Moody's moves senior debt ratings to A1. Outlook is negative
Moody's Investors Service has downgraded the insurance financial strength (IFSR) and senior debt ratings of Swiss Reinsurance Company (Swiss Re) and associated companies from Aa3 to A1.
The ratings have been assigned a negative outlook. The downgrade concludes the review for possible downgrade that was initiated on February 6, 2009. Short-term ratings of Prime-1 were affirmed.
The rating downgrade is prompted by the group's weakening profitability, capital adequacy, and financial flexibility metrics. Going forward, Moody's expects the group's core reinsurance activities to continue to perform well, but sees the potential in the short-term for overall profitability to be suppressed by further mark-to-market losses. Moody's also believes that, notwithstanding an excellent market position, the group's business franchise may be weakened to an extent by its year-end 2008 results, although Swiss Re remains in a good position to take advantage of improved market conditions. The negative outlook is principally driven by the challenge of running off the Group's legacy portfolios.
Swiss Re reported a significant net loss of CHF 864 million for the full year 2008, driven by significant unrealised mark-to-market losses. In particular, the Group's Legacy unit produced mark-to-market unrealised losses for the full year 2008 of approximately CHF6 billion, including CHF2 billion on the two structured credit default swap (SCDS) transactions. The legacy unit contains discontinued non-core activities, including the two SCDS, as well as the portfolio credit default swaps, Financial Guarantee Re and former trading activities. These losses have overshadowed good operating performance from Swiss Re's continuing operations, with a full year combined ratio of 97.9% (96.1% excluding unwind of discount), a Life & Health benefit ratio of 85.5%, and a positive total return on investments, excluding Legacy business, of 0.6%.
With regard to capital adequacy, key financial metrics such as gross underwriting leverage (4.8x at year end 2008 compared to 3.6x at year end 2007) have deteriorated, driven by a 36% reduction in shareholders' equity during 2008. Nevertheless, the gross and net natural catastrophe exposures at the 99.6% aggregate PML remain within Moody's Aa parameters. Despite the meaningful reduction in available capital, the Group's economic capital adequacy ratio of 207% at year end 2008 (year end 2007: 299%) is above the Group's target range of 175-200%.
Swiss Re has initiated capital preservation and capital raising measures including the payment of only a nominal dividend, and a CHF3bn investment by Berkshire Hathaway via a convertible perpetual capital instrument.
This instrument, which will qualify for equity credit and is subject to shareholders' approval on March 13th, 2009 is taken into account by Moody's in assessing Group capital adequacy. However, the potential remains for further capital erosion in light of the nature of Swiss Re's investment and legacy portfolios, the rating agency said.
Financial flexibility metrics have also weakened. Financial leverage, which excludes the significant amount of reported operational debt of around CHF 20 billion, stood at around 18.4% at year end 2008 (year end 2007: 13.6%), a still relatively low level, but offset by negative earnings cover during
2008 with a five year average earnings cover of around 8.5x. While acknowledging the speed with which Swiss Re has managed to raise new capital, and its potential to increase share capital subject to shareholders' approval, Moody's believes that Swiss Re's capital raising options have narrowed in the event of future capital depletion. In this regard, the Berkshire Hathaway convertible investment, depending on the final terms and conditions, would bring the Group closer to Moody's 25% hybrid equity credit limit.
The rating agency also commented that in addition to excellent product risk and diversification, Swiss Re has an excellent market position and brand in both Non-Life and Life & Health reinsurance with market shares of approximately 25% and 10% respectively. Moody's had previously viewed the Group's business franchise as outstanding but is of the opinion that it may be weakened to an extent by its year-end 2008 results.
The negative outlook is principally driven by the challenge of running off the Group's legacy portfolios. Moody's believes this task is potentially complex and the costs and duration of the process are difficult to estimate with exposures representing a source of additional earnings and liquidity risk, although Swiss Re had spot liquidity of CHF17.3bn at year end 2008. The rating agency will closely monitor this run-off process in addition to the intended transition towards a more conservative investment portfolio. Swiss Re continues to hold a meaningful amount of non-agency structured investments (13% of invested assets at year end 2008) even though it has taken measures to reduce these exposures.
The rating agency said that a return to a stable outlook would be predicated upon a stable run-off process with regard to the legacy portfolios and the implementation of a clear strategic direction from the new CEO, in addition to the continuation of good performance from the group's core underwriting activities. Conversely, further negative rating action could occur should the Group encounter significant earnings, capital and liquidity pressure.