event: Could Economic & Political Unrest Spell Trouble for Insurance Companies? May 17th 2016
 S&P Global Market Intelligence Scorecards and CreditModel™, 17th April 2016.
 S&P Global Ratings does not contribute to or participate in the creation of credit scores generated by S&P Global Market Intelligence. Lowercase nomenclature is used to differentiate S&P Global Market Intelligence PD credit model scores from the credit ratings issued by S&P Global Ratings.
 S&P Capital IQ Platform brochure. 28 February, 2014