Claims-Paying Ability and Capital Adequacy

The financial guaranty industry's assurance that insured bonds will make timely principal and interest payments to investors is backed by a claims-paying ability that is rigorously tested by major rating agencies. The major rating agencies - Standard & Poor's, Moody's and Fitch - evaluate each bond insurer to determine that capital is adequate to meet insured obligations in a number of stressed environments.

When considering the financial strength and security of the industry, a number of factors should be examined, including:

• Underwriting policies - Each company writes to a zero-loss underwriting standards meaning that the insurer expects the obligor on every insured bond to make full and timely principal and interest payments
• Aggressive portfolio monitoring
• A record of financial strength
• Adequate claims-paying resources (as measured by various ratio analyses and rating agency stress models)
• Prudent fiscal management

Rating agencies analyze financial guaranty companies to determine their capital adequacy. They use various modeling techniques to examine the insurer's insured portfolio under stress scenarios to assess the strength of each insurer's balance sheet and capital resources. Moody's uses a portfolio risk model to generate a probability distribution of credit losses in a guarantor's insured portfolio under economic stress scenarios. The model computes the loss levels associated with highly adverse, low probability events in which default rates far exceed the expected default rates for any specific credit. The model results are used to compare these potential credit losses to the capital resources available to each insurer. Moody's Aaa criteria generally require that a monoline insurer have capital resources in excess of those that would be required to withstand stress-level losses across a wide variety of macroeconomic scenarios.

Many variables determine the continuing ability of the industry to strengthen its capital base and claims paying ability. Major factors include:

• Conservative underwriting
• Ability to generate capital
• Soft capital support available
• Reinsurance relationships
• Prudent management

Enhancing these factors is a core objective of every AFGI member. AFGI member firms' claims-paying resources (statutory capital and unearned premiums) have increased every year since the inception of the association, and now exceed $48 billion.