5.4. Credit risk
5.4.3 Use of external credit ratings
- L1-133. External credit ratings may be used for the calculation of the Credit risk charge, provided that the rating agency has published default and transition statistics extending back over a sufficiently long period of time, and satisfying six criteria related to: objectivity, independence, international access/transparency, disclosure, resources and credibility. Those criteria, as well as the required time period for which statistics need to have been published, are specified in the Level 2 text.
- L1-134. When external credit ratings are used in accordance with paragraph L1-133, they are mapped to ICS Rating Categories as described in section 1.4 and further specified in the Level 2 text.
- L1-135. The IAIG may use any ratings by a rating agency currently recognised by its home insurance regulator for local capital determination purposes, subject to clear instructions provided by the home insurance regulator on how to map those credit agency ratings to the ICS Rating Categories and explicit acceptance of the use of those ratings by the IAIS.
5.4.3.1 Eligible external credit ratings
- L2-320. The IAIG may use ratings produced by rating agencies other than those referred to in paragraph L1-135, provided that both of the following requirements are met:
- a. The rating agency is regulated or recognised by a suitable government authority in all of the jurisdictions in which the agency issues ratings that the IAIG chooses to use.
- b. The rating agency publishes at least annually publicly available default and transition statistics extending back at least seven years, and satisfies all of the following six criteria:
- i. Objectivity: The rating agency’s methodology for assigning credit assessments is rigorous, systematic, and subject to some form of validation based on historical experience. Moreover, assessments are subject to ongoing review and are responsive to changes in financial conditions. The agency has an assessment methodology for each market segment, including rigorous back testing that has been applied for at least one year and, preferably, three years.
- ii. Independence: The rating agency is independent and is not subject to political or economic pressures that may influence the rating. The assessment process is free from any constraints that could arise in situations where the composition of the board of directors or the shareholder structure of the assessment institution may be seen as creating a conflict of interest.
- iii. International access/Transparency: The individual assessments, the key elements underlining the assessments, and whether the issuer participated in the assessment process are made publicly available on a non-selective basis. In addition, the general procedures, methodologies and assumptions for arriving at assessments used by the rating agency are publicly available.
- iv. Disclosure: A rating agency discloses the following information: its code of conduct; the general nature of its compensation arrangements with assessed entities; its assessment methodologies, including the definition of default, the time horizon, and the meaning of each rating; the actual default rates experienced in each assessment category; and the transitions of the assessments, eg the likelihood of AA ratings becoming A over time.
- v. Resources: A rating agency has sufficient resources to carry out high quality credit assessments. These resources allow for substantial ongoing contact with senior and operational levels within the entities assessed in order to add value to the credit assessments. Such assessments are based on methodologies that combine qualitative and quantitative approaches.
- vi. Credibility: The rating agency’s external credit assessments are widely used by independent parties (investors, insurers, trading partners). In addition, the rating agency has internal procedures to prevent the misuse of confidential information.
5.4.3.2 Definition of rating categories
- L2-321. The mapping of the agency’s ratings to ICS RCs is based on the average of the three-year Cumulative Default Rates (CDRs) associated with the agency’s ratings, as follows:
| ICS RC | Average 3-year CDR (20+ years of data) | Average 3-year CDR (7–20 years of data) |
|---|---|---|
| 1 | ||
| 2 | 0 ≤ CDR ≤ 0.15% | |
| 3 | 0.15% < CDR ≤ 0.35% | 0 ≤ CDR ≤ 0.15% |
| 4 | 0.35% < CDR ≤ 1.20% | 0.15% < CDR ≤ 0.35% |
| 5 | 1.20% < CDR ≤ 10% | 0.35% < CDR ≤ 1.20% |
| 6 | 10.00% < CDR ≤ 25% | 1.20% < CDR ≤ 10% |
| 7 | CDR > 25% | CDR > 10% |
〈 Table 32: Mapping of ratings by other rating agencies 〉
5.4.3.3 Use of ratings
- L2-322. The IAIG chooses the rating agencies it intends to rely on and use their ratings consistently for each type of credit exposure.
- L2-323. Any rating used to determine an ICS RC is publicly available, ie the rating is published in an accessible form and included in the rating agency’s transition matrix.
- L2-324. If an IAIG is relying on multiple rating agencies and there is only one rating for a particular security, that assessment is used to determine the ICS RC. If there are two ratings from the rating agencies used by an IAIG, and those two ratings are mapped to different ICS RC, the IAIG uses the ICS RC corresponding to the lower of the two ratings. If there are three or more ratings for a security from an IAIG’s chosen rating agencies, one of the ratings that corresponds to the highest ICS RC is excluded, and the rating that corresponds to the highest rating category of those that remain is used to determine the ICS RC of the security.
- L2-325. Where a particular security has one or more issue-specific rating, the ICS RC for that security is based on these ratings. Otherwise, the following principles apply:
- a. Where the borrower has a specific rating for an issued debt security other than the one in which the IAIG is invested, an ICS RC of 4 or better on the rated security may only be applied to the IAIG’s unrated investment if it ranks pari passu or senior to the rated security in all respects. If not, the credit rating cannot be used and the IAIG’s investment is treated as an unrated obligation.
- b. Where the borrower has an issuer rating, only senior securities issued by that issuer will benefit from an investment-grade (ICS RC 4 or better) issuer assessment; other unassessed securities issued by that issuer are treated as unrated. If either the issuer or one of its issues has an ICS RC of 5 or weaker, this rating is used to determine the ICS RC for an unrated claim on the issuer.
- c. Short-term assessments for a given security or facility can be used only for that security or securities issued by that rated facility. They can neither be generalised to other short-term securities nor used to support a rating category assignment for an unrated long-term security.
- d. Where the rating category for an unrated exposure is based on the rating of an equivalent exposure to the borrower, a foreign currency rating may be used only for exposures denominated in that foreign currency. Domestic currency ratings, if separate, are used to determine the rating category for securities denominated in the domestic currency only.
- L2-326. The following additional conditions apply to the use of ratings:
- a. External assessments for one entity within a corporate group are not used to determine the rating category for other entities within the same group.
- b. No rating based on assets that the entity possesses is inferred for an unrated entity. The use of internal ratings is not allowed.
- c. The IAIG does not recognise collateral or guarantees in the Credit risk charge calculation if these credit enhancements have already been reflected in the issue-specific rating.
- d. The IAIG does not use a rating that is at least partly based on unfunded support (eg guarantees, credit enhancement or liquidity facilities) provided by the IAIG itself or one of its affiliates.
- e. Any assessment used takes into account the entire amount of Credit risk exposure the IAIG has with regard to all payments owed to it. In particular, if the IAIG is owed both principal and interest, the assessment fully takes into account the Credit risk associated with repayment of both principal and interest.
5.4.3.4 Exposures in default
- L2-327. Assets for which there is reasonable doubt about the timely collection of the full amount of principal or interest, including those assets that are contractually more than 90 days in arrears, are considered as defaulted exposures for the calculation of the Credit risk charge.
- L2-328. The exposure amount for a defaulted asset is taken net of all balance sheet write-downs and specific provisions that have been recorded for the asset.
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