Hurricane Katrina, it was assumed that hardest hit
credits generated claims immediately. For remaining,
severely affected credits in the region, assumptions
were made about ratings declines, which carried
with them higher capital charges.
Losses can be moderated by various forms of soft
(third-party) capital, such as business that has been
ceded (reinsured) to third parties. Losses might also
be moderated by unconditional, irrevocable bank
lines of credit. As in reinsurance, credit for these
facilities is based on the credit quality of the bank
and the appropriate structuring of the documenta-tion so that the facility works in the context of our
model’s assumptions and requirements. A final
form of third-party capital for the industry is custo-
dial trust contingent preferred stock facilities. In
general, the mechanics of these facilities establish
trusts that then enter into agreements that allow a
bond insurer to put its preferred stock to the trusts,
at which time holders of the trust securities will
become holders of the bond insurer’s preferred
stock. Prior to that time, the trusts must be invested
in high-quality (AAA/A-1+), short-term liquid
assets. In terms of the dynamics of the model, rein-
surance and line of credit remittances are viewed as
reductions to overall losses. Conversely, the contin-
gent preferred stock facilities are viewed as an addi-
tion to capital because of the issuance of bond
insurer preferred stock and corresponding receipt of
cash from the trust.
Investment income
Existing investments earn at their embedded rate
and new investments earn at assumed conservative
rates of interest throughout the forecast period.
During the depression years, investment income is
reduced to reflect defaults on non-‘AAA’ rated
bonds held for investment. Common stocks and all
securities rated below ‘A’ are assumed to become
worthless at the beginning of the depression. Losses
from the sale of investments are recognized in (1)
the first two years of the depression because of
assumed interest-rate movements that result in an
inverted yield curve and long-term rates rising at
least 600 basis points, and (2) throughout the
depression on certain less-than-top-rated instru-
ments to reflect reduced liquidity in the markets.
Premium written and earned
For existing business, premiums are written and
earned at their imbedded premium rates. For the
growth book of business, premiums reflect current
market conditions and business plans. Because of
intense competition among insurers for many years,
premium rates became a focus of attention regard-
ing the ability of insurers to maintain their capital
adequacy. In an environment where competitive
forces are causing premium rates to decline,
Standard & Poor’s model picks up a significant
amount of the effect of changing premium rates
because it forces the insurer to write new business
for three years before the depression starts.Margin Of Safety
The culmination of all the assumptions associated
with the creation of a worst-case balance sheet and
income statement is the company’s ending, postdepres-
sion capital position. While important in its own right,
and while solvency following a severe claims-paying
environment is expected for an ‘AAA’ company, the310 Standard & Poor’s Public Finance Criteria 2007Other CriteriaThe Public Finance Department’s bond insurnace administration group is a key
intermediary between the insurance companies, the issuers, the bond market,
the bond insurer ratings group, and the investor community, coordinating the
activities associated with providing insured and underlying credit ratings for new
bond issues.
Issuers must request a Standard & Poor’s rating on insured transactions. In
those instances when an issuer does not choose to have Standard & Poor’s rate
the insured transaction, Standard & Poor’s will not issue, publish, or automatically
assign the insurer’s financial strength rating to the transaction.
For both new issue and secondary market debt, Standard & Poor’s does not
provide any official rating for insured debt until, and unless, an executed final insur-
ancepolicy is made available. In the new issue market-where an issuer and its
underwriters or advisers are in the process of negotiating, selling, or closing on a
bond issuance and an insurance policy is expected but not yet final-unless a
request for an underlying rating was made to Standard & Poor’s, no representation
of a rating should be used or made. Once an insured rating is requested and the
policy has been executed and presented to Standard & Poor’s, the enhanced rating
on the issue can be established.
For debt issuers utilizing bond insurance, but with parity debt rated by Standard
& Poor’s on an uninsured basis, it is necessary to submit the relevant transaction
documents to Standard & Poor’s, in addition to the insurance company. Standard &
Poor’s must review the proposed debt issuance to assess any outstanding, uninsured
parity debt ratings. In certain instances, issuers may plan to go to market on an
uninsured basis but later change their mind and choose to use bond insurance. In
those instances, the rating released on the debt issue may initially be based on the
issuer’s own credit quality (uninsured rating), and is then subsequently revised to
reflect the insurer’s financial strength rating once a policy has been issued by
an insurer.
All bond insurance policies are expected to cover 100% of scheduled principal
and interest on a timely basis. Such policies should constitute an unconditional,
irrevocable, and legal, valid, and binding obligation of the insurer in effect for the
life of the issue. If the primary credit obligor fails to make a payment, timely pay-
ment is assured to bondholders by providing sufficient time under the terms of the
policy for the trustee to notify the bond insurer. If an issuer defaults, there is no
mandatory acceleration of liability, and payments will continue to be made by the
insurer based on the original schedule. The risk of monies being recaptured from
a bondholder if the primary obligor becomes bankrupt (preference risk) must
be covered in the insurer’s standard policy, in an endorsement, or by the
issue’s structure.
For help with public finance-related administrative issues and assistance in
reaching bond insurance administrative personnel located in other ratings groups
at Standard & Poor’s, please call (1) 212-438-2074.
Bond Insurance Administration