KBRA Upgrades Ratings on Somerset Re and SRHL and Assigns an IFSR to Somerset Reinsurance Company

KBRA upgrades the insurance financial strength rating (IFSR) to A from A- on Somerset Reinsurance Ltd. (Somerset Re) and the issuer rating on Somerset Reinsurance Holdings Ltd. (SRHL) from BBB to BBB+. The Outlooks have been revised from Positive to Stable. In addition, KBRA assigns an IFSR of A with a Stable Outlook to Somerset Reinsurance Company, a newly established Florida domestic reinsurer that will provide a US platform for the group. Collectively the companies are referred to as Somerset.

Key Credit Considerations

The upgrade reflects Somerset’s improved capital position, increased financial flexibility and access to capital after Aquarian’s acquisition of a controlling interest, greater diversification of liabilities from structured and pension risk transfer transactions executed in 2022, launch of its US platform and recent announcement of the Prudential ULSG transaction which brings the company in line with its business plan previously provided to KBRA.

Somerset maintains no financial leverage in its capital structure. At end-2022, Somerset Re’s BSCR coverage ratio was 356% (2021: 319%) which was above Bermuda peers. The acquisition of Somerset by Aquarian on December 30, 2022, provided Somerset Re with a substantial amount of immediate and committed new capital to further drive growth and fortify its market position. During 2023, Somerset raised additional capital commitments from Aquarian to support planned growth.. Somerset Re added material asset-intensive life and pension liabilities to its reserves during 2022. The closing of the recently announced Prudential ULSG deal later in 2023 will further diversify and more than double total reserves. Somerset Reinsurance Company hired its first employee in March 2022 and became fully licensed in March 2023, providing Somerset a solid foundation for accessing US counterparties. Somerset Reinsurance Company has already begun to build a US based team.

In addition, the ratings reflect Somerset’s predominantly high-credit quality, liquid investment portfolio, strong liquidity profile, strong drivers of profitability, and sound governance structure and risk management framework. At end-2022, 90% of the Somerset’s portfolio was invested in well-diversified, liquid fixed income securities with an average credit quality of A. KBRA views this portion of Somerset’s portfolio as presenting controlled investment risk. The remainder of Somerset’s portfolio is invested in alternative strategies that present elevated investment risk. KBRA views Somerset’s liquidity profile as strong based on its ample cash position and tightly matched asset liability durations. KBRA believes that Somerset Re’s prudent underwriting, disciplined approach to pricing and focus on bi-lateral and diversification opportunities are fundamental to the group’s long-term profitability. KBRA views favorably the group’s focused pursuit of opportunities where it can best utilize its strengths to secure business. KBRA views Somerset’s governance structure and risk management framework as sound and evolving appropriately to keep pace with the group’s growth.

Balancing these strengths are volatile reported results, exposure to financial market event risk and key person risk. For 2022, Somerset reported a net loss of $681 million (2021: $43 million net loss; 2020: $93 million net income) driven by the net change in embedded derivatives in funds withheld. To assess the underlying economics of Somerset’s results, KBRA adjusts reported results to exclude the impact of the net change in embedded derivatives resulting in a net loss of $42 million in 2022 (2021: $44 million net income; 2020: $24 million net income). As the net change in embedded derivatives is unrealized and KBRA expects Somerset to hold the impacted securities until maturity, KBRA believes that viewing results without the reported impact of embedded derivatives is more representative of the group’s earning power. Somerset’s market-neutral, primarily long-short hedge fund strategy managed by an affiliate potentially exposes earnings to volatility and capital to erosion from equity market event risk. This was evident in 2022 when the fund underperformed relative to plan and was the main driver of the adjusted net loss for the year. Success remains highly dependent on the senior management team while the group continues to build bench strength.

Rating Sensitivities

KBRA does not expect positive rating action over the near term. However, the achievement of Somerset’s business plan, further diversification of the group’s liabilities and successful development of its US platform could result in positive rating action over the longer term.

A material adverse change in risk profile, significant decrease in risk-based capitalization, material realized investment losses and elevated leverage could result in a negative rating action.

A full report will soon be available on kbra.com.

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