Weighing in on one of the key points of conflict that pitted American International Group’s Peter Hancock against investor Carl Icahn in recent months, Standard & Poor’s said that not all types of diversification will help an insurer’s ratings.

But for the most part, a diversified risk profile benefits an insurer’s credit quality, the rating agency said in a report published Friday, “To Be or Not To Be Diversified: How Variation In Business Lines Affects Insurers’ Credit.”

The report recounts some of the qualitative benefits used in the business profile analysis of an S&P rating for geographic and product diversification and provides an overview of the quantitative credits for asset and liability diversification in S&P’s insurance risk-based capital model.

While all of this is generally positive, “not all diversification is equal in terms of its potential impact on credit ratings,” the report said. “We may find some forms of diversification to be credit negative,” said S&P Credit Analyst Deep Banerjee in a statement about the report.

A potential credit negative for an insurer’s rating is “a chronically underperforming business segment,” the report said. Another example involves diversifying into a country or business segment with which management is not familiar. This “could, in our view, detract from rather than support credit quality,” the S&P report said.

On the other hand, the report said that in general, S&P believes that “in a stressed environment, insurers [will] benefit from having less correlated risks.”

“For example, we would expect to view an insurer that is concentrated in one small state with a single product line as weaker (from a business profile point of view) than an insurer with global, profitable operations across life and property/casualty businesses.”

AIG has contended that Carl Icahn’s demands for the company to split into three separate P/C, life and mortgage insurance companies (to lose designation as a systematically important financial institution) would, among other things, cause AIG to lose the benefit of a diversification credit that figures into rating agency assessments.

During a third-quarter earnings conference call last year, AIG CEO Peter Hancock said that “rating agencies are the key determinant of how much capital is available for distribution, and they have given AIG significant credit for our scale and diversified business model.”

“Rating agencies have noted the existing diversification benefit from our multiline structure. Thus, we believe that less capital would be available for distribution to shareholders if we separated these businesses.”

The S&P report also noted that while the rating agency generally rates nonoperating holding companies three notches lower than operating company financial strength ratings in the United States, S&P lowers the difference to two notches if the holding company’s earnings streams are very diversified.

With specific reference to the capital model, the S&P report noted that explicit credits for asset and liability diversification are lower than those used by insurers in their internal capital models, reflecting a conservative view of the tail correlations. The report displayed correlation matrices for six groups of P/C business lines, four types of life risks, credits for writing both life and P/C business, and asset risk correlations (between three core investment classes of equities, bonds and real estate).

The report said the amount of benefit or offset in the capital model “can change year over year because interest rates, investment portfolios and business-line compositions are dynamic in nature.”

In addition, the report emphasized that the quantitative diversification benefits and offsets “are only meaningful as components within [S&P’s] capital analysis” and that the capital analysis is just one of the many components in S&P’s rating framework.

It is therefore appropriate to focus “on the final capital redundancy or deficiency derived from comparing the aggregate required capital charges (including any offsets and diversification benefits) to the insurer’s available capital based on our prospective view of capital and earnings during the next two to three years,” the report said. (Editor’s Note: S&P formally introduced a prospective assessment of capital and earnings in the financial risk profile component of its rating methodology in May 2013. See related May 2013 article, “S&P’s New Insurance Criteria Released; Method Would Have Spotted AIG’s Past Problems,” and related podcast, “S&P’s Rodney Clark Explains Prospective Capital And Other Financial Risk Profile Rating Factors.”)

All About Reinsurance

Over at AIG, Hancock and other executives discussed the capital diversification benefit they believe is present in S&P’s capital model and others and how they factor into thinking about selling off pieces of the insurance enterprise. During a Jan. 26, 2016 strategy update presentation, executives showed a slide putting the amount of benefit between AIG’s life and nonlife businesses at somewhere between $5 billion and $10 billion “based on internal estimates, the recent IAIS Insurance Capital Standard field test and S&P’s capital model.”

During the update conference (which took place before AIG nominated a representative of Icahn Management LP to take a seat on the board), Hancock stated: “We are absolutely open to [additional] divestures…even of our largest units. But you don’t make a decision of that scale without thinking very hard about the impact on tax and on our financial strength.

“And if the most recent reserve action says anything, it’s a reminder that we have a very sizable legacy casualty book, which as a standalone monoline business would be harder to capitalize than as part of a diversified group,” Hancock said, referring to the fact that AIG boosted prior-year loss reserves by $3.6 billion pretax at year-end, mainly for the U.S. casualty book ($2.2 billion).

The $5-$10 billion diversification credit estimate prompted an analyst to ask Hancock whether the high range of figures “raises the bar” on the price AIG might be willing to accept in a sale of one of its diversifying units.

Hancock said it absolutely does. “At the end of the day, we’re in the risk business,” and there are three ways that AIG can manage aggregation of risk: through diversification, through reinsurance, or by having a conservative reserve and capital structure.

“We look at the relative cost of those. If you were to divest a major subsidiary that was providing diversification, you would either need to dial up the amount of reinsurance that you buy on the pieces remaining or run it at a much more conservative capital structure. So you’re absolutely right. It raises the bar.”

As to the question of how much it raises the bar, “that’s all about the price of reinsurance,” Hancock stated.

“Given the scale of some of our legacy exposures, for us to reinsure all of our legacy right up to a high attachment point would be pretty costly and would test the capacity of the reinsurers who in many cases have balance sheets much smaller than ours,” he said.

Separately, at least two P/C organizations have recently entered into large reinsurance deals to cover legacy U.S. casualty business.

Last week, Enstar Group Limited announced that a subsidiary would reinsure $1.1 billion of Allianz Re’s legacy U.S. reserves (including workers compensation; construction defect; and asbestos, pollution and toxic tort business originally held by Fireman’s Fund Insurance Co.).

On the same day, IAG announced a reinsurance transaction with Berkshire Hathaway that mitigates both legacy asbestos liabilities (in liability and workers comp lines) as well as adverse development it is experiencing from the February 2011 Canterbury earthquake.