Rating agency Fitch is rolling out a new stochastic model called Prism, which aims to assess insurers’ capital adequacy more precisely than existing risk-based capital models do. The agency is also taking a fresh approach to assessing companies’ in-house capital models with a view to better understanding the correlation between different risks on insurers’ books.
The timing of the launch is critical, because raters have come under increasing pressure to justify their stress-tests for catastrophic risk following unprecedented losses from the 2004 and 2005 hurricane seasons. On May 12, Fitch announced preliminary changes to its catastrophe risk analysis that will require companies to hold on average 10% more capital than before to support their catastrophe exposures.
Keith Buckley, global head of insurance of Fitch Ratings, declined to comment how the new tool is likely to affect companies’ ratings. “When we started down the road of developing Prism, we had no agenda at all in trying to purposely increase or decrease capital requirements,” he says. “Our singular goal was to try to create a model that was more reflective of the risk profile of the varying insurers we rate.”
According to Buckley, Prism uses more detailed and sophisticated data than the tools used by regulators and other observers. He says the tool is innovative because it uses market- and company-specific information, public and local market data, individual risk-profiles, and output from risk modeler AIR Worldwide’s Cattrader product.
“Prism allows us to simulate what would happen with a company’s cat exposure, where it hasn’t given us additional information,” he says. “Where the results may be different, we are in a really good position to have a healthy dialogue with them as to why. A lot of other models can’t do that.”
Fitch will solicit feedback about Prism between now and July 10. After this date, insurers will be able to access a draft version of the tool over the internet for about six months while it is fine-tuned. The final version will be available from early 2007, whereupon insurers will enter a so-called cure period lasting a further three to five months. During this time, Fitch will take no ratings actions based on Prism’s results if companies can demonstrate a willingness and ability to improve any deficiency in their capital position.
Initially, the rater will limit its use of Prism to analysing the U.S. life and annuity, non-life, and primary insurance and reinsurance markets. In the third quarter of this year, however, it will introduce parallel models in Germany, France and the U.K., following this up with models in Bermuda and Asia at a later date.