KBRA Upgrades IFSR and Debt Rating of Knighthead Annuity
27 Jul 2023 | New York
KBRA upgrades the insurance financial strength rating (IFSR) to A from A- on Knighthead Annuity & Life Assurance Company (Knighthead Annuity). KBRA also upgrades the debt rating to BBB+ from BBB on Knighthead Annuity’s $50 million prescribed capital notes (subordinate unsecured debt) due December 2042. The Outlook for both ratings is Stable. Knighthead Annuity provides fixed and fixed indexed annuities to an international client base, sold by regulated US and global financial institutions, and reinsures similar liabilities ceded by companies domiciled in the US. The company is domiciled in the Cayman Islands and holds a Class D reinsurer license from the Cayman Islands Monetary Authority.
The upgrades reflect Knighthead Annuity’s significant growth over the past five years as well as its nascent track record in raising both debt and equity capital. While the recent raises were relatively modest, KBRA believes that they demonstrate the company’s ability to access capital and will provide financial flexibility to the company as it executes its long-term growth strategy.
Key Credit Considerations
The ratings reflect Knighthead Annuity’s strong capitalization, conservative leverage metrics, strong liquidity profile, tight ALM, comprehensive risk management framework, seasoned management team, unique position in its chosen market and diversified distribution channels. At end-2022, the company was in full compliance with the capital requirements of its license as well as its internal target. The company has grown capital at a 14.7% CAGR over the past five years. Financial, investment and reserve leverage are all conservative compared to peers. Knighthead Annuity maintains material cash balances on hand and had a liability duration to the end of the initial surrender period of 45 months (2021: 40 months) across its direct business at end-2022. At end-2022, the company’s reinsurance assets were well matched to liabilities with asset convexity exceeding liability convexity by slightly more than three months (2021: slightly more six months). The company has a robust risk management program that is embedded across the organization and that is periodically audited by independent third parties to identify deficiencies and incorporate latest best practices. Management has broad knowledge of annuity products as well as extensive experience in complementary areas of the financial services industry. Staffing has grown to adequately support the company’s growth and to develop appropriate bench strength. While several financial institutions offer various tax neutral structured solutions that have captured a portion of Knighthead Annuity’s market, the company remains the only insurer offering fixed and fixed indexed annuities to non-US taxpayers. The company has successfully closed on several flow reinsurance transactions and has a robust pipeline of future opportunities. Knighthead Annuity maintains distribution partnerships with over seventy financial institutions in the bank and broker-dealer channels, most of which are US-based. Distribution for reinsurance business is both direct through management contacts within the industry and indirect through major reinsurance brokers.
Balancing these strengths are results that can be volatile and concentrated earnings sources. In 2022, Knighthead Annuity reported a $239.3 million net loss for the year (2021: $78.1 million net income). The loss is driven by the US GAAP accounting treatment of reinsurance loss reserves under ASC 825 Fair Value Accounting whereby unrealized fair value changes in the credit risk component of loss reserves is reported separately in other comprehensive income rather than as an offset to the associated current period expense. The company reported $3.7 million total comprehensive income (2021: $80.2 million), driven by lower net investment revenues due to interest rate hikes and significant market volatility during the year. KBRA believes that total comprehensive income is a better proxy than net income for the economic results of the company. Regardless, KBRA expects volatility in year-over-year results due to the company’s investment strategy related to approximately 20% of invested assets and the US GAAP accounting basis that results in earnings fluctuations due to interest rate movements. Knighthead Annuity only writes fixed and fixed indexed annuities which exposes the company to disintermediation risk in a rising interest rate environment. Slightly more than three quarters of the company’s annuity exposure emanates from the US.
KBRA does not expect positive rating action over the near term. However, measured growth in line with growth in capital, consistent internal capital generation and higher capitalization could result in a positive rating action over the longer term.
Material change in risk profile, liability growth that outstrips capital growth, meaningful asset impairments and the departure of key members of the management team could result in a negative rating action.
A full report will soon be available on kbra.com.
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