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Equity Credit
Date: Apr 11, 2005
Contributor: Julio Gilcrease
A.M. Best Special Report: Equity Credit for Hybrid Securities
In recent years, the issuance of nontraditional debt securities within the insurance industry has expanded dramatically. The increased use of these types of securities reflects, in part, the generally more favorable treatment they receive in the analysis of an issuer's capital structure by regulators and rating agencies.
Increasingly, market participants are asking for guidance as to A.M. Best Co.'s perspective on hybrid securities and the amount of equity benefit that may be forthcoming to an organization's capital structure in the rating process. Because of these requests, A.M. Best has released its methodology for the treatment of equity credit for hybrid securities issued by insurance-related entities, which highlights the importance of debt-service capabilities. The assessment focuses on these instruments' use within an entity's capital structure and their impact on financial ratios and the financial flexibility of the entity issuing the hybrid security. The methodology should be read in conjunction with A.M. Best's Ratings & the Treatment of Debt methodology, both available at www.ambest.com/ratings/methodology.
Hybrid securities, typically in the form of a preferred stock, trust preferred or convertible security, share basic characteristics associated with common equity. Hybrids can include a variety of features that, over time, allow them to exhibit changing proportions of debt and equity characteristics.
When assessing a specific entity's capital structure, A.M. Best analysts review the company's history in managing its overall capital base, its funding needs and the sources and types of financing used to satisfy its capital requirements.
The equity-debt continuum is the starting point in A.M. Best's analysis of a hybrid's equity credit. The focus of the continuum is on the features of a particular security and the amount of equity credit it may receive. It also summarizes A.M. Best's perspective on how debt-like or equity-like a given hybrid security is based on seniority, maturity and the cash-flow flexibility provided by its terms and features.
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