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S&P Slashes Bond Valuation Discount Rate

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NU Online News Service, March 12, 2003, 11:07 a.m. EST – Standard & Poor’s Rating Services, New York, is making a major change in the discount rate it uses when valuing the bonds and preferred stocks in insurance company investment portfolios.

S&P is cutting the discount rate to 6%, from 8%.

The cut could reduce insurers’ capital ratios an average of 10% to 15%, and it could cut some insurers’ capital ratios as much as 25%, according to Jose Siberon, an S&P credit analyst.

S&P plans to put the change in the discount rate into effect in 2004. To compensate for the change, insurers will have to raise capital or reduce risk, Siberon says.

S&P will also be excluding goodwill from calculations of total adjusted capital and changing the way it treats structured settlements.

Goodwill, created when one company acquires another, is the difference between what the buyer pays for a company and its fair market value.

S&P says it will no longer consider goodwill in financial assessments because goodwill is a “soft” form of capital that provides a company with little or no cushion to absorb risk.

Because state regulators already limit the amount of capital and surplus allowed in total-adjusted-capital calculations, the change in the S&P TAC valuation rules should have little effect on most U.S. insurers, S&P says in a commentary discussing the changes.

The third change, to treatment of structured settlements, will lower S&P’s capital risk charge for structured settlements to 2%, from 3%. S&P will be reclassifying the settlements as medium-risk, from high-risk.

“A small, select group of insurers have had structured-settlement products for a long time, and for them, the settlements have proven to work well,” Siberon says.

The change in criteria could help the ratings of companies with established structured-settlement operations, Siberon adds.